Wall Street Squeezes Main Street Owners

NEW YORK CITY (Blue MauMau) - In the aftermath of Congress approving an $840 billion bailout package last Thursday to salvage the financial crisis, experts are still saying that the woes of Wall Street and failing banks will have a profound impact on small business owners. Many in the franchise industry have an ongoing belief that when unemployment is high, franchise sales boom because unemployed workers look to own a small business. That's not the case right now.

This Crisis Different

While the number of unemployed has been rising (see chart), franchisors are saying this is one of the toughest times to sell a franchise that they have seen. A number have begun offering two-for-one deals.

A few franchise consultants suggest that this downturn may be similar to the popping of the dot-com bubble, which led to a recession in the early 2000s, but also led to boom times for those selling franchises.

Irwin Barkan, a franchise owner and a prominent commercial real estate leader for three decades, cautions, “Anyone who claims to know what the next few weeks will be like in the financial markets is kidding you.”

This crisis is different. It involves the meltdown of the financial industry, the one sector that feeds all industries. Hans Sohlen, the founder of Sohlen Franchise Advisors, a firm that organizes mergers and acquisitions for both franchisors and franchisees, declares the gist of the current crisis. “Lending activity has slowed down significantly," he says.

Customer Confidence Dropping

Expansion and the need for credit is one thing. But a major concern for small business owners is the market psychology—whether customers will continue to buy.

Customers have been drying up.

The Senior Vice President of the American Bankers Association's Center for Commercial Lending and Business Banking, Bob Seiwert, states, “Consumers need to be convinced that things are all right. When they start spending again and the markets start functioning again, small businesses and the economy will be well on their way. But this cure will not happen overnight.”

Crisis of Confidence Leads to Loan Rate Increases

Besides diminished customers, the uncertainties of the market and the economy are compounded because lenders are genuinely spooked and have raised interest premiums to reflect higher risk.

In addition, the general lack of confidence is also affecting the credit market. The market runs on confidence. The word “credit” is borrowed from the French word that means credibility and trust. Lenders become very anxious when they cannot even trust the solvency of fellow lenders and banks. “At the end of the day this is about a crisis of confidence,” observes Bob Seiwert, Sr. Vice President of American Bankers Association's Center for Commercial Lending and Business Banking.

The Small Business Research Board has a quarterly survey of small business leaders that shows a significant drop in small business confidence from 2007 through June of this year. The results from July through September of 2008 are not in yet.

The lack of confidence is resulting in higher loan rates.

Seiwert observes, “Bankers are pricing for the perceived level of risks and they are getting it today because there is less supply of funds that can be loaned.”

Auto dealerships (franchises) have been some of the first to feel the swift and severe economic impact of the credit crunch. Finding financing for auto purchases is extremely difficult in today's environment and is a significant reason why car sales have dried up. The result is that venerable car dealers are increasingly closing, as when Bill Heard Chevrolet in Florida, founded in 1919 and one of the nation's largest car dealerships, shuttered its doors two weeks ago.

Car franchisees in general are distressed across the nation.

Speaking of the impact of the credit crunch to franchisors, franchise owners and small businesses, Hans Sohlen summarizes, “In today’s economic climate loans are not only tougher to obtain, due to tightened credit standards and the bank liquidity issues, but they are also more expensive.” He continues, "Bankers have limited funds to make loans and they are pricing more fully for the risk inherent in making them.”

Seiwert of the American Bankers Association agrees. He thinks that small business and franchise owners in today's environment will need to be extra vigilant to find funds. “A good number of banks have an increasing number of problem loans on their books," he declares. “Banks are not looking for more problem loans and as a result only the most creditworthy requests are getting honored. If you have a request that is on the bubble, meaning they might do it or they might not, bankers are going to take the conservative route and pass on it today.”

Seiwert thinks that bankers will be particularly wary of restaurants, including restaurant franchise loans. “Restaurant loans are considered in general to be among the riskier types of loans a bank can make,” he observes. “Loans are almost always secured and carry rates of interest that compensate the bank for the risk fairly. But at times like these, bankers are not actively pursuing more restaurant loans.”

