Experts: Cash is harder to get, but options exist

Martin Desmarais of IndUS writes that the franchise industry has typically benefited from downturns because many professionals turn to it for new career options. Industry insiders expect the same to hold true today, but the uniqueness of the credit and loan crisis is having a dramatic impact on franchising financing, which may dampen industry growth.

In a recent online seminar, the International Franchise Association brought together a panel of experts to discuss franchise financing in today’s economy and the message was pretty clear: forget the past; the current downturn is changing all the rules in regards to the franchise industry, particularly in terms of financing. Headquartered in Washington, D.C., the association pledges to protect, enhance and promote the franchise industry. It has a membership of 1,300 franchise systems, 11,000 franchisees and 500 vendors.

Darrell Johnson, president of FRANdata, an Arlington, Va.-based research company that tracks franchise systems and their performance, called what is happening to franchise financing in the current economy “a real paradigm shift.”

According to Johnson, preferred lenders now prefer not to lend, conventional lenders are mostly sidelined, local lenders are taking over from national lenders and credit departments rule the lending process more than anything else.

Banks have changed their approach in lending to franchises, now looking to “not lose money” compared to “make money,” he said.

Overall, Johnson pointed out that the lenders that are available to franchisees now have less experience in franchising, though he said that U.S. Small Business Association lenders have the most money to lend right now and are the best option.

Johnson reflected back on downturns in 2000-2002 and 1990-1992 and the way in which the franchising industry grew right through them. He said he still anticipates the franchise applicant pool expanding as people look for other options. “There is a lot of unemployment going on, so we have to expect a growth in franchise applicants,” he added.

However, because of the paradigm shift in lending, it is not going to be as easy to translate these franchise applicants into franchise locations, according to Johnson. He believes access to capital is going to be the crucial factor for franchise growth now and franchisors are going to have to play a more active role in targeting lenders.

“Franchisors must change the way they help franchisees get financing,” Johnson said.

In addition to Johnson, the panel of franchising financing experts also included: Ron Feldman, chief executive officer of Siegel Financial Group, a Philadelphia-based firm that concentrates on securing financing for business acquisitions and franchise startups and resales from $50,000 to $10 million; and Reginald Heard, president of Bankers One Capital, a Danbury, Conn.-based finance firm that focuses on loans for franchise startups and purchases, independent business acquisitions, hotel financing, commercial real estate transactions, working capital, partner buy-outs, restaurants, as well as gas stations and convenience store deals.

Feldman said there are a number of things that franchisors can do to help their franchisees get access to capital. The first and foremost is to be listed on the SBA franchise registry. According to him, doing this will streamline the process of getting loans and avoid having banks or credit departments delving into a chain’s specifics and Franchise Disclosure Documents.

Banks are now concerned about the amount of time a chain has been franchising, the number of units, training programs, the amount of exits and transfers from the system and the numbers of stores that are shut down. Other areas banks may be interested in include management and performance claims.

“What you need to do is make sure you are presented in the most favorable way to lenders,” he said.

“There is a lot more demand for capital than there is supply right now,” he added. “Any transaction that does not put you in a favorable light … will put you behind the eight ball.”

Feldman also emphasized that franchisors must manage troubled locations and make any effort to keep them from “going dark” and shutting down store locations. This includes transferring the ownership to another franchisee.

“Lenders don’t want to hear the store closed yesterday. That is the worst thing that can happen,” he said. “Talk to lenders as soon as you know there are issues. They can work with you.”

On the franchisee end, Feldman said lenders are looking for good management experience, a consistent credit report, good credit score and a personal income need that is reflective of what a franchise will generate. He said required cash is now hitting 30 percent of a loan and home equity is no longer acceptable without outside income to cover the debt. In addition, he pointed out lenders are looking for additional liquidity, such as living expenses for three-to-six months, so that franchisees do not need to draw a paycheck from startup franchise businesses.

Lenders are also looking for franchisees that are involved with the business. “The banks really want to see franchisees that have skin in the game and are at risk,” Feldman said.

According to Feldman, it is acceptable for franchisors to provide standby financing to get franchisees rolling.

Feldman says all the scrutiny from lenders is just a reflection of the current economic times. “All those issues were not an issue until we had this credit crisis,” he said.

While there used to be many options for national lenders for franchises, Feldman said there is now only one: Wells Fargo & Co. According to him, local lenders are now the way to go. Typically these local lenders will only take part in financing for under $250,000.

Feldman said this change to local lenders is part of the “paradigm shift” that Johnson referred to.

As he explained it, prospective franchisees used to ask franchisors who their local lenders were, now franchisors are asking prospective franchisees about what local lenders they now.

Continuing to compare past to present, Feldman said having a good franchisee and a good franchise concept used to be enough to secure financing, but that is not the reality now and probably never will be again. “What’s happened now is what was a science a year ago is now an art,” he said.

Bankers One Capital’s Heard pointed to the SBA as still a strong avenue to pursue for financing, particularly considering the administration has eliminated borrower fees for the time being. “Borrower fees are on moratorium till the end of the fiscal year,” he said. “That makes SBA loans very attractive to small business owners.”

Still, he also confirms the increased lender scrutiny. “SBA underwriting guidelines are tightening up,” Johnson said. “The emphasis you are seeing today is placed much more on industry experience.”

“You also need to look at a franchisee’s equity,” he added. “The key is to see how deep-pocketed the franchisees are.”

Johnson also looks toward the government to continue to work for business owners and improve the lending atmosphere. “The president is concerned about this and will help this administration understand that access to capital for small businesses is really the lifeblood of our economy,” he said.