Financing Programs Aim to Help Franchisees
With Bank Loans Scarce, Companies Create Lending Arms to Assist Business Owners—but Terms Are Sometimes Strict.
Arthur Romanov and Irina Salgan opened their sixth Edible Arrangements fruit-basket shop recently to take advantage of low real-estate prices and easy-to-negotiate contractor bids.
Despite good credit and a strong track record, the longtime franchise owners weren't able to secure traditional bank financing, as they had for past expansions. Instead, Mr. Romanov and Ms. Salgan used a lease-to-buy program offered by Edible Arrangements International Inc.'s year-and-half-old financing arm, Farid Capital.
As bank lending continues to be sparse, a number of corporate franchisers are providing financing arrangements and other aid to potential franchisees. Though business owners say they're grateful for the assistance, many of the programs do come with strict terms.
Farid Capital's lease-to-buy program requires most franchisees to contribute about 30% of the costs. But Mr. Romanov says he wouldn't have been able to afford the $130,000 in start-up expenses without the $60,000 he requested from Farid. "We need all the help we can get," he says.
The moves by franchisers to provide more aid come as many former top lenders, including CIT, Comerica and Banco Popular have severely curtailed their lending, says Ronald A. Feldman, chief executive at Siegel Financial Group, a business consulting firm in Conshohocken, Pa., that specializes in business acquisitions and franchise financing. What we're seeing is that some franchises will now "provide credit enhancement to banks, such as partial guarantees on the loan," Mr. Feldman says.
Others are helping candidates become more viable before heading into the bank. Dunkin' Donuts has reduced some of the royalty fees the franchisee would pay, so long as the shop opens in targeted markets. Because franchisees pay those fees on the sales they make, they can show the lender "greater profitability and ability to repay with reduced expenses," explains Grant Benson, vice president of franchising for Dunkin' Brands Inc.
At the International Franchise Association, a trade group in Washington, spokeswoman Alisa Harrison says more franchises are brainstorming strategies, such as developing internal financing divisions. "Members have told us some of their highest-quality prospects are still having a tough time getting financing," she says.
Banks are expected to lend $6.7 billion to franchises in 2010, an amount that is projected to fall some $3.4 billion short of demand, according to a study released in December by the IFA and FRANdata, a franchise research firm.
Not all franchises are in need of a creative work-around system, as the severity of the credit crunch has varied from franchise to franchise. Prior to the recession, franchisees often found start-up capital at lenders that were partners with the franchiser. But lenders are now more wary of those franchises that carry high loss and delinquency rates.
Before the recession, too-lenient franchisers sometimes funneled weak candidates through the start-up process, says Bob Coleman, who collects data on loans backed by the Small Business Administration. According to a preliminary report compiled on loans from the government's last fiscal year, some franchises had loss rates as high as 27%. As a result, "banks today look at the performance of the franchiser," he says.
Corporate franchisers lending to potential franchisees isn't new. Sylvan Learning Inc., a tutoring company, and Firehouse Restaurant Group Inc., a Midwest and Southwest chain that owns Firehouse Subs, established lending arms years ago.
But some of the newer lending models don't follow the traditional mold. Quiznos, privately owned by QIP Holder LLC, created a lending division earlier this year that allows parties to buy a store with only a $5,000 down payment. Participants don't pay the franchise back in predetermined amounts. Rather, owners must funnel store profits—80% each month—back to the company until the loan is repaid, which is expected to take two to five years. Initial losses are tacked on to the loan.
John Fitchett, the program's president, says the company uses different criteria than banks, rating applicants based on experience and personality first, while other factors such as financial history and credit scores are secondary.
"We're seeking out [candidates] who have a restaurant background, and the savvy to run it," says Mr. Fitchett.
Until the loan is paid off, the store owners are actually Quiznos employees and the store is legally owned by Quiznos. If the store doesn't turn a profit in 12 months, Quiznos reserves the right to change ownership, Mr. Fitchett says.
Eight stores have opened and Mr. Fitchett says he expects about 200 to follow by the end of this year. The program is open to new owners or existing ones who want to expand.
Steve and Valerie Mallard, one of the first accepted applicants, opened their Quiznos store in Denver last month and have hired 15 employees. Mr. Mallard, who has a history of working with Subway and Ruby Tuesday restaurants, says he wouldn't have been able to finance such a store on his own.
Despite being the "guinea pigs," he explains, "it's nice to have a low-risk program in this economy."