Good News For Finance Seekers

Good News For Finance Seekers

With the recession in the rearview mirror, operators finally have more financing options available to them. Finding those options, though, is another story.

downloadLet’s talk money.

First, the good news: There is plenty of money available for foodservice operators and brands looking to grow or strengthen their concepts. Stakeholders from across the restaurant financial services spectrum agree on that. U.S. Small Business Administration (SBA) financing is at a five-year high. Hospitality is a hot industry again for private equity firms. Alternative funding options are becoming more common and regulated. And, more importantly, consumer disposable spending is back up.

“There’s a huge amount of money in the market,” says Ed Prensky, CFO of Plamondon Hospitality Partners, operator of 20 Roy Rogers, “both in equity and lending.”

Signs of this abound. GE Capital, Franchise Finance (GEFF), for example, announced in October an initiative targeting “entrepreneurial” multiunit brands and franchisees in the mid-market space. Soon after, GEFF loaned Specialty’s Café & Bakery Inc.—a 50-unit, fast-casual bakery/café chain—$37.5 million to refinance existing debt and provide funds for growth. That announcement was followed in January with news of a $7.6 million loan and $2 million revolving credit line granted to Milano’s Restaurants International for the development of a new fast-casual pizza concept, Blast 825° Pizza. (GE Capital announced after this story was written that it would sell its finance division.)

Now the bad news: The outlook is not as positive for those new to the industry. Post-recession, banks and investors are more cautious with whom they do business. Unless an operator can demonstrate proven restaurant experience or partner with an established enterprise brand, raising capital in this financial climate is tough—but not impossible.

“It’s more challenging for the little guy to get into the restaurant business than it was in the past,” says Tom Finn, vice president of franchise development at The Greene Turtle Franchising Corporation. “Bankers are sensitive; they still view the industry as a risky environment. It’s hard for the entrepreneurial types to raise capital. But there’s more than one solution.”

To get a sense of what is possible and what makes sense at which stage of the growth process, we talked to franchisors, franchisees, operators, bankers, and investors about three of the top ways to raise capital—commercial lending, equity investment, and alternative financing.

images (2)Working with banks

Matt Andrew, CEO of the 29-unit Uncle Maddio’s Pizza Joint, uses phrases such as “cautiously optimistic” when talking about today’s commercial lending environment. One can hardly blame him for being reticent. Andrew was president of Moe’s Southwest Grill from 2001 to 2006 and started Uncle Maddio’s one year after the Great Recession began. He’s seen how quickly fortunes and tastes can turn in foodservice.

“I’ve never seen before—and probably shouldn’t—the types of deals we were seeing in 2004–2006,” Andrew says. “A fifth-grader could have gotten a $300,000 loan. But it’s a new day.”

Andrew is referring to increased scrutiny and lending requirements by both federal and banking officials. The bank-financing climate has loosened, but it’s still tight compared with pre-2008 levels—especially for emerging brands and new operators. It’s no longer enough to have a good idea. Operators hoping to get a capital infusion from a bank also need a good business plan or track record to tell their story.

“Money is there for the right candidates,” says Jeff Jackson, president of Billy Sims BBQ, a Tulsa, Oklahoma–based fast-casual franchisor with 44 units. “Banks are looking for personal wealth and experience. They’re looking at the concept, too: the training available, the track record, how many units. The franchise has to be solid.”

Even with a solid franchise behind them, entrepreneurs new to the foodservice world will find that conventional loans are virtually impossible to secure. That’s where SBA loans come in.

Since 2009, the SBA has approved through commercial lenders more than 30,000 general small business, or 7(a), loans in the foodservice space, with an average deal coming in just under $300,000. Last year, 5,784 restaurants received SBA funding, a 9.7 percent year-over-year increase from 2013.

“Our business banking division has seen an increase in SBA lending activity since 2011,” says Cristin O’Hara, managing director and Restaurant Finance Group head at Bank of America, the No. 1 lender in the SBA market. “We’re working with operators with less than 10 units and $50 million in revenue.”

The SBA offers a variety of loan programs for very specific purposes. The four main categories are: general small-business loans, or 7(a); real estate and equipment loans (CDC/504); microloans; and disaster loans. Approval for 7(a) general business loans, the most common type used in foodservice, is weighed against several factors, including a would-be borrower’s debt-to-worth ratio, cash flow projections, available capital, collateral, and resource management.

