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Finding the Right Credit Partner

Five years ago there was an abundance of credit, lots of local, regional and national lenders, and enough financially qualified prospects that many franchisors didn’t have to worry too much about finding credit partners. Obviously, today is a different story as the franchise industry, like all businesses, struggles in the Great Recession to obtain the financing necessary to fuel growth. Moreover, the competition is fierce for what loans are available.
According to Franchise America Finance CEO Ron Feldman, CFE, the threshold question in seeking financing is whether system franchisees are profitable. “If they are not, or if the franchisor doesn’t know, the franchisor first has to fix the system,” said Feldman. The next step, according to Feldman, is to “determine where the system fits in the overall lending scheme and where your deals will likely be approved.”
Many franchisors have determined that they are their own best credit partner.

Investments below $150,000 are not generally financed, instead the capital comes from the prospect’s own cash, 401(k) assets and home equity. Franchises that require an initial investment or more than $150,000 are candidates for conventional business or SBA loans. From there, there are two types of lenders: transactional lenders and program lenders. Transactional lenders make individual credit decisions on a case-by-case basis and have no contractual relation with the franchisor. Some transactional lenders are national banks and we have seen a growth in regional and local community banking.
Franchisors should cultivate these transactional lenders and educate them on the system so that these lenders become potential partners going forward, willing to write more loans to system franchisees. Marco’s Franchising Vice President and Chief Financial Officer Ken Switzer said, “It’s important to find a credit partner who will take the time to learn and understand your business so you don’t need to start at square one on every new loan.”

Making an Item 19 in Your FDD
Whether it’s a one-off loan transaction or an effort to cultivate a lending relationship, to better assist the franchisee’s lending prospects in the transactional lending world, it is critical that the franchisor make an Item 19 Financial Performance Representation in its Franchise Disclosure Document. Often the FDD and its Item 19 are a lender’s primary source of information on a privately held franchisor and the financial performance of its franchisees. Unlike a prospective franchisee, it’s a near certainty that bank loan officers aren’t going to be calling other franchisees in the system to ask about their financial results. Thus, an Item 19 that shows that system franchisees make money is critical. In a competitive lending market, it is a wonder how any franchisor can secure financing for its franchisees without an Item 19. In addition, Feldman recommends that franchisors obtain a bank credit report, prepared by FRANdata, which provides franchise system metrics in “bankers speak.”
Program lending, on the other hand, differs from transactional lending because rather than analyzing each deal as a one-off transaction as they come off the street, the program lender has a structured program in which it lends to a member franchisor’s qualified franchisees. Program lending is generally open to mature franchisors with a history of success. Franchise American Finance is one such program lender, partnered with Bancorp Bank, which offers national franchise lending to 30 seasoned franchisors with strong system and unit metrics and with a proven franchisee selection process. To qualify, a franchisor must have 50 units open for five years and have a minimum loan size of $150,000 a unit. According to Feldman, once the brand passes the hurdle of getting into the program, FAF works with the franchisor to identify what the standards for credit approval will be in each system. “As long as the prospective franchisee meets that criteria, and it fleshes out in the full underwriting process, the franchisee will get the loan,” said Feldman.
The costs associated with program lending vary, are based on the franchisor’s track record, and are borne by the franchisor, franchisee or both. There are almost always upfront fees and other credit enhancements in which franchisors agree to guaranty each loan, fund a percentage of loss in the event of a franchisee default or re-market, or take back defaulting units as part of the program. According to Mount Pleasant Capital Corp. President Bob Rodi, sharing some of the risk “enables franchisors to expand their market presence and increase franchise sales for deals that a transactional lender would not approve on its own.” In fact, program lending seems to be taking off as of the writing of this article, as Mount Pleasant Capital announced a new franchise finance program along with its partner, Franchise Credit, LLC, in which it will underwrite, fund and manage franchise transactions in the $100,000 to $5,000,000 dollar range with a focus on non-real estate, multi-unit operators. Similarly, Denny’s just announced a national lending program brokered by Pinnacle Commercial Capital, which in turn is working with BancAlliance, to provide up to $100 million in loans for new Denny’s restaurant units; however Denny’s will provide operating loss support if a franchisee defaults for up to the lesser of $12 million or 12 percent of the outstanding loan.

