Published: January 31, 2011
If you only read the business pages, 2010 might look like a bullish year for franchise finance. Private equity funds are snapping up restaurant concepts and big lenders are back to inking deals.
Talk to restaurant entrepreneurs, though, and you find a great divide. The deals are mostly for chains with more than 500 units.
For little guys, credit is still crunched. In a January survey by the International Franchise Association, 32 percent reported that more than half their franchisees were unable to get financing. For 87 percent, the credit shortage was limiting their ability to expand.
“What I’m seeing right now is a dichotomy between the haves and the have-nots,” says investment banker Rod Guinn of FocalPoint in Albuquerque, New Mexico. “Many lenders will tell you they will look at those smaller deals, but they’re not going to do them.”
But the entrepreneurs below are expanding anyway. They’re pioneering new sources of finance, with the help of some new financiers, who realize something the big lenders have forgotten: A well-run restaurant chain can be a solid investment, in any economy.
How much is that pizza oven in the window?
Straw Hat Pizza,
San Ramon, California, 76 Units
Three years ago, just after Straw Hat had hired a new CEO and launched a major expansion, Bank of America canceled its credit. Incoming CEO Jonathan Fornacci asked a hard question: How much should it cost to open a restaurant?
Back then, a new restaurant required at least $200,000 in up-front investment. Today, most Straw Hat Restaurants come in under $100,000, which most franchisees can pay from their pockets.
His biggest trick is to fill new restaurants with lightly used equipment. Pizza ovens and Hobart mixers can last decades, and these days there are plenty to be scavenged from closed eateries. Instead of spending $25,000 on a new oven, he can buy two at auction for $8,000. He buys many pieces through resellers, who offer guarantees, and some off Craigslist.
“I tell the franchisee he can make his entire cash investment back in eight to 18 months,” says Fornacci. “If we made people spend lots of money, the average return on investment would take five years.”
Smoothing the way with private equity
Tropical Smoothie Café
Destin, Florida, 275 Units
Before the credit freeze, this QSR chain tried to speed its growth by signing up area developers. Afterwards, several no longer had the money to develop their territories. If president Jim Valentino wanted to keep opening 28 restaurants a year, he needed to buy back some turf and sell franchises directly.
Enter Atlanta consultant Scott Pressly. A private equity veteran from the Roark Capital Group, he started providing strategic advice and ended up investing. His BIP Opportunities Fund put in $4.4 million.
Some of his investment goes to buy out selected area developers. The rest bulks up the chain’s staff, like hiring a new head of franchise development, a CFO and three regional support managers. “Five years ago, equity funding provided liquidity,” says Pressly. “Today, it’s targeted: infrastructure, support and marketing.”
As a minority shareholder, Pressly focuses on hooking up franchisees with local and regional banks. Meanwhile, with $30 million in his fund, he and two partners are looking at two more restaurant deals.
Loan guarantees, hold the anchovies
One of the great victims of our economic turbulence has been access to capital for small businesses. While there are some signs that the markets are becoming more accessible, the last few years have stretched franchisees’ creativity and patience when seeking capital.
When the flow of capital virtually shut down overnight, IHOP franchisees developing restaurants, like other franchisees, had to think differently. They had experience, proven financial success and a business plan for the new restaurant, but for many of the traditional capital providers this was no longer enough. With IHOP opening 60 to 70 franchise-developed restaurants each of the last several years, capital was critical for franchisees to achieve their development commitments.
To combat this, franchisees turned to their local banks or build-to-suits, in place of many national lenders. In general, they were welcomed and found their requests better received at local lending institutions and landlords. Not only did this franchisor and franchisee creativity and flexibility allow franchisees to receive the capital needed for the current project, they enhanced existing relationships and formed new relationships that should prove beneficial for years to come.
Toledo, Ohio, 208 Units
Marco’s financing options are as varied as the toppings on a pie. They started last year, when several owners committed $500,000 to an in-house equity fund. The fund took minority stakes in new restaurants, to help franchisees meet 50 percent equity requirements for getting loans.
It turned out that most franchisees were leery of sharing ownership, drawing only $290,000 from the fund. So CFO Ken Switzer devised three new programs. Two banks will lease franchisees up to $200,000 per restaurant, both for equipment and for capital improvements. Marco’s also diverts a portion of royalty payments into an escrow fund, dubbed Marco’s Assurance, which guarantees 20 percent of a loan or lease and pays up to $50,000 to relocate a restaurant.
Of 23 restaurants opened in the first half of 2010, nine used one of the programs. That record helped bring a third bank on board, offering up to $7.5 million in loans. Says Switzer, “What I hear from banks is that it’s unusual to find franchisors who are willing to go the extra mile for their franchisees. They’re saying, ‘Here’s a franchisor who’s not going to stick me with all the problems.’”
Parasole Restaurant Holdings
Edina, Minnesota, 15 Units
If you’re developing 11 distinct concepts around the Twin Cities, you need someone who knows where the money is. Someone like CEO Dennis Monroe, a longtime franchise attorney. “We’ll do anything we can do to get it done,” he says. “If I wasn’t well connected, it would be impossible.”
Monroe’s latest brainstorm is going into business with his landlords. His $2 million Mozza Mia is a joint venture with property owner Lund Food Holdings. Lund finances buildout, while an affiliate puts up 40 percent of equipment and working capital and gets 40 percent of the profits. A second new store, a Manny’s Steakhouse, is a joint venture with developer Ralph Burnett.
Putting the business back in small business loans
Franchise America Finance
Throughout the Great Recession, one out of every nine Small Business Administration loans have gone to foodservice. The trouble is that the spigot keeps turning on and off. Congressional incentives for more generous loan terms have expired four times in two years.
Ron Feldman of Franchise America Finance had an idea for making the process more reliable: pre-qualify top-notch chains for franchise loans. After talking to 41 banks, he partnered in
April with SBA lender The Bancorp Bank. FAF will pick up to 30 chains that meet stringent criteria, like keeping at least 50 units open for three years, with failure rates under 5 percent. In return, their franchisees will get near-automatic approvals, says Feldman. “As candidates come through the door, if they fall into the box we’ve agreed to, their financing is going to be approved.”
So far, a dozen systems are in the underwriting process, half of them restaurants. His borrowers will get a big boost from the new Small Business Jobs Act of 2010. It raises maximum loan amounts from $2 million to $5 million and makes the raise permanent.