Restrictive Financing May Cause Franchisors To Change For The Better
Due to tighter lending standards franchisors have taken to helping finance new franchisees having difficulty raising capital through traditional lending sources. Marco's Pizza, Quiznos and other franchisors are creating financing arms when banks decline to work with "franchisees who are unable or unwilling to make a large equity investment in their business."
"This year, the franchise industry is expected to seek $10.1 billion in capital, but banks are expected to lend only $6.7 billion, according to the International Franchise Association." Unfortunately for franchisors, banks are taking a closer look at the cash flow of these companies and selecting only the stronger systems to finance. "Darrell Johnson, president and chief executive of FRANdata, a leading franchise analysis business, predicted that the tighter lending environment would impose a new form of natural selection on franchisers. Until recently, financing has been available to both poor performers and high performers, but it will increasingly favor the latter. To survive, he said, franchisers need to “think like bankers.”" - NY Times
Mr. Johnson seems to believe this could be a good thing for franchising going forward:
“Banks are defining who can play and who can’t play on the basis of risk analysis,” Mr. Johnson said. The stronger franchisers “are going to survive and do well because they’re going to get access to capital,” he said. “But it’s going to require the performance of franchise systems to change to meet the standards that banks are requiring. It’s going to be a system-strengthening process.”
Re: Ray, Harvesting "Wheat" or "Chafing" Under the Strain
Ray, there is a much larger issue at play here. Under traditional funding circumstances the franchisor, while having a "personal guarantee" from the franchisee, does not have a "secured" claim. Rather, the personal guarantee is an unsecured claim that can be disposed of under bankruptcy. I am very curious to know if this new funding concept requires the franchisee to sign a secured claim against the franchisee's home, assets, etc. that CANNOT be disposed of under bankruptcy codes.
SBA and other bank loans used for purchasing a franchise require collateral be assigned to the loan in case of business failure. Richard Solomon has, on occasion, stated the SBA does not follow through on the taking of that collateral upon default - NOTHING can be further from the truth. (no disrespect to Mr. Solomon intended in any way here). Lending institutions performing the lending function for the SBA are placing liens on the homes at the signing of the loan documents and refusing to remove them even after bankruptcy - trying to collect whatever they can to offset the SBA's losses. However, franchisors, with unsecured "personal guarantees" are left in the dark with no assets to claim - even if there is home equity - usually due to "homestead allowances" in many states (here in the U.S.).
Now, with the franchisor "funding" the purchase of the franchise, they will have a direct claim on the franchisee's assets that cannot be written off by bankruptcy. The difference of now vs. then? Before, if you failed the franchisor did not have legal recourse to take your assets. They could, if you did not declare bankruptcy, get a judgment against you but they could not "take" your assets. Now, due to direct lending, they will have a lien on your assets that bankruptcy cannot remove - even with "homestead allowances" because the franchisee has permitted this lien thereby negating any "homestead allowance".
While I am not an attorney and there may be nuances within these laws that change to some extent the outcome, I have been involved enough to know that the franchisor will now have a much tighter rope around the neck of the franchisee should they finance through this new "route".
Lastly, what about selling the site should the franchisee have financial (or personal) difficulties? With the franchisor now as your "partner", what type of restrictions can the franchisor place on the zee with regard to the sale? The zor now "owns" your home (or other assets) so they don't care what your personal situation is. Better yet, can the franchisor, seeing a very successful site, force the zee out early in order to take over the site? Are there restrictions on the franchisor preventing an "early call" of the loan?
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The threat of personal guarantee consequences
The only thing I would add is that franchising often involves the leveraging by franchisors of the fear of personal guarantee consequences throughout the contract term no matter who holds the guarantee. In one way they are the ultimate threat to ensure compliance with anything. Franchisor finance does open up the potential for new heights in that threat.
When franchisors have to finance the sale of franchises in any economy it could be argued to be smart business or desperate business and more likely a reflection of a lousy franchise product in a world of countless lousy franchise products.
A few days back a TCS franchisee remarked to me that he would bend over backwards to be compliant but he would not bend over forwards. I suggested that wasn’t his call while he still has his home.
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seperating wheat from chaff
Franchising has always been great business for the banks but now small business operators are more vulnerable where consumer spending is tight and what was a seemingly an ‘acceptable’ level of failures is now set to rise to unacceptable.
Banks [and include SBA and CSBFA programs] have in the past assisted in deluding franchisees by backing any lousy franchise investment where the banks inherited family homes along the way. Now that isn’t exactly a healthy market either.
While business might be tough for everyone, difficult economic times always separate the wheat from the chaff. I just hope we lose a lot of franchise chaff and if the banks take a hit then they might continue, in the short term, to be more selective.