Large institutions are rarely funding anything these days but the largest restaurant chains. That leaves regional banks to do the lending for mid- to smaller-sized chains in need. The problem is, most regional banks don't know how to spell the word "franchise," industry execs joke.
Part of the challenge is a perception issue, said Marco's Pizza CFO Ken Switzer. He had been speaking at a conference on franchising last February in San Antonio, and was approached by a skittish lender afterward. The lender told him that he was wary of lending to pizza chains because he had a bad experience with a national concept whose leadership regarded franchisee failures as the bank's problem. "I have a hard time getting a Marco's program through my credit committee now because of that," the banker said.
Switzer asked him, "Did you ever have a bad dinner? And do you still go out to eat?"
Indeed, not all franchises are created equal. In fact, the ones getting funding right now are those who proactively engage with lenders to show their financial support of franchisees. Switzer's company is doing that with the new Marco's Assurance Program that debuted last summer. It's one of the most revered franchisor-backed funding initiatives in the pizza industry.
The plan just makes good business sense.
"If the bankers didn't require (some guaranteed monetary franchise support) tomorrow, they'd still give us better terms, better interest rates and longer term amortization because of it," Switzer said.
So how does that guarantee work, exactly?
New law No. 1: Ensure your franchisees' success
Marco's has been on a roll, having opened around 50 stores the past two years with plans for 60 more for 2010.
The momentum is reaching breakneck speed, requiring more than just private investment to fund new stores. Switzer said they have already received deposits to build about 1,000 stores in the next 5–10 years. "We have a tremendous need for capital because of that planned growth," he said.
The company is set to secure a new loan program in the next couple of weeks to help. It's brokered through a regional bank, which will provide funding for new franchisees' with the Marco's Assurance backing.
How did they squeeze capital out of fruitless money tree? Switzer primarily credits the company's Assurance Program with assuring lenders of reduced risk. Marco's introduced the program to help fund franchisees last July. Switzer helped engineer the private equity fund that guarantees up to $50,000 on a loan per store and up to $100,000 for funding relocation. And he says any pizza chain with an upstanding history can put a similar program in place – with a few caveats.
"First you have to have great unit economics. And a low failure rate," he said. "Because if you have a high failure rate, you're going to pay more out paying off bank loans than you're bringing in in income." A great track record also is a must, he said.
New law No. 2: Do your due diligence
Of course, no single component will guarantee a big bank loan, but another apparent "must" in the current lending era is a credit worthiness report from a third-party source. Marco's executives got theirs done by FRANdata, whose Bank Credit Report costs $3,000 to commission – but was worth every penny, Switzer said.
FRANdata president Darrell Johnson said the reports assess a company as a credit department. When companies have flagged or negative issues in such reports, they have the option to file explanations.
"We'll allow them to put a letter from management that allows us to address the risk," Johnson said. "It might say, â€˜We know that happened, here's why it happened, etc.'"
John Hayes, franchise financing expert and author of "Help Your Banker Say Yes!," said such reports are becoming musts for regional banks, most of which are totally new to the franchising world and its risks.
"The first thing the banker's going to say to himself is, â€˜We don't know anything about franchising; we'd have to go learn all about it. So, who is willing to take 10 days to study franchising and this chain for a possible $400,000 loan instead of a $4 million real estate deal?' You have to walk in with a due diligence report already."
New law No. 3: It's all about the relationships
Hayes also acknowledged the need for franchisors to establish working relationships with banks – something that simply didn't happen at the national lender level.
"So franchisors are having to get with local banks to literally show that they'll stand behind the franchisees, so they'll be able to collect the money," Hayes said. "The bank would never hear from the franchisor before.
"Also franchises (could) become customers of a bank. So if you can invest $25,000 in a CD, that makes a difference – you're not just looking for a bank that will give loans."
Making things more personal can pay off on several levels: Stevi B's president Matthew Loney said the gourmet pizza buffet chain is testing a program similar to Marco's Assurance at the corporate level. The "Manager Own It" program uses performance incentives to offer managers $100,000 to own their own stores. But more than being a measure to attract lenders in the future, Loney said these kinds of programs work for the company's morale and makeup, securing the best franchisees possible.
"It's a way of capturing good talent right now, and finding someone who's really looking at this as a career instead of just kind of as a job."
And that always helps expansion.
*Flickr photo by TW Collins