When it comes to helping franchisees find capital, some franchise companies want to do more than point to a list of approved lenders. In an effort to assist prospective unit owners and to be more competitive in an increasingly crowded franchise world, many franchisors are taking a more active role in financing. Some are lending money to franchisees, guaranteeing loans for them and even signing on as equity partners.
Franchisors say they developed financing programs to make sure franchisees have enough money to buy locations, update their current stores or expand into new markets. These programs can help franchisees avoid much of the hassle of applying for loans from banks, but more importantly, the new partnerships and loan funds can help grow a restaurant chain.
“Franchising thrives when capital flows freely from lenders to qualified franchise borrowers,” said Steve Caldeira, president and chief executive of the International Franchise Association, based in Washington. “While credit has, in fact, eased somewhat over the past year or two, there are still significant gaps to meet the forecasted demand in our industry. In-house financing and custom lending solutions have without question helped to spur much-needed access to capital for qualified prospective franchisees of many brands.”
Of course, “qualified” is the key word here. Just as banks will decline borrowers who likely cannot repay the loan, so will franchisors.
“We have strict criteria,” said Martin O’Dowd, president of the 50-unit Hurricane Grill & Wings. “We look at credit history, credit score and restaurant business experience. We are not just out there throwing money around.”
The West Palm Beach, Fla.-based company partnered with Mount Pleasant Capital in Pittsburgh to develop a $10 million fund to help current qualified franchisees and new franchisees develop units. A franchisee can borrow up to 75 percent of startup costs to build a new unit. For Hurricane Grill & Wings a new unit costs up to $600,000, so the franchisee can borrow up to $450,000. In addition, Hurricane Grill & Wings guarantees 35 percent of the loan.
O’Dowd explained that with this setup the third party acts as fiduciary, and Hurricane Grill & Wings acts as guarantor. The franchisee puts up the restaurant as collateral, and if the franchisee defaults on the loan, Hurricane Grill & Wings has first right to take over the unit.
That hasn’t happened yet, O’Dowd said, noting he is confident that the restaurant company’s selection process is thorough enough that the franchisees are good picks. He also said he expects current franchisees to be more interested in the offer than newcomers.
“We have current franchisees who would like to expand, but they don’t have $600,000 in liquid assets, and they may not be bankable today,” he said. “We are intimately familiar with their financials, so we might be comfortable guaranteeing a loan for them.”
Hurricane Grill & Wings launched the program in late 2012 and in the first three months completed three deals. The company will revisit the program after the first year and decide whether to continue it and how much to put into the fund.
“We are trying to be competitive within the arena in which we play, which is casual dining,” O’Dowd said. “Everyone is playing aggressively.”
Other franchisors agree that bringing some financial services in-house is a way to help the chain grow and to compete.
Jersey Mike’s Subs, based in Manasquan, N.J., plans to build 1,000 stores in the next seven to eight years.
“We realized as we were ramping up that it was going to require $200 million to $250 million in capital from lending institutions,” said Hoyt Jones, president of the 700-unit chain. “We’ve got franchises coming that are fairly well-capitalized, but we also have many that need a little help.”
To get some of this help, three years ago Jersey Mike’s Subs began working with Portsmouth, N.H.-based Direct Capital to offer franchisees loans of $30,000 to $100,000 to update their stores.
“The general rule is: Every seven to eight years, you want to reimage and retrofit your store,” Jones said. “We’ve been growing so quickly, and we wanted every store to have the new look.”
Jersey Mike’s Subs also works with Franchise America Finance, a commercial finance firm that set aside a certain amount of money — Jones declined to specify — for SBA loans and other business loans for franchisees. That partnership began in 2012. The restaurant chain pays the lender a fee for setting aside the capital, and the lender gets qualified, motivated borrowers.
“We do require $100,000 to $125,000 in liquid assets, so we kind of weed a lot of people out of our process just with the upfront requirement of capital,” Jones said.
Also, Jersey Mike’s Subs is very selective, preferring to sign multiunit, multibrand franchisees who have restaurant experience. That selectiveness plus the way the lending program is structured means the lending carries little risk for the franchisor.
