| “New Techniques For An Overleveraged Situation” |
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by Dennis
L. Monroe and Timothy R. Ring |
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from Franchise Times Articles, May 2001 issue |
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Too much
debt leverage is currently the biggest "buzz" in
the multi-unit franchise industry. Over-leveraging has
occurred, in part, because of a slow down in consumer
spending, reduced value of multi-unit assets, the increased
cost of operating multi-unit operations, and competitive
market pressure. An over-leveraged situation may work
for a short period of time because of accumulated reserves,
the ability to stretch payables, short-term assistance
from franchisors and, in general, creative cash flow
management. However, in the long run, over-leveraged
situations must be addressed, and the lenders involved
need to be consulted and negotiations between the parties
must occur. Addressing issues or anticipated problems
with a lender upfront preserves relationships and increases
the chance for a receptive audience and creative resolutions.
Over the last year, we have seen and accomplished a number of negotiated restructures that allow the multi-unit operator to achieve suitable cash flow to service appropriate debt levels; thus allowing survival of the multi-unit operator. It is evident from a number of recent business articles that many franchise systems have epidemic proportions of over-leveraged multi-unit operators. In addition to the health of the multi-unit operator being in danger, the health of the franchisor may become an issue. Also, since franchisors are publicly traded, their equity values are greatly diminished when franchisees are over-leveraged.
The silver lining of over-leveraged situations is that in most cases bankruptcy is not a viable option for the lender or operator. There are a number of reasons for this. The most significant reason is that it is very seldom a multi-unit franchisee can infuse or obtain (through bankruptcy) appropriate equity or liquidity to provide the requisite legal assurance in bankruptcy that a restructure is viable. Further, lenders are obviously opposed to bankruptcy scenarios because, in most cases, liquidation values are at $.10 on the dollar. Owners and operators would prefer to avoid the negative stigma of failure as well as the other legal issues prejudicial to owners that arise upon bankruptcy.
With the above factors in mind, it becomes imperative for all parties to work out creative and viable solutions. In most over-leveraged situations, the practical reality is that all of the parties must share the pain equally.
Below are some basic recommendations for addressing over-leveraged situations:
1. Prior to any default payment to lenders, landlords, franchisors and other creditors, open discussions must occur as to pending problems with the company.
2. The over-leveraged operator needs to have a strong handle on cash flow and the liquidity position of and projections for the company. A pro forma financial projection must include all required capital improvements, required reductions to accounts payable to bring accounts payable into normal trade terms, and proper reserves and contingencies so that a restructured company will be viable. The solutions approved by all parties for the restructure of the operator should not be mandated by any party, but should be solutions that are taken into account to maximize the health and ongoing viability for the operator.
3. The franchisor is not there just for money, royalty relief or debt forgiveness. Franchisees should look to the franchisor as an ally in their discussions with senior lenders and other creditors. The franchisor has a significant interest in seeing its franchisees succeed so as to preserve its ongoing royalty stream. The franchisor should be a part of creditor arrangements with senior lenders. The franchisor should further provide a system-wide approach to troubled franchisees. Tricon is a good example of working with over-leveraged Taco Bell franchisees. This may become a model for other franchisors.
4. Look at all available ways to cut costs. The senior lenders will want proof that the company is being run effectively and efficiently. Lenders are intolerant of excess general administrative expenses, excess ownership compensation and needless development costs.
5. Be realistic about pro forma projections for cash flow, sales increases or decreases, and the cost of downsizing. All of these operational aspects are normally underestimated or, in many cases (particularly in the sales area), over-estimated. Be realistic about the company. Lenders and other creditors are much more likely to buy into a plan that shows conservative projections. Also, it is very difficult to go back to a lender for a second restructure so the first restructure must work.
6. A restructure will bring about a partnership, in most cases, among the franchisor, the owner and the creditors. Thus, the owner will not have the kind of autonomy that existed prior to the restructure.
It is very important for the franchisee to be proactive with lenders, creditors and franchisors. Franchisees should not wait until there are payment defaults or they are out of cash to begin discussions. Now is a good time to pursue a restructure because the industry and lenders recognize the poor financial state of many multi-unit operators.
Next month's article will be on the anatomy of a good restructure. We will give some examples of how a good restructure should look.
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