Serving as Their Own Best Credit Partners
Indeed, many franchisors have determined that they are their own best credit partner and are offering credit enhancements, loan guarantees, captive financing programs or operating lease programs for real estate, furniture, fixtures and or equipment. This isn’t a new phenomenon and there are plenty of examples of systems that have thrived on these techniques long before the economic downturn. And while some programs are specifically targeted to less financially qualified individuals, most exist to accomplish other business purposes, such as re-franchising company-owned units, reopening a franchisor’s or a former competitor’s closed units, entering into new markets or more desirable real estate or merely attracting the best operators irrespective of cash or credit. Very few are designed to give people with no experience or bad credit free money or a free franchise; all are strategies to finance or reduce the initial investment or to give the lender some defined recourse against the franchisor. In our experience, franchisors close a unit they have guaranteed or to which they have given a credit enhancement only as a last resort.
In 2009, Marco’s Pizza launched several innovative financing opportunities for its franchisees including the creation of an affiliate, Marco’s Assurance, to offer a qualified franchisee’s lender a credit enhancement in the nature of a limited guaranty to supplement the SBA’s guaranty. To create a pool of funds that could be offered to lenders as a credit enhancement, Marco’s Franchising defers a portion of its franchise fee and royalty fee into an escrow account held by Marco’s Assurance to cover guarantees made by Marco’s Assurance. Marco’s believes that the existence of this program has also generated new financing from third-party sources. “Marco’s Assurance is evidence that we back our franchisees with more than just support, we put our money behind them,” said Switzer.
Similarly, The Dwyer Group’s franchisor brands offer qualified franchisees financing of up to 80 percent of the initial franchise fee. “Because our franchisees don’t normally have a lot of fixed assets or equipment to offer as security, loan terms offered by traditional lenders weren’t necessarily attractive,” said The Dwyer Group Chief Financial Officer Tom Buckley. “We found that we were our own best credit partner and by being in control, are able to work with our franchisees in ways that a third-party creditor would not.” Another benefit notes Buckley, is that interest in The Dwyer Group’s brands did not wane during the recent economic downturn. “By offering our own financing, we have been able to keep up our traditional growth rates despite the general difficulty in the credit markets.”
Other franchise systems have made it easier for prospective franchises with operating experience to partner with investors who will bring the money to the project. Jersey Mike’s Subs has experienced strong growth over the last few years in the face of the credit crisis. “One factor in our recent growth has been the flexibility afforded our franchise owners in structuring the ownership of their franchise agreements,” said Jersey Mike’s Subs Chief Development Officer John Teza. “We have avoided heavy-handed managing owner and capital to equity ratio requirements. In doing so, we have encouraged highly qualified operators to partner with highly motivated investors to the benefit of parties and to the growth of our brand.”
Finally, many franchisors are also looking to their supply chain partners as sources of franchisee financing for certain equipment to lower the initial investment. For example, several franchisors have entered into agreements with vehicle manufacturers, like Ford and Chrysler, to specially fit-out and finance vehicles used by system franchisees. Likewise, many franchisors have arranged sweet-heart leasing deals for their franchisees for certain equipment with vendors by agreeing to remarket the equipment or pay a percentage of losses. Further, in today’s real estate market, an ideal credit partner may be the franchisee’s landlord, who is financing more of the fit-out and undertaking more of the risk through lower base rents with a higher percentage rent.
In today’s economy, it will be every franchisor’s challenge to assist their franchisees in gaining access to credit. Whether or not a franchisor is a candidate for program lending, all franchisors are well served by originating new lending sources which understand and appreciate the business metrics. Access to credit is what will distinguish successful franchisors in the future. 

Lane Fisher, CFE, is a partner of the full-service law firm FisherZucker LLC. Fisher is a member of the IFA Board of Directors and has served as chairman of the Legal Symposium Task Force and Supplier Forum. He can be reached at the Philadelphia office at 215-825-3131 or lfisher@fisherzucker.com.

Fisher will moderate the concurrent session “Chemistry and Alchemy: Finding the Right Credit Partner and Creating Your Own Financing” on May 21 and May 22 during the IFA Legal Symposium in Washington, D.C. Find the full program brochure at www.franchise.org under the “Events” tab.

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