The restaurant industry is entering a period of the unknown, a time of great opportunity but also great competition. Thought leaders from the finance and transaction world all agree that the "new normal" isn't going to look exactly like the old normal.
That was the consensus of three restaurant industry stalwarts who discussed what comes next during a Franchise Times panel, Creative Capital, Terms and Tactics in Today's Franchise Business. Joining the Dealmakers Week session with moderator and FT Publisher Mary Jo Larson were Tim Ring, an M&A expert at law firm Monroe Moxness Berg; Brett Bishov, a middle-market investment banker in the restaurant industry at Capital Insight; and Chad Spaulding, managing director at structured financing firm CapitalSpring.
Ring said there are two big things happening in the franchised restaurant space right now when it comes to financing growth or acquisitions.
"Two events are coming together that is compressing capital in the restaurant space. The first is three large institutions have largely redlined franchise finance," said Ring. "That redline is tier-two and tier-three concepts, big banks have moved away from that space."
That's much like living in a ZIP code where mortgage lenders won't lend. That makes it harder for those not-hot brands to get financing.
The second big issue, according to a survey Ring referenced, is roughly half of lenders pulled back from their typical lease-adjusted leverage rate.
In conjunction, those events made it harder to get capital from traditional sources. That pushes borrowers to offer more equity and a bigger piece of their business or find creative ways to get all the capital they need if they're not among the hot QSR brands that thrived during the last 16 months.
"Top-tier brands are desirable and it's really the byproduct of awesome performance. Chicken and pizza were a big winner during COVID. The brands that have performed are getting capital the Taco Bells of the world, Popeyes, KFCs, some of the better, more affordable products with good off-premises," said Bishov. For everyone else, "it's, how do you look at the credit and how do you underwrite based on the chasm of March and April of last year and how do you normalize? The short answer is there are lenders out there doing deals, they are just fewer and further between and more conservative posturing."
This comes just as many of those brands are looking to capitalize on the opportunity served up by closed restaurants or reinvesting the 2020 QSR windfall into new growth. That has led to a lot more creativity at the deal table, new sources of capital and alternative lenders willing to take the risk for a greater reward.
"We've also seen a need for creative capital in the mid 2000s and through 2007," said Spaulding. "In the last five years, the banks have been very aggressive in that time, but you’ve gotten back to a place where traditional lending and equity was all you needed, but now that's changed."
Spaulding said this is fertile ground for consolidators looking to build a larger portfolio of those not-top brands or expand their casual dining holdings, and firms like CapitalSpring that can help with alternative financing. But he stressed growth-minded operators should seek out long-term industry players that understand the bumps and curves of the restaurant space.
"A non-bank lender is technically taking more risk providing more flexible capital structures and those are the guys who, if you don’t really know the industry up front, you're going to get stomped pretty hard," said Spaulding. "If you haven’t seen this moon before, the economy pops, a [highway] exit closes, little things like that these guys go nuts and they don’t realize this is normal. And you have some 28-year-old MBA kid with you for the next six months trying to save your business that he doesn't understand, that happens all the time."
Bishov and Ring both noted that seasoned franchise financiers can make deals that make sense and carve out important wiggle room for the restaurant industry's typical and atypical cycles.
Catch more finance insights from these three franchise-finance gurus and where they see opportunties by watching the full panel. Register or access panel recordings here.