SBA franchise loan rules

When you're starting a business from scratch, the owners must supply at least 10% of the full project cost themselves, according to the SBA's lender rules. Lenders call this the equity injection. It simply means cash you contribute rather than borrow.

Buying a business that's already running follows the same 10% rule, in what the SBA terms an initial acquisition. Should that route sound right for you, see buying an existing franchise.

Since 10% is the minimum, your cash sets the upper limit on project size. Here's what different savings amounts can support when owners put in exactly 10%:

• With $50,000 in savings, you can take on a project of up to $500,000, which means borrowing $450,000.
• With $100,000, the ceiling rises to a $1,000,000 project and a $900,000 loan.
• With $250,000, you could fund a $2,500,000 project by borrowing $2,250,000.
• With $500,000, a $5,000,000 project is within reach, with a $4,500,000 loan.

Project cost means the full expense of opening, not only the franchise fee. To check how each brand compares with the cash you have, visit franchise financing.

The most a 7(a) loan can be is $5 million. When a brand's opening cost runs past $5 million plus your own contribution, one 7(a) loan won't stretch far enough.

The interest rate is something you negotiate with your lender, though the SBA sets a maximum for variable-rate 7(a) loans. The maximum is tied to either the prime rate or the SBA's optional peg rate, plus an added amount that cannot exceed the limit shown for your loan size. You'll find the caps on the SBA's lender page.

The caps work like this:

• Loans of $50,000 or less can go as high as the base rate plus 6.5%.
• Loans from $50,001 up to $250,000 are capped at the base rate plus 6.0%.
• Loans from $250,001 up to $350,000 are capped at the base rate plus 4.5%.
• Any loan above $350,000 is capped at the base rate plus 3.0%.

Think of these as ceilings rather than your actual rate. Since the rate is negotiated, your offer could come in under the cap.

The SBA keeps a Franchise Directory, and lenders use it to check whether a brand is eligible for SBA-backed financing (see the SBA's guidance for lenders). Ask your lender early whether the brand you're considering is on it.

FDD stands for Franchise Disclosure Document. It's the paperwork a brand has to hand you at least 14 calendar days ahead of any signing or payment. Two sections matter most when you're working out a loan, and the full document is explained at franchise disclosure document.

Item 7, the cost to open, lays out the brand's estimate of everything it takes to get going. The law requires it to include extra funds covering a startup stretch of at least 3 months, which makes the total a good starting point for your project cost. FDD Item 7 walks you through every line.

Item 10 shows any financing the brand offers directly, under the federal franchise rule. Reading it alongside a lender's offer lets you compare both options. If you want to line up two or three brands' opening costs, try franchise cost comparison.

Not necessarily. The Federal Trade Commission points out that a bank saying yes to your loan is no guarantee the franchise is a safe investment. Approval is about the loan, not about how well the business will do.

To judge the business itself, check any sales or earnings figures the brand shares (Item 19), covered at FDD Item 19, plus the roster of outlets and their owners (Item 20), covered at FDD Item 20. And if you'd like a second set of eyes on the contract before you sign, a franchise lawyer can review it with you.