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Good shepherds

Leading franchisees out of credit purgatory


Devil Dollar

The credit world has changed: Today, a lender might be looking for someone who's been managing an ice cream store, has a 650 credit score, $85,000 in cash, a $100,000 mortgage, no car payments and a spouse who's a school teacher.

Early last year, when the credit markets were looser, Midas International, in Itasca, Illinois, let its franchisees find financing on their own. Today, Harry Oliver, the franchisor's new director of treasury, introduces new franchisees to national lenders and stays in constant contact with them throughout the loan process. "We want to make sure there are no bumps in the road," Oliver said.

Bumps abound. The major hurdle, of course, is tighter credit markets. Some local and regional banks are moving out of startup financing altogether; the banks and non-bank lenders that remain are scrutinizing franchisees and the franchise systems they hope to join more closely than ever. "On their own, franchisees are in credit purgatory," said Bernie Siegel, president of the Siegel Financial Group in Bala Cynwyd, Pennsylvania.  He and other loan brokers, lenders and franchise executives provided the following advice to franchisors who want to lead prospective franchisees over financing rough spots and into franchise ownership:

Be aware of lenders' new criteria for loans

 "A year ago a downsized IT manager with an 800 credit score, $200,000 in cash, a $400,000 mortgage and two car payments might have looked like a good prospect," said Nate Greenberg, general manager of Siegel Financial Group. "Today, a lender might prefer someone who's been managing an ice cream store and has a 650 score, $85,000 in cash, a $100,000 mortgage, no car payments and a spouse who's a school teacher." Lenders are mitigating their risk by looking closely at applicants' personal budget needs, tax returns and outside sources of income. They prefer applicants with past managerial experience and sometimes insist on direct experience in the franchisor's industry. And they'll turn down anyone of questionable character, Greenberg said. Franchisors can assist new franchisees by helping them "connect the dots" on their loan applications and resumes, he added, by ensuring that all information is consistent and by helping them fill in any suspicious-looking gaps.  

Franchisees that don't pass initial muster may require the services of a loan broker, like Siegel Financial or Diamond Financial, headquartered in Raleigh, North Carolina. Don Johnson, owner of Diamond's New Jersey branch in West Keansburg, says his firm charges prequalified franchisee prospects $1,000 to help prepare their business plans and shop their loans to a variety of national lenders. The bulk of their fees are paid by the lending institutions and prospective franchisees who are not approved for loans get refunds.

Be on the SBA Registry

In the past 25 years, the federal Small Business Administration has guaranteed over 56,000 franchise-related loans, said Danna Oweida, client solutions specialist at FRANdata, the Arlington, Virginia corporation that administers the Registry. For $2,500, any franchisor can have its Franchise Disclosure documents screened by FRANdata for eligibility for SBA loan guarantees. Those that pass are listed online, at http://www.franchiseregistry.com/ . As of press time, 833 systems were registered. Besides speeding up the SBA-guarantee process, a registry listing provides a measure of credibility to non-SBA lenders, Oweida said.

Stay off the 'SBA bad list'

Each June, Coleman Publishing, in La Canada, California, publishes a report on SBA 7(a) and 504 Loan Franchise Default and Charge-Off Data. The $149 report tracks the total number of SBA-guaranteed loans dispersed to each franchise system over the past six years and lists the percentage of each system's loan failure rates and the percentage of dollars charged off. In aggregate, the report is encouraging. According to the June 15, 2007 report, in 2006 the total SBA loan failure rate was 5.9 percent; for franchise loans it was 6.9 percent. Twenty-nine franchise systems, including Comfort Inn, Primrose Schools and Firehouse Subs, had no loan failures at all. But another 30 franchises had failure rates of 33 percent or more (at the top are Obee's Soup Salad Subs, in which 55 percent of loans defaulted and Executive Tans and Hair Color Express, each with 46 percent). 

To obtain an SBA-guaranteed loan today, a franchise system must have a Coleman Report rating below 10 percent, finance experts agree. As with the Registry, non-SBA lenders also check the report for franchise system soundness. Lenders are also looking closely at franchise closures and transfers listed in a system's UFOC (FDD) and, again, are supporting only systems with less than a 10 percent failure rate. To ensure that their new franchisees can obtain loans, franchisors must shore up their ailing existing franchisees.

When Ron Berger purchased Figaro's Italian Pizza, Inc. (Coleman rating 26 percent), in Salem, Oregon, in 2001, the system was already troubled. Previous owners had pressured franchisees to open additional units too close together," Berger said. "We approved a whole bunch of closures." Today, Berger is working to prevent unapproved closures by negotiating lower prices for basic ingredients, like cheese and flour, for all 130 Figaro's franchises. "We've instituted a hardship program," Berger said, "for franchisees who encounter competitive or operational problems." Troubled franchisees can obtain a $10,000 interest-free loan and a temporary waiver of royalties and ad fees, he said, "and pay us back when they're doing better." Corporate pays for a special marketing campaign for ailing stores and helps franchisees who are not doing well to sell their units to new owners. "We had a new operator who took over a failing store last summer and immediately doubled the revenues," Berger said.

Watch out for twists and turns in the lending community

To stay solvent, lenders are frequently shifting their loan parameters and franchisors should appoint someone like Midas' Harry Oliver to stay on top of the changes. "Lenders who used to deal with systems that had been in business for two years and had 35 units open may now insist on five years in business and 50 open units," said Goldberg. And lenders today may abruptly stop dealing with a particular franchise company or an entire segment, like pizza, or an entire industry, like restaurants.

"Franchisors must develop multiple sources of financing," Goldberg warned. And must prove that their franchisees can make enough money to pay back their loans. "If you don't have an Item 19 (earnings claim) in your UFOC/FDD, add one, or put together a detailed analysis of unit economics you can share with lenders, " he advises.

John Dring, COO of Cartridge World North America (Coleman ranking 2.3%) in Emeryville, California, said, "A few years ago we fobbed new franchisees off to a list of lenders. Today we have 25 master managers in the field working hand in hand with four or five national lenders, to make sure they're comfortable with our concept."

The biggest challenge: Finding loans in new systems

New franchisors, with no track records of franchisee loan repayments, are in an especially precarious position today. Many lenders will not finance their franchisees under any circumstances. To be attractive to lenders that will deal with new systems, the experts offered this advice:

Design a robust training program to show lenders that your franchisees are prepared to run your business.

Select only strong, well-capitalized candidates as your first franchisees. You can't afford to have any of them fail.

Find a lending partner that believes in your concept.

Gail Johnson, president and founder of Rainbow Station, a childcare and after-school program for children up to 14 years old, in Glen Allen, Virginia, said, "When we started franchising in the last recession, we had two strikes against us. We were new and our units cost $5 million to build. I talked to many people before I met Michael Dunleavey (regional account manager for CIT Small Business Lending in Richmond, Virginia) at an IFA convention. Mike made it his business to make our financing happen. He brought so many people down from CIT's corporate office in New York to see our schools that he could lead the tours himself. CIT helped finance several Rainbow Station franchises and even approved two loans after the economy turned."

"Franchisors can no longer take financing for granted," said Siegel. "Franchisors who don't get involved in helping their franchisees obtain financing will be shut out."

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