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At the recent Restaurant Finance and Development Conference I was fortunate to lead a distinguished panel of five financial experts, each providing his insight into the current state of the marketplace for financing. Five types of financing were covered during our panel discussion: (1) the senior debt markets (John Shrewsberry of American Commercial Capital); (2) SBA lending (Brad Gilbert of Comerica Bank); (3) the private equity market (Mark Saltzgaber of Dorset Capital); (3) the public equity market (Murray Huneke of US Bancorp Piper Jaffray); and (5) real estate sale and leaseback (Kirk Cypel of The Midtown Niki Group). The expert in each financial market reflected on what he felt was the state of the market, the opportunities and constraints for the borrowing community.
Each expert addressed six key questions: (1) market characteristics; (2) key players; (3) situations where this financing is appropriate; (4) the process for obtaining the financing; (5) financing terms; and (6) constraints.
As previously written in this column, financing is not just a type of financing (such as debt or equity) but should be viewed as a continuum. The continuum starts with the most conservative financing being senior debt and ends with the most aggressive and highest return required (that being pure common equity investment). However, between the two ends of the continuum are many varieties of financing possibilities.
Keeping the above in mind, consider our experts’ comments:
1. Senior Debt Market. This is the most common form of franchise financing.
a. Market Characteristics. First security position amortizing debt used for working capital, acquisition of equipment and real estate. Senior debt is normally secured by all of the borrower’s assets.
b. Key Players. National commercial banks, local and regional banks and commercial finance companies (a few examples are ACC/Wells, General Electric, Imperial Capital Franchise Finance, Irwin Franchise Financial Services, Bank of America and Citi).
c. Financing Situation. This type of financing is most appropriate in combination with an equity base for acquisitions, refinancing, development and recapitalization.
d. Financing Process. This financing can be obtained directly by calling the source of the financing. These sources have large sales staffs so contacting them is easy.
e. Key Financing Terms. The interest rates will be 300 to 400 points over corresponding U. S. Treasury obligations, which puts the rates in the 6.5% to 8.5% range.
Equipment and leaseholds loans are at a 5-7 year amortization and real estate is at a 10-15 year amortization. The interest rates can be either fixed or floating. Floating rates will, of course, will be lower.
f. Constraints. The key constraints with this type of financing are that meaningful equity is needed, the collateral has to be real and substantial, and in most cases, personal guaranties are required.
2. SBA Loan Market. The SBA loan market is a subset of the senior debt market.
a. Market Characteristics. SBA loan monies can be used for leasehold improvements, equipment and real estate.
b. Key Players. There are a number of national players (a few are CIT, Wells Fargo and Comerica Bank); however, in addition to these large players, SBA loans are available through local banks in every state. Franchisors are key in determining availability of SBA lending. Franchisors who have worked to complete the application for the SBA Registry will open the doors for their franchisees to pursue this type of financing.
c. Financing Situations. SBA loans are available for start-up units and small development. SBA loans are a major source of funding for small franchisees for the first several units.
d. Financing Process. This process involves an SBA application and approval by the appropriate institution.
e. Key Financing Terms. Personal guaranties are required. In most cases the financing is floating and tied to the prime rate. In most cases, this loan is secured by assets and personal guaranties.
f. Constraints. The individual borrower must be able to prove he or she does not have other available financing and must materially participate in the borrowing entity. Finally, there are prepayment penalties.
3. Private Equity Market. Private equity has probably been the one area that has grown the fastest in the franchise industry.
a. Market Characteristics. Private equity financing is available for proven, high-growth, well-positioned concepts with experienced management teams and strong unit models.
b. Key Players. Some of the key players are Dorset Capital Management, Rosewood Capital, Dorset Capital, Maveron, Apax, Catterton, Oak, Northwood, GS Capital, United Enterprise Fund, Roark Capital Group, SB Partners and Brentwood Associates.
c. Financing Situations. The appropriate situations for private equity financing are for companies with revenues greater than $20,000,000, with high growth concepts, demonstrated units, and concept portability.
d. Financing Process. The process for obtaining this type of financing is dealing with specialized professionals in this area (such as accountants and lawyers), who can help put together a business plan that is realistic, not overly aggressive and is defendable. Contacts with private equity firms are secured through networking.
e. Key Financing Terms. Private equity funding comes in as equity with a first out preference. Normally the private equity holders want a redemption provision where they are taken out after a certain period of time of 4 to 6 years. There are normally certain negative covenants and restrictions as to management, anti-dilution protection and board of director seats or observation rights.
f. Constraints. The key constraints, besides the control terms, are agreeing on the valuation and percentage of the company that the private equity holder will own.
4. Public Equity Market. The public equity market has been a tight for the franchise community, but recently we saw the IPO of Buffalo Wild Wings (a franchisor). It has been a number of years since a public equity offering for a franchisee. Keeping this in mind, there may soon be a window for the public equity markets.
a. Market Characteristics. The public equity market utilizes the whole publicly traded securities world.
b. Key Players. An example of some key players are Bank of America, Piper Jaffray and SG Cowen.
c. Financing Situations. Public equity is appropriate for a sizeable, multi-unit operator willing to commit to scrutiny costs and a long-term commitment of being a public company, including spending $500,000 and $1,000,000 annually for compliance.
d. Financing Process. In order to qualify the company must expect to generate at least $4,000,000 to $10,000,000 in after tax net income in the succeeding 12 to 18 months and have expected annual growth and profits of over 15%. The process of obtaining this type of financing is to begin early, speak with the various investment banking firms, attorneys and accountants who work in this area.
e. Key Financing Terms. The key terms of this type of financing are straightforward. It is common equity, a general public ownership, no covenants or other restrictions (other than voting rights of the equity investors). Again, this type of financing is subject to extreme reporting requirements and costs.
f. Constraints. The key constraints of this type of public equity financing are that it requires a significant growth plan, history of earnings, relatively large size, depth of management and clean audited financial statements.
5. Real Estate Sale/Leaseback. This is probably the fastest growing type of financing available to the franchise community.
a. Market Characteristics. These monies are available to franchisees, small operators, nationally recognized companies, and even companies with difficult financial histories (if they have strong sites).
b. Key Players. The key national players in this industry are the people who are involved in 1031 like-kind exchanges (such as Marcus & Millichap and CB Richard Ellis), institutional lenders (such as Realty Income, CNL, AEI Fund Management, American Commercial Capital and Chesapeake) and boutique groups (such as Martin Capital and The MidTown Niki Group). Local players are real estate owners and landlords of shopping centers.
c. Financial Situations. The key situational use for Sale and Leaseback is unit development, recapitalization, and in recent cases, leveraged acquisition that involve real estate.
d. Financing Process. The process for obtaining sale/leaseback financing is networking and using brokerage firms. Your franchisor can be of great help by developing feeder relations with sale/leaseback groups.
e. Key Financing Terms. The key general terms are, financing equal to 100% of the cost of the property or its fair market value, a long-term lease (normally 20 years with renewal options) and a lease rate between 9% and 11.5% of the purchase price. Lease payments are normally fully deductible. Sometimes personal guaranties are required. In all cases the leases are triple net, which means the tenant pays all costs associated with the property.
f. Constraints. The key constraint is giving up the long-term ownership of the real estate.
Hopefully the above information serves as a current update on the status of the various financing markets. Again, think of financing in terms of a continuum. Make sure the assets you are acquiring match the appropriate financing vehicle. Also, when using debt, make sure there is adequate equity involved. Thanks to my panel members.
Next month’s column will spotlight one of our great franchisees, Aslam Khan.
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