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In the world of franchise finance, it is always wise
to reflect on what has happened over the previous year
and see how the past can create opportunities for the
coming year. 2006 was a year filled with significant
activity in the franchise community: (i) an unprecedented
number of new franchise concepts were created; (ii)
an impressive number of franchisors were sold; and
(iii) a large number of franchisee to franchisee transactions
were closed.
Let’s look at what happened with franchise financing
in 2006. These are not specific transactions
but broad topics that can be reflected on and used
as a resource in your 2007 planning process.
- New Senior Debt. A number of new senior
debt lenders came into the franchise lending market
in 2006. Some of these were major players,
such as insurance companies (e.g., AIG) and large
financial institutions (e.g., Merrill Lynch). Additionally,
there were a number of niche players that continued
to expand (e.g., Pinnacle Commercial Financial). In
general, there seems to be more competition than
ever. The large players, who have been in this
space for a long time, seem to still have an appetite
for the franchise lending field and will continue
to provide funding.
Additionally, it appears that some of the traditional
lending criteria in the franchise space (such as size
and national penetration of the concept) have been
lessened, providing the opportunity for the small franchisee
or franchisor to access some of the larger, more traditional
senior lenders.
- Sale/leaseback. The sale/leaseback
market continues to be robust and available. While
I thought the like kind exchange market would slow
down, it seems to maintain a sustained pace. Additionally,
the private market remains strong (except for possibly
in southern Florida and California). There
are still a number of smaller sale/leaseback companies
with available funds. GE’s acquisition
of Trustreet this past year created a huge sale/leaseback
group that will continue to serve the franchise space
using significant capital resources.
- Hedge Funds. Capitalizing on the fairly
low cost of funds, there were a number of large franchise
transactions in 2006 that involved hedge funds. We
will continue to see hedge funds in the franchise
space as long as they have available funds and franchise
businesses can utilize leveraged transactions.
- SPACS. Special Purpose Acquisition
Companies (SPACs) are a vehicle that has been around
for a few years. SPACs are public entities
that are funded to make targeted acquisitions. We
saw this past year the entry of several SPACs into
the franchise space and these entities acquired both
franchisors and other franchise assets. SPACs
are unique vehicles in that the funding is created
prior to the acquisition and available to the SPAC
so it can move quickly and take advantage of opportunities. I
believe SPACs will continue to be a source of capital
for the franchise space in 2007.
- Private Placement. Private placements
continue to be available. We particularly saw
this in 2006 in the restaurant space where a number
of private placements were completed with what amounts
to extremely strong multiples. These private
placements can be as small as $1,000,000 or $2,000,000
or can be as much as $10,000,000 to $15,000,000. The
key point is that there are a number of institutions,
wealthy individuals and home offices that are willing
to look at private placements for emerging, growing
franchise businesses.
- Multiples. In general, the multiples
again stayed strong for the sale of franchise businesses
in 2006. We saw some erosion in the casual
dining area (particularly in the franchisee side). QSR
multiples were equal to or greater than they were
in 2005, and it appears that multiples for QSR will
still stay strong through 2007. Further, service
type and lifestyle franchise companies showed a continued
increase in multiples. There were some overpriced
transactions in 2006, which anticipates a continued
rise in multiples that did not materialize. In
many cases these transactions were pulled off the
selling market with the idea that there was an overestimation
of the selling price.
In summary, most multiples will remain at historic
highs in 2007 but will not continue to grow; in fact,
there may be a slight downturn in the family and casual
dining sectors and high capital intensive franchisees.
- Continued Use of Private Equity Funds. The
line between debt and equity is blurred in today’s
marketplace. Private Equity Funds remain as
major players, providing money for everything from
large transactions (such as the Dunkin Donut transaction)
to smaller transactions (involving areas such as
health care type franchises (e.g., Urgent Care)). Private
Equity Funds see the franchise space as a viable
investment option; and thus, more and more Private
Equity Groups will continue to enter the franchise
space as more money is raised in these funds.
- Public Debt. Public debt continues
to be fashionable and accessible to the franchise
community if a franchisee or franchisor grows to
a fairly large size. This type of scenario
was seen with National Pizza Company.
- Royalty Securitization. In reviewing
the marketplace and speaking at conferences this
past year, I have noted a renewed interest in royalty
securitization. Royalty securitization is a
viable source of financing for franchisors. The
amazing thing is that there is more and more creativity
in this type of financing, including packaging several
franchisors together to get a larger funding.
- Disposition of Distressed Sites. Closed
locations plague the franchise community. What
is a franchise business owner to do with leases or
under-utilized real estate? There are a number
of companies who look at distressed sites as a business
opportunity and are willing to (i) joint venture
with the franchisee/franchisor; (ii) acquire the
closed locations; or (iii) come up with creative
solutions for the distressed real estate. We
have seen this happen with large and small franchisees. Certain
companies (e.g., DJM Asset Management) have become
major sources of liquidity for the franchise community
to acquire or sell troubled or under-utilized sites.
- Franchisor Assistance. With the availability
of funding for franchise businesses (particularly
public franchise companies), we continue to see a
renewed interest by the franchisor in helping their
franchisees with financing. Franchisors want
to upgrade their systems and realize that in order
to facilitate these upgrades, they need to provide
financing to their franchisees (particularly to the
smaller franchisees). With the availability
of creative types of senior debt and mezzanine financing,
the franchisor is able to provide franchisees financial
assistance.
2007 has a bright outlook. Senior debt will
not have the same interest rates as we experienced
in early 2006. Multiples obtained in sale transactions
will be flat but still at historic highs. We
will continue to
see an influx of new funds while continuing the process
of blurring the line between debt, equity and mezzanine
financing.
Have a wonderful 2007 and happy money finding!
Next
month’s article will discuss how to save
money on your insurance.
Dennis L. Monroe is a partner and the chairman of Krass Monroe, P.A., a
law firm specializing in multi-unit franchise finance, mergers and acquisitions,
and taxation. Krass Monroe, P.A. is located at 8000 Norman Center Drive,
Suite 1000, Minneapolis, MN 55437-1178; (952) 885-5999. For previously
published articles, and other Krass Monroe information, please refer to our
Web site at www.krassmonroe.com.
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