by Nancy Rathbun Scott
If you're going to buy a franchise, you can expect to tap into personal assetsavings, stocks, IRAs, personal propertyfor about a third of the cost, according to the International Franchise Association. The remaining two-thirds will likely come from banks, specialized lenders, or the franchisor. But just how hard is it to find this extra two-thirds? Four primary sources comprise the lion's share of franchise loans, according to Mark Bucher, director of operations at FRANDATA. This company, which specializes in providing financing and other insider data to the industry and government, says prospective franchise owners should look for financing from the franchisors themselves; from affiliated financing companies in which a franchisor has an equity interest; from third-party lenders who have a contractual relationship with the franchisor; and from independent lenders. From these sources, franchise owners can obtain financing for everything, including the initial franchise fee, acquisition, construction, equipment and inventory, accounts receivable, leasehold improvements and sale/leaseback arrangements.
The Franchisor
Prospective franchise owners who are eyeing a particular franchise shouldn't necessarily be daunted by a high price tag. Buyers with good credit, good prospects, and their own capital to invest may find franchisors willing to help. Take Moto Photo, for example. Michael Adler, chairman and CEO of the 15-year old franchise, has been wrestling with the economics of his burgeoning system. One barrier, he says, has been the $300,000-plus price tag. Coupled with the fact that some stores won't become profitable until the third year of operation, high debt service on a mortgage can create a hefty cash flow burden for a fledgling owner. "We realized that we needed to grow faster and we've spent a lot of time worrying about our franchisees. What made sense was a quick-start program that would bring down the barrier in the first couple of years." The solution was a Moto Photo program that lets a franchisee buy a store for just $75,000. "It made sense to partner with our franchisees to develop a program that's a lot more palatable than the typical five-year mortgagea program whereby we lease the facility to the franchisee for a percentage of sales. The franchisee pays us on a monthly basis. If the store does poor volume, they pay less. As the store goes along, they pay more. Meanwhile, wethe companypay a traditional kind of long-term loan to a bank with easier payments, so all the contributions from the franchisees go to service the debt. That means franchisees have no obligation on basic debt. It there's an excess of money to pay basic debt, it gets split among the players." Despite Moto Photo's eagerness to help new franchise owners get off the starting block, Adler points out that the program is not for people without financial resources. "Most of our franchisees are in their 40s and have accumulated net worth." Franchisor assistance is available for other categories of buyers, too. Investors willing to locate in "enterprise zones," for example, will find franchisors like Athlete's Foot or Blimpie's eager to help. Such zones, established by the federal government in cooperation with the business community, are designed to jump start economic activity in neglected inner city areas. Through a combination of capital infusion, tax incentives and technical advice, these areas represent an exciting initiative. At Blimpie's, the company intends to award up to 200 units nationwide, with no franchise fee. Furthermore, they intend to award an additional 300 units at fees that are substantially reduced from those normally required. Current franchise owners with a proven track record also commonly get a break from the franchisor when they want to buy additional units. Other franchisors will even help employees move into ownership. "At Lawn Doctor, if an employee works for a franchise owner for five years or more and receives a letter of recommendation, we offer them a discount program equal to the multiple ownership program. It costs about half what it would be for a conventional franchise," says the Russell Frith, chairman and CEO, of the well-established lawn care franchise.
Third party lenders
When choosing a franchise to buy, it pays a prospective owner to select a franchise company approved by the Franchise Mortgage Acceptance Corporation. FMAC is a major securitized lender to franchisees. "We will do $2.2 billion in loans this year," says Wayne "Buz" Knyal, FMAC's president and CEO. Knyal says FMAC borrows money from a bank, makes loans to franchisees, and then bundles all those loans into a security that sells on Wall Street to replenish FMAC's money. "We take the money back from Wall Street, pay off the banks, make a little in the meantime, and start the process all over again." Bundles go to Wall Street four to six times a year and don't seem to be affected by recent stock market jitters. "Right in the teeth of the worst stock and bond turmoil, we securitized $375 million worth of franchise loans," says Knyal. "Bond buyers are still comfortable with the credit risk that loans to small business people present." Clearly, prospective franchise buyers are apt to benefit from FMAC's judgment on credit-worthy chains. "Our assessments are based on a franchise company's financial statements and franchise offering circulars, research by our professional staff, and our view of the viability of that brand over time," Knyal says. Once a franchise company qualifies as an FMAC approved brand, its franchisees are eligible to tap into this long-armed source for long-term loans. "There are over 100 approved brands," Knyal says, and they are taking on newer franchise companies as well. FMAC's senior vice president John Rinaldi confirms that a franchisee that works with a securitized lender has greater access to capital. Although FMAC typically lends to existing franchise owners looking to build more units, FMAC does make loans to first-time franchise owners, particularly when the franchisor is willing to guarantee some portion of the loan. Rather than merely evaluating assets, FMAC bases its loans on the business value, focusing on unit- and corporate-level cash flows as the primary criteria for evaluating a prospective borrower's loan application.