Almost all of Uncle Maddio’s 56 franchise groups got their starts with a SBA-backed 7(a) loan, which makes Roger Wagerman, the chain’s vice president of sales and development, somewhat of an expert. The process, Wagerman says, has its frustrations—significant paperwork and lengthy processing times, for example—but for many operators and brands, it’s the only option.

“Banks are only doing SBA loans for emerging concepts like ours,” Wagerman says. “The good news is more banks are opening SBA programs. We get calls all the time from banks trying to get our development business.”

The growth opportunities banks see in SBA lending means bankers with expertise like Rebecca Grant, vice president of business development at Ameris Bank, are in high demand. Grant is an almost 30-year veteran in the SBA lending space and has a plethora of advice for operators and brands looking to take advantage of the program.

The first step for a franchisor, she says, is registering the brand on the Franchise Registry to streamline approval. The Franchise Registry lists every SBA-eligible franchise in the U.S. and is run by FRANdata. Registration is free. Eligibility is determined based on franchise’s submitted disclosure documents. Inclusion on the list is an indication that a brand’s franchise agreement allows an operator to qualify as a small business owner. Participation is voluntary—sort of.

“You have to be registered for most banks to even consider doing an SBA deal with your franchisees,” Grant says.

Once registered, smart franchisors should do everything possible to pre-qualify and prepare candidates to expedite the SBA loan process.

“You can’t close an SBA loan without a lease in place,” Wagerman says as an example of the type of knowledge he shares with franchisees. “You can’t have any bankruptcies or felonies on your record. You need to prove bankable assets … and be able to defend your projections.”

download (1)Still, strict criteria aside, the dollars for growth are there.

“It’s a borrower’s market if you’re an established brand,” says Pierre Panos, founder and CEO of Fresh To Order, a 14-unit fast casual based in Atlanta. “Banks will lend to their good customers and strong operators.”

To keep Fresh To Order on the minds of the three to four banks with which it has relationships, Panos sends regular updates on Fresh To Order’s performance and growth. “The best thing you can do for your brand is know your bankers,” Panos says. “Maintain a connection even when you don’t need money. It takes time and work, but it’s worth it in the end. Well-managed debt is a great asset.”

Investor dollars

Private equity firms are increasingly hungry for hot foodservice brands.

“If I wanted to do a private equity deal today, I could,” says Uncle Maddio’s Andrew. “I probably get a phone call a week.”

And he’s not the only one. Panos at Fresh To Order says he receives almost weekly calls, too. Both attribute the interest to their place in the fast-casual category, a segment that is very attractive to investors.

“The country is still wide open for fast casual,” Panos says. “Fast food is saturated. Casual dining is dying, and fine dining suffers when the market is down. Fast casual offers great store-level profits inside a smaller footprint.”

Neither Fresh To Order nor Uncle Maddio’s is ready to take on additional partners right now. But for those facing a liquidity event such as a merger or buyout, or those looking for debt-free growth capital, opportunities abound.

Cohnreznick, the accounting services firm, included the restaurant category among “Industries of Particular Interest to the PE Space” in its Momentum 2015: Middle Market Private Equity Outlook report. The report cites record-high quick-service restaurant valuations of 14 times EBITDA (earnings before interest, taxes, depreciation, and amortization) and improved credit terms, low interest rates, and economic stability for the increased interest in the segment. Investors are both buying and selling interest in restaurant companies at top dollar.

For many, the exit strategy is an initial public offering. Restaurants IPOs raised more than $440 million in 2014. Cohnreznick predicts 2015 IPOs will be just as strong. If Shake Shack’s January IPO is any indication, Cohnreznick is right. Shares of Shake Shack went from $21 to $49.50 on the first day of trading.

“There’s a lot of equity interest in foodservice overall because consumers are coming back,” Prensky says. “Investors have taken note of the industry’s focus on maximizing sales and ROI and developing steady performance and a steady customer base.”

The interest goes both ways. New York–based Alliance Consumer Growth (ACG), whose $44 million debut fund helped Shake Shack grow from a food cart to a 60-unit global chain, regularly fields unsolicited inbound calls from investment bankers hoping to bring them in on the next big restaurant deal. But ACG does not partner with just anyone. It proactively seeks emerging brands in the restaurant and consumer product goods categories. ACG’s sweet spot is deals in the $5–$15 million range where the firm can come in as a minority stakeholder and help a brand with 15–20 units grow through ACG’s access to expertise and resources around site procurement, financing and reporting, executive and board recruitment, and exit strategies.