“We are not guaranteeing any of the loans,” Jones said. “We are facilitating access to capital.”
Sometimes, access to capital is all a franchisee needs to get started. Toledo, Ohio-based Marco’s Pizza has launched several such programs over the years. In 2007 the company introduced MFS Leasing to lease equipment and lend money to franchisees at an interest rate of 9 percent.
“We had a $3 million loan from a bank to do that,” said Ken Switzer, chief financial officer for the 339-unit Marco’s Pizza. “We borrowed money and lent it back out.”
The spread, or the difference between the interest rate MLS Leasing paid its lender and the higher rate it charged franchisees, helped revenues, but Switzer said the more important goal was to help the franchisees grow the Marco’s Pizza brand.
That was still the goal in 2010 when the company started Marco’s Capital, a fund to help franchisees pay the down payments for a franchise. Through this program Marco’s Capital would become a 19.9-percent partner in the store.
Today, Switzer said, franchisees find their own funding for down payments, which are typically around $30,000, but they still have trouble raising the $250,000 or more that a new store costs to build. So in 2010 Marco’s Pizza started Marco’s Assurance, a captive loan loss guarantee company. The company provides a guarantee to the bank of up to $50,000 per loan.
Switzer said Marco’s Assurance does incur certain risks, just as banks do.
“The bankers know there are three reasons a business can fail: business model, location and management,” he said. “If you can analyze the risks of each of those three areas, you can minimize your risks.
“I know Marco’s Pizza is not a risky concept,” Switzer added. “Marco’s has been successful everywhere. We are in 22 states and the Bahamas.”
Management risk is mitigated with careful selection of franchisees, who are mostly experienced, multiunit operators. Location is tricky because certain factors change over the years. In fact, Marco’s Assurance will help pay to relocate a store that ends up in a bad location, although Switzer added that they’ve never had to do that.
Switzer said Marco’s Pizza has a development pipeline of 1,400 stores, and providing these financing programs can help get many of these stores open. Also, Marco’s Assurance does more than help franchisees with money.
“It communicates to the finance community that we back our people in the event of a problem,” Switzer said.
Caldeira said lending is all about assessing risk.
“Clearly, by utilizing in-house financing, franchisors are taking on more risk than when franchisees obtain financing from a traditional lender. At the same time, they are putting their money where they see growth opportunities,” he said.
He added that setting up these financing programs also sends a message to potential franchisees.
“The franchisors are putting their own skin in the game, which could give prospective franchisees more confidence about investing in the brand,” he said.
Another way to give franchisees more confidence is to invest with them. Last year, Coppell, Texas-based CiCi’s Pizza started its Franchisee Investment Program. A franchisee would pay, for example, $125,000 toward buying a franchise, and the franchisor would contribute $100,000, for a 56-percent to 44-percent split in ownership.
It’s not a loan but an investment, explained Forbes Anderson, chief financial officer for the 500-plus-unit CiCi’s.
“We say, ‘Here’s our money, go build a store,’” Anderson said. Franchisees pay an additional investment-monitoring fee of $250 a month for corporate to review the franchise’s financials. At any time, the franchisee has the right to buy out the franchisor’s share of the unit at the original investment amount.
The goal for the Franchisee Investment Program is to speed up growth of the chain, said Thomas McCord, vice president of franchise development for CiCi’s. If a multiunit operator has the capital to open three new locations, the additional investment from CiCi’s will allow that franchisee to open six, instead.
“They can build out much more quickly in the same period, not stretch it over 10 years,” McCord said. “That’s actually going to position the franchisee better for success.”
Further, if a franchisee expresses interest in an untapped market, the investment can help CiCi’s build a presence in that area quickly.
CiCi’s also offers other programs. Last year, it launched its Patriot Program for qualified, honorably discharged U.S. veterans. The franchisor waives the franchise fee for the first unit and offers a 50-percent royalty-fee reduction.
The programs help the chain grow, but there is also a symbolic aspect.
“It’s a partnership,” McCord said. “We are not just signing a development agreement and collecting their checks. We provide support.”