Small Business

Buying a Franchise with Bad Credit


A microloan could be the answer for borrowers who have been turned down by traditional banks

It's true that it's easier to get a bank loan to buy a franchise than it is to start your own business, but that doesn't mean it's easy—especially if you have less-than-perfect credit. But for potential franchisees who been turned down by traditional banks, a microloan could be the answer.

Microloans are designed for borrowers who would be otherwise "unbankable," with more flexible terms and eligibility requirements than either a conventional bank loan or a 7(a) loan backed by a Small Business Administration (SBA) guaranty. The only catch is that microlenders charge above-market interest rates, typically between 8% and 16%, to compensate for the additional risk involved.

While the $35,000 to $50,000 available through a microlender wouldn't be nearly enough cash to finance a capital-intensive franchise like a hotel or a retail store, it's within reach of the initial investment required for many home-based or service-oriented franchises. To find out more about landing a microloan for a franchise, BusinessWeek.com spoke to Lori Kravets, executive director of the Growth Opportunity Connection in Kansas City, Mo., a nonprofit contractor in the SBA's microloan program that also administers several regional and local loan programs. Edited excerpts of the conversation follow.

Who is a good candidate for a microloan program?

Microloan programs focus on clients that have already been denied by a bank. In our case, it's someone seeking a loan of $50,000 or less (other SBA-backed microloan programs lend amounts up to $35,000). Typically, a good candidate has some technical experience or expertise in the business they want to start, but they've never owned or run a business before. Usually they have what I'd call an average credit score—in the mid 500s or 600s—but not a high credit score.

If they had a credit score over 700, they could probably get a signature loan at the bank. Usually, they have collateral items that banks typically don't want, like restaurant equipment, or it might be a service business that doesn't have a lot of collateral, but they can contribute something to the business in terms of capital—it doesn't have to be very much, a couple thousand. And the last piece of it is that their business idea has validity—they've really researched it.

What about franchises?

Franchises are usually a really good bet, from the perspective that they have a good business plan —they have a history that's somewhat dependable for us to look at. When we think about franchises we usually think about fast-food restaurants, and generally you couldn't start a restaurant for $50,000. However, we have used microlending for franchises like Merry Maids or other service-oriented franchises that are possible to start with less than that.

The SBA does require that franchises be approved, but if it's not already approved, it's a pretty easy process to get them vetted for lending. [See this registry. What we can't do are direct-marketing, pyramid kinds of franchises—so no Amway, no Mary Kay Cosmetics, no Tupperware, or anything like that.

Just how bad can your credit be to be eligible for a microloan? What if you have a previous bankruptcy?

Most banks will not finance you with a bankruptcy at all. They might look at you after seven years, depending on the circumstances. There's a difference between having a bankruptcy because of poor credit-card management and a bankruptcy because of a death or a medical issue or something of that nature. Microloan programs are unique.

We've done loans for people with credit scores in the low 500s, and even high 400s, and we've also done loans with people who have discharged bankruptcies that are at least two years old.

If your credit score is less than 600, you need to be able to explain why it's poor, and it's best to be truthful. If it's poor because you made bad credit decisions, you need to say that. If it's poor because of a bad relationship with a boyfriend or husband, you need to say that. In other words, don't try to hide why, just be straight: Air your dirty laundry. If it's really bad and it's not something can we do in-house, we help find a nonprofit credit collection service that can.

Is it impossible to get a loan without any collateral?

It's harder, but not impossible. If you didn't have a home, we'd probably require you have something of value to pledge as collateral—a car, jewelry, something that's valuable to you. What we would look more closely at is the kind of business you're starting, your experience, and your business's expected cash flow.

Why do most people get turned down for a microloan?

On our side, it's generally a felony or nonpayment of child support, something that throws them completely out of SBA eligibility. Of the 20 loan applications we get per month, 10 of them are completed, four of them are successful, and three of them are denied. Three of those were felons or parolees or were not up on their child support, and three either had inaccuracies on their application, a recent nondischarged bankruptcy, or their idea was too risky.

Miller is a New York-based staff writer covering startups and small business. Miller is a graduate of Brown University.

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