“Creating Your Own Source Funds”		«BACK
	by Dennis L. Monroe
	from Franchise Times Articles, February 2002 issue

Over the last six to twelve months I have seen a phenomenon that I call "creating your own source of funds." In effect, this involves developing a story, and then taking this story and selling it to appropriate investors and lenders.

WHAT DOES "CREATING YOUR OWN SOURCE OF FUNDS" MEAN? The following are some steps in this process:

1. Business Plan. The first step (whether it is buying a multi-unit business, buying a concept or just developing new stores) is to come up with a business plan that takes into account the following factors:

a. Reasonable Leverage. Reasonable leverage from a senior lender is probably two times the historic cash flow from the business or the reasonable pro forma cash flow for new stores.

b. Flat Sales. Projections have to assume fairly flat sales.

c. Reasonable Equity Investor Return. If you are seeking equity investors, these investors will want somewhere around a 30% return or more.

d. Exit. Provide for a reasonable exit strategy or refinancing.

e. History. It is important to show you have the experience to effectively implement your business plan.

f. Cost Effective Approach. Businesses or stores must be purchased in a very efficient and cost effective manner. Nobody is willing to invest in or finance a Taj Mahal.

g. Margin. There has to be a financial margin and adequate liquidity for unexpected events or downturns.

Once these issues have been candidly addressed up front, you then have a model that can be sold.

2. Selling the Plan. If you have a major investment opportunity, it is very helpful to get involved with investment bankers. If you have a small business venture that is not of monumental size (such as the $1,000,000 to $5,000,000 range), much of the legwork in securing the appropriate funding has to be done by the owner-operator. Key advisors are of great help and may provide wonderful contacts, but it is clear that the owner-operator/entrepreneur is the one who sells the opportunity. This can be done in the form of a formal private placement or just a business plan. A business plan can be taken to small buyout or sponsor firms that invest in top operators, or the plan can be presented in a more individualized approach to wealthy friends and family who believe in the entrepreneur.

a. Targeting the Investor Group. The key is to have a targeted approach. Decide who the investment fits and what type of investor you need to effectively carry out your business. Do not shotgun the approach by sending the business plan to everyone you know. Your business fits a certain type of investor. The key is to determine what that investor type is and identify investors in a targeted manner.

b. Be Realistic. What type of dollars will an investor put into your business? If the investor has invested with you before and has been successful, he or she is much more likely to invest a larger sum of money. In most cases, investors in the first round are going to put in a smaller amount by "putting their toe in the water". Just remember, you are creating your own source of funds. Make sure the investors' attitudes and profiles fit the way you want to run your business.

3. Finding Senior Debt. The investor component represents only a portion of the needed funds. It is probably one-third of your cost of acquiring or developing a business. The other two-thirds is going to come from lenders. Always look to investors that will attract senior debt; that is, people who have connections with banks and other financial institutions that provide senior debt. The higher the level of equity, the greater the opportunity to secure the attention of a wider variety of lenders; not specific niche lenders, but lenders who will look favorably at the overall chances of success for the deal because of the lack of leverage. It is key to always look at the type of investors, the type of senior lenders they can attract and what various senior lenders are going to require in terms of leverage.

Senior lenders, in most multi-unit franchise concepts, are looking at lending to a level of two times annual cash flow. This may go up to three times, and for stronger transactions, it may be four times. A safe rule of thumb is two times. The equity component has to fill in the rest. Most transactions in this industry that are on the smaller side are being priced at three to four times cash flow, so the type of scenario we discussed does fit into the pricing model for current transactions.

As you can see, the type of return to an equity investor (if the multiples on the value of the business go back to what they were several years ago) is huge. It also has to be recognized that since the leverage component is down, the return investors used to obtain because of leverage (i.e., the use of senior debt) is down. But expectations for equity investors, while they have not dropped as quickly as interest rates, have become more realistic.

So, to create your own parade:

1. Decide on a business that makes sense, is viable and is something you can sell.

2. Put together a business plan that takes into account the market conditions and financing parameters.

3. Identify investors that fit your deal.

4. Be realistic as to the senior lenders and use your investor group to attract the senior lenders.

5. Under promise and over-perform.

I hope your parade is a sunny one.