A recapitalization can be a precarious predicament. As uncharted territory, it can be extremely unnerving for both small and large franchisees.
Even the most experienced franchisees of national chains face intimidating executive management challenges. Between managing stores, developing personnel and fulfilling franchisor requirements, things can go wrong. Consumer trends can change overnight, significantly impacting the brand regardless of whether it's a “hot concept” or a fledgling brand. With the concerns of franchise royalties, commodity pricing and taxes and debt service, even the most successful franchisee can be caught off guard by a sudden market shift.
A franchisee can have several lender relationships that provide necessary funding for growth and working capital. All lenders have a variety of terms and debt-coverage ratios that require compliance on a continual basis. In a sales downturn, coverage ratios are strained and lenders are the first to instigate stringent debt-payment deadlines. The franchisee becomes a victim of the struggling brand overnight. This typically leads to the franchisor being advised of lender concerns, which in turn leads to a recovery plan commonly known as a “workout” or “recapitalization.”
A recapitalization can be a precarious predicament. As uncharted territory, it can be extremely unnerving for both small and large franchisees. The phones start ringing; stakeholders are calling and various “debt-solution” providers offer immediate services. A franchisee scrambles while evaluating offers from multiple providers. He finds himself at a fork in the road; he could choose a debt solution provider's offer which would yield immediate short term results, or hire a seasoned business financial advisor, who would provide a slower, but more effective long-term solution. Debt solution providers do not analyze the franchisee's long-term health of the franchisee's business, however, they can provide a short-term infusion of cash. Typically, they utilize the second mortgage on business or personal assets. Whereas, a financial advisor will slow the process down in an effort to restructure the franchisee's business appropriately for the long run, and also save him money.
A common solution in a sudden downturn is pushing back against the franchisor for solutions to improve sagging sales and brand appeal. The alternative is the proactive fix of selling operating restaurants that currently contribute cash flow to the franchisee. In the process of evaluation, the franchisee discovers that embedded real estate value can be tapped into, and is often 75 to 80 percent of the total value of the property. This value can be accessed by freeing funds with a sale-leaseback transaction and is sufficient to retire debt and/or fund an image upgrade. Should a franchisee also hire a real estate broker, a financial advisor can tailor a reliable recapitalization/workout strategy that can provide a franchisee with financial restructuring, and can leverage the franchisee into a positive cash position even though the brand may remain flat.
A typical workout strategy utilizes five major indicators to analyze a franchisee's financial condition. While these industry standards are no secret, the procedures are critical.
The initial assessment of the franchisee's business is the brand trend. If the brand is well established on a national and international level, it is considered a strong tier I brand.
The second step is the evaluation of the franchisee's business: the number of years in the business, concepts owned and operated, and how many units they have. The franchisee's size and strength play a large role in how they are assessed.
The third evaluation involves recommendations from third-party financial consultants. A good financial advisor is instrumental in creating a “road map” to troubleshoot the franchisee's situation and generate the most efficient approach to the franchisee's financial recovery.
Long-term financial strength is the fourth key factor in assessing a franchisee. The evaluation is contingent upon what the company assets include, such as fee properties, ground-lease properties and leasehold properties. Strong store sales are the best indicator of the franchisee's ability to pay rent for the term of the lease. In short, the evaluation of the franchisee's situation provides a comprehensive view of the franchisee's debt situation, and his ability (or lack thereof) to pay down his existing debt.
Finally, assessed fifth is the retail trade area in which the property is located. Desirable factors include large population, high median household income, big box trade area anchors and recent or ongoing development. By physically visiting each specific trade area, the financial advisor and an experienced real estate broker are able to determine retail (cap rate) value.
The downside of this restructuring is that it reduces overall ownership of the franchisee's properties. This will impact potential borrowing capacities in the future. Another downside is a business financial advisor can be a costly monthly expense; as his services are not always needed, retaining a financial advisor can seem like an unnecessary drain on monthly cash flow. Lastly, not all floundering franchisees have the time to see a restructuring through; for some, the short-term lower yield from the debt solution providers is all they think they have time for. Indeed, hiring these services can be a costly investment to a franchisee. Yet the payoff to all the creditors can be extremely beneficial, enabling the franchisee to be virtually debt free and maintain vastly improved debt coverage ratios.
Peter Nisbet of The Nisbet Group is a senior associate at Marcus & Millichap. The Nisbet Group has a unique market niche in focusing on triple-net lease workout and recapitalization strategies. Peter can be reached at www.nisbetgroup.comStories
