Big Questions Answered about Franchise Financing

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I know what you are thinking, “not another article on the credit challenges faced by franchisees!” As a nationwide provider to the franchise industry for nearly 20 years, Direct Capital is aware of the challenges faced by the industry.

We thought some insight from the people making the decisions on approving franchisees for credit would be helpful. We had a Q&A session with three of the most experienced credit people on the Direct Capital team to ask valuable questions for franchisees and franchisors in this crisis.

Here are answers to some common questions we hear from franchisees and franchisors:

    1. Why is the franchise industry faced with such a significant credit crisis?

The franchise industry is not the only industry facing this problem. The credit & liquidity crunch has impacted every sector. Franchise restaurants have felt a larger impact as lenders were less willing to providing financing to this sector even in good times, do to general restaurant industry failure rates. Top that with the fact that previously stable large lenders have exited this market and you have bit of a perfect storm on your hands.

    1. How is lending to a franchisee different then lending to a general small business?
      The franchisee has a distinct advantage over the independent business due to:

      • Brand /concept recognition in lending – qualified lenders already have a thorough understanding of the concept
      • Franchisor strength is valuable in making credit decisions
      • Franchisors have a significant pre-screening process in place / specific requirements to qualify
      • The FCC/UFOC provides excellent insight on the performance of the concept, successes, challenges, etc
      • Multi-store owners provide lenders with comfort that there is a more diverse income stream
      • Most concepts provide advertising support that goes well beyond the local level and is regional and/or national in scope
    2. What are the 5 biggest factors in selecting franchisee’s for financing?
      • Personal & business credit profile
      • Franchise concept strength
      • Number of units/stores individually owned
      • Current debt levels
      • Franchisee time within concept & concept tenure
    3. What is the most common theme for applicants not approved for financing?

Poor personal / business credit is the immediate answer, but that goes well beyond franchise finance alone. Becoming highly leveraged too quickly is a real concern.

    1. Exposure seems to be big in determining approvability, especially for multi-unit owners wanting to develop more stores. What’s the issue and how can they overcome the issue?

Expanding too quickly can create concerns for your lender if there is insufficient cash flow to support additional needs. Diversity to capital is key in this market. We speak with many franchisees that have reached exposure limits with their existing lender. That is not a dead end for the franchisee. We are able to provide them with new capital if we do not have any exposure issues ourselves. No business can rely on one lender for all needs; especially if they can only offer one type of financing. Credit monitoring & awareness of your financial approvability also needs to be an on-going focus point.

    1. What do franchisors need to do to improve the chances of approvability for their franchisees?

Don’t view your lending partner as a commodity but as a partnership. Supporting your lender and their efforts and doesn’t end with getting approved. Lenders need to feel comfortable that a franchisor is aligned with them to maximize the lender’s offering capabilities. Some requests might include sales/revenue reporting, creative analysis on system needs, and front to back support / transparency.

Decision Making Tools for Franchisors

Franchisors and their associations have been vocal in publicizing the lack of capital available and many have fallen short of accomplishing their development plans as result. The credit crunch has struck new franchise acquisition the hardest and the economy has decreased those willing to put up the investment needed to launch. Franchisors are refocusing their development strategy on currently good operators, and new locations for poor operators.

The initiative requires the franchisor to ask some big questions:

  • Which franchisees are best suited for expansion?
  • Which franchisees have the best likelihood of getting approved for a loan?
  • How well do we really know our Franchisees?

Tracking sales data and a solid track record should mean that particular Franchisees should be able to easily grow and flourish. But, the real solutions often go deeper than numbers. The answers on which franchisees can grow reside in which of your franchisees can get approved and which ones cannot.

To this end Direct Capital provides detailed reports to franchisers that give them a good understanding of the financial viability of franchisees and their ability to access credit. Contact us with questions on the types of reports available or share your questions in the comments below.

Photo credit to pepo at http://www.sxc.hu/photo/1130056

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