What Is a Conventional Loan
A conventional loan is a bank-issued loan not backed by government guarantees like the SBA provides. For franchise buyers, this typically means working directly with commercial banks or credit unions that evaluate your creditworthiness, business plan, and collateral without a third-party guarantee program cushioning the lender's risk.
Banks issuing conventional loans to franchise buyers usually require a FICO score of 680 or higher, though competitive rates typically start at 700+. You'll need to document personal liquidity, often requiring 20 to 30 percent down payment on the total franchise investment, plus demonstrate liquid reserves equal to 6 to 12 months of operating expenses.
How Conventional Loans Differ for Franchises
When evaluating a franchise opportunity, understanding conventional financing matters because your lender will scrutinize the franchisor's Item 19 disclosures in your Franchise Disclosure Document (FDD). Banks want to see historical unit performance data, renewal rates, and franchisor support documented in the FDD before committing capital.
Unlike SBA loans, which have standardized underwriting criteria and are designed specifically for small business purchases, conventional lenders set their own requirements. They may request detailed Item 19 financial performance representations, documentation of franchise territory rights and exclusivity terms, and proof that renewal terms are favorable enough to justify the long-term investment. If your chosen franchise shows weak Item 19 data or concerning franchisor obligation gaps in the FDD, a conventional lender may decline the deal outright.
What Conventional Lenders Look For
- Total franchise investment breakdown: Lenders require itemization of franchise fees, real estate costs, equipment, working capital, and other startup expenses. They compare these against Item 19 financial data to assess viability.
- Franchisor stability and support: Banks review franchisor obligations outlined in the FDD, including training, marketing support, and ongoing assistance. Red flags include franchisors with histories of litigation or weak renewal term provisions.
- Territory rights definition: Clear territorial exclusivity strengthens your loan application. Vague territory rights in the franchise agreement weaken your competitive position and make lenders hesitant.
- Personal credit and business experience: Conventional lenders typically require 2 to 3 years of business management experience and may require a personal guarantee on the loan.
- Collateral availability: Real estate, equipment, and inventory serve as collateral. If the franchise requires mostly intangible assets (brand licensing), securing conventional financing becomes harder.
Advantages and Drawbacks for Franchise Buyers
Advantages: Conventional loans often carry lower interest rates than SBA loans (currently 3 to 8 percent depending on credit and market conditions). Once approved, the process moves faster than SBA underwriting. You maintain direct control over negotiations with your lender.
Drawbacks: Larger down payment requirements strain your working capital reserves. If the franchisor performs poorly, you have no government recourse program. Stricter lender requirements may disqualify you if your credit score is borderline or your franchise choice lacks strong Item 19 data.
Common Questions
- Will my lender require an Item 19 from the FDD? Most conventional lenders will request it or at least ask you to provide it. Strong Item 19 data showing profitability across multiple units accelerates approval. Weak or absent Item 19 disclosures signal higher risk and may result in denial.
- What happens if renewal terms in the franchise agreement are unfavorable? If renewal terms are expensive, limited to one renewal, or require renegotiation at the franchisor's discretion, lenders view the investment as having limited long-term value. This reduces loan amounts offered or increases interest rates.
- Can I use a conventional loan if I don't have 20 percent down? Some lenders offer 10 to 15 percent down programs, but you'll pay higher interest rates and may be required to purchase loan loss insurance. Compare total costs against SBA loan options before deciding.