Tampa, Florida–based fast casual PDQ is another of ACG’s investments.

“We spent a lot of time identifying and building relationships with Shake Shack and PDQ,” says Josh Goldin, ACG cofounder and managing partner. “We view them as best-in-class concepts in their categories.”

The need for knowledge, not capital, was the catalyst for both the Shake Shack and PDQ deals.

“There are places to go if you just want money,” Goldin says. “A good investor should be a value add, providing resources and opportunities to network with other emerging concepts. Do your diligence. Investment firms are very different culturally and philosophically.”

Bob Barry, CEO of The Greene Turtle, echoes that sentiment.

“The money is the easy part,” Barry says. “You’re really looking for additional help.”

Barry speaks from experience. The Greene Turtle partnered with JPB Capital Partners, a Columbia, Maryland–based private equity partner for lower- to middle-market companies to grow its franchisee base. JPB Capital is the majority stakeholder in The Greene Turtle Franchising Corp. Its restaurant portfolio has included brands such as Kenny Rogers Roasters, Baja Fresh, La Madeleine, and Caribou Coffee over the years.

“My interest was finding somebody who understood the consumer business,” Barry says. “I want an outside perspective. You have to go surround yourself with people smarter than you.”

To gauge whether a specific private equity firm is the right partner, Barry says, operators should ask the firm the following questions: What is your focus? Why are you interested in my brand? What is your fund philosophy? And, what are your performance expectations and the time frame around them?

In cases where the equity firm takes a majority stake, alignment on goals and expectations is particularly important before signing over a portion of the company.

“You have to understand they’re purchasing your brand,” Barry says. “You will be working for the private equity group. You are no longer the final say and can even be ousted if they don’t feel they’re getting the ROI they want.”

images (3)Non-bank loans

For operators without enough cash on reserve or an established line of credit, or those without enough buzz to attract investors, alternative lending—non-bank loans—is increasingly becoming a solution to access capital. Approval and terms are based on transactions and revenue versus credit worthiness and assets, which means a start-up with little credit history can find funds. Other advantages include greater flexibility to manage cash flow and quicker access to cash. In some cases, business owners can be approved within 24 hours and receive funds the next day.

“We are not going to provide the long-term dollars that are going to help somebody open a multiunit operation,” says David Sederholt, executive vice president and COO at Strategic Funding Source, an alternative funding company that works with small and midsize companies. “Our average loan is $35,000–$40,000 and is used for all kinds of things.”

Though it’s estimated to be a $3 billion per year market, non-bank lending is relatively new. CAN Capital, another alternative lender, began operations in 1998. New players to the market include PayPal, OnDeck, Square, Kabbage, and Lending Club. Each uses its own unique algorithm to determine financing pricing, amounts, and terms.

Products in the space fall under one of three categories: merchant cash advance, which is a pre-paid purchase of future credit or debit card receipts, wherein financing is based on average credit card sales; working capital loans, which offer money to operate the immediate and short-term needs of a business, such as payroll or other reoccurring payments, but is not intended for investing or buying long-term assets; and social lending, in which investors bypass financial institutions to lend directly to borrowers, often through online portals.

The easy access to capital that these products and companies provide does come with a price, though. Interests rates can be up to 30 percent.

“Our funds are much more expensive than a traditional lender,” Sederholt says. “But it’s available.”

Sederholt also cautions would-be borrowers considering alternative funding to take a hard look at the lenders—especially since legislation and regulation has yet to catch up to the industry’s growth.

“There are many reputable firms out there,” Sederholt says. “But there are also those who are not. Do your homework. … Are they transparent around their operations, their officers, where they are based? Are they receptive to your needs? Do they have a restaurant specialist on staff?”

The most important question operators should ask before seeking capital from any external source, experts say, is: Why do I want to grow?

“You have to have a plan,” Plamondon Hospitality’s Prensky says. “And then you have to take the time to think about every aspect of your operations to make sure your plans are realistic. You can’t be so wedded to growth that you stress your existing operations. Don’t be afraid to step back and say we’re not going to do that just because the money is available. That’s what separates the good operators from the bad.”

[franchises ids=”3701,3705,3709,3711,3712″ display=”name” ” count=5]