Independent Lenders
A franchise buyer seeking a loan from an independent lender can now benefit from SBA's new Central Franchise Registry. The Registry streamlines SBA's review process and changes the way franchise borrowers can qualify for an SBA loan guarantee. "Once a franchise system is on the SBA franchise registry, lending institutions are on notice that its franchisees are eligible for SBA loan guarantees," says FRANDATA's Bucher. "Now a franchisee can walk into a bank, identify the franchise, and the bank loan officer can determine eligibility for SBA loan guarantees just by checking the online SBA franchise registry. If the franchise system is on the registry, it's slam-bam; they go right through. It's a credit deal on the franchisee and they are done. A loan can be turned around in that first meeting, if the franchisee meets the bank's normal credit criteria." On the other hand, if the franchise system is not on the register, a franchisee can face a very difficult and time consuming process to obtain SBA loan guarantees. Fortunately, the process of franchisor registration is fairly simple. "Log into www.franchiseregistry.com. It's an SBA site where franchisors can register online. The company has to answer 22 questions and meet certain eligibility guidelines, but the goal is to make everyone eligible, so, if there is a problem, SBA works with the franchisor to get them eligible." Since June 1, when SBA started the procedure, 65 applications have been approved and another 110 are in progress. Bruce J. Major, vice president for franchise development at Sandella, says his new company was one of the first 25 franchises to sign onto the registry. "This really short-cuts the time that it takes our franchisees to get a loan. In addition, the SBA loan limit will be going up from a maximum of $100,000 to $150,000." For a growth-minded franchisor like Sandella'swhich hopes to put 500 of its light-fare, health-food restaurants on the map by year's endfast can never be too fast.
Loan consultants
For the most part, franchisors are prepared to help new owners package loan documents, identify lenders, and make loan applications. But suppose a prospective owner wants general advice about the prospect of obtaining a loan: am I credit worthy, how much might I be able to borrow, or how do this particular franchisor's financial statements look? In such cases, a loan consultant can help. "Ultimately, a lending institution is going to make the decision on the strength of the buyer, not the franchisorwhich means the buyer has to maintain or walk into the loan with good credit, the ability to put cash into the loan, and show they are capable of operating their own business through some personal qualities or track record," says Stephen Weeks, president of The Loan Consultants, Inc., a professional loan consultant/brokerage business with 900 affiliates in the U.S. and Canada. Weekswhose own company and affiliates counsel people seeking start-up financing every daysays, "The more eyes you have on a financial transaction, the better off you are." "We tell our people to verify everything when they interview prospective loan clients." They examine a franchisor's financial statements, their uniform offering circular, and even interview the franchisor to find out particular information. "Say the franchisee is being offered a new market. We want to know the risk and the opportunity involvedthings that you really can't see on paper." Loan consultants, with their knowledge of finance, are in a position to give would-be borrowers a candid evaluation of their prospects. Borrowers benefit from the eagle-eye of a loan consultant who is astute at reading a UFOC and evaluating financial statements. A consultant also may be able to look beyond what a normal borrower might see. "Just by reviewing the borrower's personal financial statements and resume, you can tell about 90 percent of the time whether you have a loan or not. It's the best protection for the borrower because the worst thing we can do is have a borrower get in over his head and find out he is in trouble."
What's New At the Money Table
by Nancy Rathbun Scott
Mark Bucher, director of operations at Washington, D.C.-based FRANDATA Corporation says two big developments have hit franchising in the past few months. "The biggest change in franchise finance over the last six months is securitization," says Bucher. Fannie Mae has been buying and bundling home mortgages into securities that sell on Wall Street for years. Now third party lenders like FMAC are pooling franchise loans into securities in the same way. They have standardized the franchise loan process by conforming the forms, applications, and contracts, just like in the home loan market. "It gives FMAC more money to make more loans and they cut all their risk by cashing out through the sale of securities." All that adds up to more loan money available, faster than ever, for franchise owners. The next biggest news is that the SBA has changed the way they lend to franchise systems. "In the past, the SBA had 69 regional officesall operating independently like a herd of catsevaluating franchise systems and issuing contradictory judgments in approving or disapproving franchise loans. A government commission wiped out the whole deal and, as of June 1, set up the SBA Central Franchise Registry of franchise systems eligible for SBA loan guarantees." With an SBA loan guarantee of up to 85 percent, banks are more willing to risk franchise loans. "A franchisee can walk into his bank andif his franchise company is on the registrythe loan can be turned around in that first meeting." Prospective franchise buyers looking to evaluate their financing options will soon be able to consult FRANDATA's "Guide to Franchise Finance," an unbiased, independent evaluation of franchise financing. "We are tracking three different variableswhich financial institutions make loans to the franchise community; what types of loans they makeequipment, real estate, inventory; and at what rates and terms." FRANDATA also is looking at which franchisors offer direct or indirect financing to their franchisees, what they finance, at what rates and terms, and through whoma handy comparison for prospective franchise buyers. "The Guide will be cross referenced by categories like equipment financing, so you can see all the banks that do equipment financing and at what rate and terms. It's the first all-encompassing report that includes everything." The Guide will be available after Christmas in book form and CD ROM through FRANDATA and in bookstores. Updates will be available every quarter after that. After Christmas, information will be available at the FRANDATA websitewww.frandata.com. "Our strategy here is to put independent third party information up on the Weba free site that anyone can go to."
® copyright 1999 Nancy Rathbun Scott
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