Banks Try to Sort Out Their Own Solvency Problems

Another major issue is bank liquidity. In normal times few notice when credit circulates through the banking system, ebbing and flowing. But when banks stop circulating loans, businesses start immediately feeling their own mortality.

In years past, borrowed money flowed through credit markets at historical volumes, which magnified profits from public securities like the mortgage-backed products. But when consumers had problems paying mortgages, mortgage securities tumbled and the leverage worked in the opposite direction, magnifying the downside.

As the chart of April 14, 2008 from Wikinvest.org shows, many Wall Street banks have taken significant hits from uncollectable mortgages and loans sparked by sub-prime lending.

“There are a lot of banks who counted on the ability to sell existing loan assets into public security markets,” Seiwert observes. “When they sold those, it freed up funds to make new loans. They aren't able to sell these assets today, even if they are good assets. So until the liquidity crisis gets taken care of, there will be limited funds available, even if you have great credit." Continues Seiwert, "As banks struggle to remain solvent or to trim down their bad loans, bankers will take care of their good customers first.”

Having started in banking in the '70s working for Mellon Bank, Seiwert recalls how that bank handled its own liquidity problems during a downturn many years ago.

“I vividly remember being called into the room with all the relationship managers, commercial lenders of the bank. The president of the bank stood up and said that we have a credit crunch here. We have limited availability. We will take care of our existing customers. We will not entertain any new loan requests from people who have not banked with us before and we are going to limit the types of loans that we do.”

“The best customers get served,” declares Seiwert. “If a small business owner has no relationship with a banker, the small business has put itself at a disadvantage when times get tough like this.”

Well Established Brands Have a Leg Up

Money is always available to well established businesses where the owner understands what she needs to do and how best to present her story to the bank. “If a business is well established with a good track record, has a great relationship with its banker, has delivered in the past and honored all financial obligations, money is to be found, although it may have to look around,” Seiwert states. “The folks who are finding challenges are either just starting a business or in the early stages of their business. They don't have a track record.”

“Businesspersons seeking to open a franchise with a well-known established name have a leg up in terms of getting a loan over someone who wants a loan for a franchise that is not well-known or established,” the banker advises.

“Here's why: Before a McDonald's takes someone on, they obviously do their due diligence, but they also have a whole on-board school to make sure things get up and running in the McDonald's way. They have experience in working with franchise owners to help them. The franchise has brand value. If the business is a start-up franchisor with a start-up owner, it will be really hard to obtain a conventional loan.”

"Banks will be very conservative in granting new loan requests. They will first support their existing customers.” Because of this, Seiwert advises, “Those who seek loan funds should first go to the bank that they bank with.”

Buyer’s Market: Owners Sell Businesses at Discounted Rates

The financial institutions are now looking for deals with more equity in them, and the cost of equity is higher than debt. “Selling will slow down rapidly because of higher equity requirements and the higher cost of debt,” predicts Sohlen.“Sellers will have to sell for less."  He says that  some who wanted to sell at multiples of 5, for example, may have to settle for 3.5.

As a sign of the times, some franchisors are now offering two-for-one deals.

Sohlen feels that healthier, top-tier franchise systems will benefit from this trend. “Stronger franchises can purchase struggling franchises,” he says.

Real Estate Begins to Free Up

Mr. Irwin Barkan is no stranger to franchise ownership. He has been a regional master franchise for Mail Boxes Etc., owned a chain of self-service laundries and has been an owner and operator of four Dunkin' Donut shops in New England.

A 30-year commercial real estate professional that has owned or managed some 2 million square feet of shopping centers, Barkan thinks that those who are in the process of leasing a store location will find that right now is an excellent opportunity to renegotiate terms. “If your small business is in a basic industry like food, energy, or anything ancillary that benefits from basic industries, stay calm, hold on to good locations and rights,” he says. “But if you have not closed on an acquisition that was negotiated 90 days ago, reprice the deal using new underwriting.”

“Don’t be shy,” he advises.

Property owners are nervous right now. “All owners are nervous. If property owners are not concerned about their own debt and cash flow, then they are at least concerned about their retailer tenants staying in business and paying rent—any rent.”

Barkan concludes, “In reality the landlord’s position and response to a deal today is going to be a welcome change to what you heard any time in the last five to eight years.”

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