So you need financing for your restaurants? Just like packing for a trip, you need some standard items - things to keep in mind before you pick up that phone. Beyond the broad economic conditions, multiple factors weigh into the lender's credit decision. Here are seven to consider:
Which of the main restaurant categories - full service, quick service, fast casual, and snack - are in growth mode and which are in decline? Is the Franchisor responding to, driving, or missing market changes and demands? There are always winners and losers. Although sector shifts don't happen overnight, most lenders take an extended view regarding portfolio performance, which extends years or even decades and must be cognizant of broad trends. Other considerations such as labor laws, supply-side input costs, demographics, household income trends, and interest rates will factor into a lender's overall assessment of the sector.
How is the system performing based on key metrics such as Same Store Sales, average unit volumes, COGS & Labor expenses and operating margins, and expected unit-level EBITDA? Is the concept performing above or below industry averages? Is the P&L insulated or susceptible to material input or COGS changes? How does the franchisee's performance over the past three years stack up against these benchmarks?
There are two categories: orderly and disorderly. The former represents a controlled closure for strategic or financial reasons while the latter indicates an unintended closure caused by poor performance. Store closings in a system aren't always bad - they may be tied to a naturally expiring lease or relocation across the street to better suit traffic patterns. But unplanned closures are a definite red flag.
If the borrower's lease on the premises or restaurant franchise agreement expires without options prior to expiry of loan term, a lender will struggle to offer financing. For suppliers with short A/R lifecycles this is not a significant concern since their terms often run only 30 days in contrast to the five to 10 year term for a loan. Does the borrower own their dirt or rent third party? What is the rent factor and appropriate cap rate if the borrower is looking for real property financing as well? A lessee paying above-market rents has less capital leftover to make their debt payments and all fixed charges get factored into their debt servicing covenants.
Is the proposed borrower a financial buyer with operating partners or an existing owner/operator? What is the purpose of the restaurant financing? Does the borrower have sufficient "skin in the game" and operating infrastructure to perform successfully? Is the partner growth oriented or content running a static business? What are the borrower's short and long term objectives?
Are the restaurants in good locations? How long ago were they renovated and do they represent the standard for the system? How will required renovations impact the valuation of the enterprise?
Every transaction has variables that impact the unit-level EBITDA. For example, a borrower with 10 existing stores may have sufficient corporate office infrastructure to absorb a five store acquisition without adding additional G&A expense thereby amortizing their cost base over a greater number of stores and enhancing the unit economics. Alternatively, a franchisee may be looking at a revised FMV lease structure at expiry of term that impacts his free cash flow negatively.
Concurrent with analyzing these factors and criteria, lenders prefer long-term partners with growth potential. For CIT, in our decades-long experience supporting restaurant franchisees, we have found that a smaller number of lasting relationships works best for us as well as the clients. When we know a franchisee's business inside and out, it positions us as a trusted advisor to guide them in selecting the most appropriate finance products and structures to assist them in maximizing their performance. Any franchisee who requires restaurant financing should consider carefully not just the terms of a first transaction with a lender, but whether that lender is sincerely invested in their future.
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For prospective operators who want a slice of the industry, there are expectations that go beyond menu items and counter service.