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What works

Summit gives welcome advice for what ails you


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It's probably a sure sign of the state of the real estate market that comments such as this are coming out of the mouths of franchisors:

"There is nothing about a concept that is sacred," said Bridget Sutton. She's the president of Baja Sol Franchising, Inc., a 22-unit regional burrito chain based in Minneapolis. As competitors entered her market and then failed, her company has stepped in to claim the available space.

While moving into a second-generation space requires some tweaking of the concept to fit the space, Sutton said, the move can save the franchisee a lot of money on up-front costs and can help with the bank loan. The equipment and utilities are already there, after all, and in this environment where there are more closures than there are expanding concepts landlords are far more willing to listen and negotiate.

And Baja Sol isn't the only concept that thinks this way, at least according to those speaking and attending the Krass Monroe Winter Franchising Summit in early March. John Hyduke, vice president of franchise development for the Old Chicago Franchising Corporation, compared his restaurant chain to a "hermit crab" that can adapt to just about any kind of shell.

Such moves, he said, can save hundreds of thousands of dollars off the buildout costs, and so Hyduke discounted any thoughts that the concept should be left alone. "It isn't a shrine to Old Chicago," Hyduke said. "It's a restaurant."

Mike Pearce, senior vice president of development for bd's Mongolian Grill, said his concept was able to get a steep discount off a closed Texas Roadhouse location. And Ken Larson, CEO of the furniture retailing franchise Slumberland, said a mall seeking an anchor tenant recently approached his company, offering a year free rent, with a gradual increase the following two years, as a carrot.

"Who was that mall's owner?" Sutton asked in response.

The discussion about the real-estate market, and the opportunities it provides concepts that are expanding, was one of the few bright spots in a summit that was filled with a sizable amount of pessimism. Few seem to believe that the economy will turn around any time soon.

"Usually at this event I give a 'View From The Hill,' which is a generally positive view of the American economy," said Thomas MacIntosh, an attorney with Krass Monroe, a franchise law firm out of Minneapolis that specializes in financing issues. "Needless to say, I'm not going to make that speech today."

The restaurant companies in particular had few optimistic projections. Damon Fraser, vice president of structuring for Buffets Inc., noted that there are some wild swings in business on any given day. "The predictability is all over the charts," he said, adding that his company - which had declared bankruptcy - determined last year that the economy was a "two to three year problem."

Mark Bartholomay, interim chief operating officer at Kona Grill, agreed with that estimate, and noted that while some markets are up, "a big up today is up 3 percent, and a big down is down 20 percent. It doesn't exactly even out."

And Barry Blum, former Burger King attorney who is now with Krass Monroe, said that many franchises will "be in survival mode the next two to three years," and may have to "add by subtracting units" that may not make it. "There are some tough calls that need to be made," he said.

Blum cited his experience at Burger King, which during some struggles in the early part of the decade had done some workouts with struggling franchisees and chose to close ones not expected to make it. The company is in a better position today. So companies may have a better system in place when the economy does pick up in three or four years. "Whatever doesn't kill you makes you stronger," he said, "and that may really be the case nowadays."

Bartholomay, citing Minneapolis-based barbecue chain Famous Dave's recent decision to suspend development schedules, said that other franchisors should do the same thing. "There isn't a single franchisee out there who's going to make their development schedule," he said.

That's largely because of financing reasons. While there are many franchises that are eager to develop - and need to do so to protect key sources of revenue - the financing remains a major obstacle.

Consolidations and business departures has left the franchise market with fewer lenders, said Randy Evans, attorney with Krass Monroe. They're also increasing their requirements, frequently asking borrowers to put more money down and back more of the loan with collateral.

Lenders are also asking franchises to ensure there is more of a cash cushion above their fixed costs. In years past, Evans said, the fixed charge coverage ratio would be 1.1 to 1.2 - meaning the bank wanted the franchise to have $110,000 to $120,000 in cash flow if it had $100,000 in fixed costs. Today, that ratio is 1.25 to 1.5.

In general, many franchises are taking significant steps to help their franchisees get financing. Evans said that many systems would employ credit-enhancement strategies, such as limited guarantees and direct operational assistance. But many more are going as far as sponsoring their own financing, using their own cash reserves or by borrowing the money themselves and setting up a fund.

Pearce said that his company had set aside funds to build corporate stores in emerging markets. Now, when it encounters a qualified prospect in a market it wants to build up that may be concerned about the risk, bd's will use those funds to pay for 51 percent of a joint venture in that community. After a year, the franchisee can buy the corporation's stake at cost if satisfied with the outcome.

 

"We’re going after people who already own franchises. And I’m going to call every single one of them if I have to, even if I have to work until midnight."

—Mike Pearce

Sellers themselves are also getting into the lending act. Tightened lending requirements are making it tougher for franchises trying to sell their restaurants to get the historical market price. For instance, say a person wants to buy a restaurant at $500,000, using $100,000 in cash and $400,000 in debt. But the bank, wanting the lender to put 40 percent down instead of 20, may only be willing to loan $300,000.

The buyer may not have $200,000 and might be less willing to pay the full $500,000 for the unit. "One of the ways to bridge the gap is through seller financing," Evans said. "If you want to get near historical value, a small piece may have to carry back on a seller note."

Yet the financing market is also forcing changes in companies' development strategies. Because many lenders aren't soliciting business, and will only loan to those with experience - in other words, existing multi-unit owners - bd's Mongolian Grill is targeting existing casual dining franchisees looking to expand their portfolio. And they're not waiting for those franchisees to call.

"We're going after people who already own franchises," said Pearce. "And I'm going to call every single one of them if I have to, even if I have to work until midnight every day."

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