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Follow These 6 Tips For Better Franchisee Financing

[ 0 ] Jul. 11, 2011 | SBO Editor

As president of National Restaurant Development Inc., a board member for the International Franchise Association, and owner of more than 50 quick-serve restaurants, Aziz Hashim is a veteran of the franchise business.

With brands like Popeyes, Checkers/Rally’s, Subway, and Moe’s Southwest Grill under his watch, Hashim has the know-how to obtain the finances needed for developing restaurants.

In today’s post-recession lending market, he explains the creative steps franchisees can take to get the funds they need for development.

1. Understand the costs and capital structure of your brand.

The foundation and perhaps the most important thing to do before the lending process is make sure you’ve read the [Franchise Disclosure Document]. Young franchisees will often skip this step because of its length, but it is the most important document for the future of your units. I’m surprised at how few phone calls I get regarding the FDD, and what that tells me is that people aren’t reading, and I imagine their business is struggling because of it. Read and reach out for support; you’ll be surprised how much help you get.

Once you’ve made the right brand choice, you need to understand the capital structure for your brand and, again, this is different for each brand. Capital structure for an in-line modality brand is different than a brand that requires a freestanding building and land ownership with construction afterward.

You have to have the equity to claim. There’s not a lot of 5–10-percent-down equity levels out there anymore. To be safe, you should have around 20–30 percent equity ready to get the financing you need.

2. Choose a bank that is right for your needs.

Next is the question of whether or not to go with a local or national bank. With the capital structure in mind, you can choose the right bank to get your money. Most of the time, if there is real estate involved, go with a local bank. These banks have a better understanding of the land and costs around local real estate than the national bank chains.

If your brand is a large company and requires you to get a large loan, national brands are the way to go. Most local banks are not cash-cow lenders. They can handle the real estate, but don’t have the company structure to handle that big of a loan. National chains have better cash flow and can develop a relationship with the franchisor. Typically, national banks are more comfortable with the bandwidth of the loan and can work with both the franchisee and franchisor.

3. Take your time on the loan application.

When you finally get the application from the bank, look over it carefully. Banks don’t counter-offer the way you want them to. They are very quick to reject, and it’s up to you to prove that you’re worth it. Good people in your corner can help and advise you during this process. However, if you pres ent a business proposal that anticipates growth and calculates downside risk management, the bank is more apt to invest in you. If you don’t have these in order, it weakens your application and gives the impression that you don’t have the proper mindset to run a business.

4. Save money with any line item you can.

After this process, look at your proposal and find ways to save money. Every single line item has a potential financing source. Maybe you can go to the equipment vendor and get some leasing options that work for your budget. Perhaps the franchisor can waive the franchisee fee. A lot of franchisees look at the total project cost and go to one or two banks expecting to get that money. Today, especially with the economic changes in the past two years, you won’t get the loan you need with this strategy.

5. Keep your balance sheet in order to keep the bank happy.

Once you have the money, consistently make sure your balance sheet is in order. If you’re not sure, put it up against that wall and determine if it is in compliance with covenant tests that banks will put you through.

Typically, there are two formulaic tests the banks will run: debt service coverage ratio, which is the primary measure to determine if the property will be able to sustain its debt based on cash flow; and fixed charge coverage ratio, which is the ability to satisfy fixed financing expenses, such as interest and leases.

When you know the results of these formulas for your units, you can repair it. Maybe you need to inject more equity or possibly close or sell a unit to maintain a positive pulse. When the balance sheet is in order, your business will endure a healthy growth.

6. Think ahead and factor in possible margin pressures.

It doesn’t stop there, though; franchisees need to constantly secure their money and investment. Some market changes, especially those that come from the legislative end, can drastically affect business. What happens when costs go up and you can’t pass it on? Moreover, charging the customer more can’t always solve rising costs for you. The best tactic would be to run a classic margin squeeze.

The franchisor is doing the same thing to make sure their brand endures the changes. If you factor in margin compressions, you can conduct the business in a smart way. If I know my margin is going down, I’ll be more reluctant to pay for some new property or purchase a new dining room for a unit. Always make sure you have enough cushion to withstand not just economic hardship, but governmental mandate.

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Category: Features