Financial Summit. The New Normal. Part One. Part Two

Financial Summit

• What is the New Normal? • What are lenders

looking for: – Franchisors – Franchisees • What are reasonable

development schedules for lenders?

• What did the stimulus stimulate for franchising?

Part One

• Leverage Ratios and Debt Service ratios • Is Private Equity right for

my company? What will it cost?

• What is the reality on Roll Over Business Startups (ROBS)? • Leveraging deferred

compensation to fund reimaging strategies

Part Two

The “New Normal”

• Selective lending to very strong franchise concepts • Rates are up to 9%-14%

• Availability to multi-unit operators that are thriving in the current climate only

•50%-60% advance rates/ outside collateral required Leasing Alternatives:

• Available for expansion and re-imaging programs • Rates from 9%-20% depending on credit

• Limited availability for start-up equipment packages – 15%++ interest rates

The “New” Normal

SBA Lending

• Pricing – SBA Loans are capped at rates that are currently below the market rates for commercial loans.

• Secondary Market – The guaranteed portion of SBA loans are sometimes sold on the market. This market has been eviscerated by the credit meltdown. The market has self corrected, and is working properly without any help from Uncle Sam!

• Guarantee Faith – Loans submitted to the SBA for re-purchase have seen their guarantees invalidated due to a technical or subjective breach. Lenders rely on the guarantee in making SBA loans, as they are almost always under-collateralized.

The New Normal- Best Practices

• Make your brand bank friendly – Read your FDD with your banker hat on…

• Bank Credit Report – FranData • Lender Addendum • Your FDD is not your friend

– Enhance credit if you can • Prequalify prospects correctly

– FICO is only a guide

– Real Injection funds, not borrowed

– Spousal income or post closing liquidity needed – Resume issues, especially in food sector

Industry/ Geography Issues

Industry/ Geography Issues

• Food Sector Moratorium by many lenders

• Major tightening on start ups – moratorium by some lenders

• Size Matters!

• Most lenders have minimum loan sizes of >$200k • Areas with big housing issues are being looked at

negatively by lenders, unfortunately, many of these areas are where franchisor growth has historically been targeted.

How to get access to capital when

demand > supply?

Understand What’s Happening • Lender conservatism dominates

• Most lenders today are less experienced franchise lenders

• Preferred lender model is 20th_{century concept}

• Lenders are cherry-picking

Development Schedules & Lenders

progressing until:

– Unit #1 us open for 12 months

– Unit #1 is cash flow positive and paying 1.3X debt service + owners salary

• Unit #3 can generally start after cash flow is sufficient from units 1&2 to service all debt • CLEAN books and records from franchisee.

What did the stimulus stimulate?

• SBA Lending

– 90% Guarantee

– Removal of borrower fees – Change in size limitations – Loan amount raising to $?MM – Higher Regulatory oversight

• Conventional Lending

– Higher Regulatory oversight • Bank Failures/conservatism

What Type of Financing is right for my

investment size?

< $100k CASH + 401k $100k - $200k Above + HELOC $200k-$2MM Above + SBA Loan $2MM+ Conventional lenders or SBA?

Practical Applications by a Franchisor

Credit Crisis

Effects-• Demand for funds is higher than supply • So, banks can be, and are “picky” to whom

they lend

• They are seeking to improve the Risk vs.

How Lenders Are Seeking to

Improve the Risk / Reward

Relationship

• Seeking borrowers with less perceived risk • Seeking business models with less

perceived risk

How Lenders Seek to Reduce Risk

with Borrowers:

• Higher equity required • Higher credit scores

• Higher Cash Flow coverage required (Creates a larger margin of error) • Seek borrowers with more experience • Seek a secondary source of repayment

How Lenders Seek to Reduce Risk due

to the Business Model:

• With Franchisors that are historically successful

• With Franchisors that they believe will help insure they (the lender) get paid

• With Franchisors that go the “extra mile” to insure franchisee success

Lenders Seeking More Equity:

• 30% equity now seen as minimum • Higher equity is more consistent with

historical trends, but pendulum may have over-reached (20% down days gone) • Higher equity ratio does reduce total debt

service and lender risk

What Lenders Are Asking for to

Reduce Perceived Risk With

Borrowers

And What Franchisors Can Do…

If Higher Equity Required…

• Contribute equity to franchisee via initial franchise fee reduction or gift

• Help find “partners” (but screen them) • Analyze every line of PFS for hidden cash • Don’t forget 401k conversion programs • Form a Private Equity fund to contribute

Lenders Seeking Higher Cash Flow

Coverage Ratios

• Due to uncertainty, lenders want a greater margin of error

• Greater scrutiny of Pro-forma’s and assumptions (takes more time to do deal) • Typically, EBITDA of 1.25 or more times debt

service (and some look at EBITDAR)

If Higher Cash Flow Coverage

Required…

• Try to lengthen initial amortization period • Revisit the business model (Are you doing

everything you can to improve cash flow?) • “Require” higher leasehold improvement

allowances from landlord

• Consider corporate buy-down of interest rate

Lenders Seeking a Secondary Source

of Repayment

• From other stores or businesses • Spousal income

• Third party guarantees (who can repay from cash flow and not sell assets)

If Secondary Source of Repayment

Sought…

• Find a capital “partner” that invests and guarantees loans

• Consider a direct franchisor guarantee of finance program

• Consider an indirect guarantee of loans through loan loss program

If More Experienced Franchisees

Required…

• Recruit from company owned units • Lengthen training programs • Focus on growth from experienced

franchisees

Franchisors can help Reduce

Perceived Business Model Risk

• Document your success with FRANdata Bank Credit Report

• Develop a “special assistance team” to help struggling units that want to improve

• “Think through” what else can be done to reduce perceived risk

Guarantee Franchisee Loans

• Directly guarantee first dollar loss in lender “Financing Program”

• Indirectly guarantee a portion of any loss through a subsidiary or affiliate on any loan • “Do the Math” (You may be pleasantly

surprised)

• Remember FDD considerations

Develop Relocation Programs

• Goal is to relocate a business with a “bad location”, but has good management • Requires appropriate lease language • “Do the Math” (It may have great ROI) • Remember FDD considerations

Develop Re-Sale Programs

• Don’t let “new sales” goals interfere with the “big picture”. Re-selling a struggling location is cheaper than its failure.

• Consider a package of incentives to all low volume re-sales

• Franchisor should consider paying the brokerage commission (“Do the Math”, it may have great ROI)

Scrutinize Every Transaction

Involving Borrowed Funds

borrowed funds

• Review terms of new store financing to insure “Margin of Error”

• High level of scrutiny of SBA loans • Remember, loan defaults and franchise

closures do count against you!

Other Thoughts…

• Know the lender. Franchisors should never submit unqualified applicants

• Consider using a loan broker as they have multiple financing options

• Don’t go to any bank unprepared. “Amateurs” don’t get loans today

• Franchisor should offer a “system” solution to package all loan requests

And Finally…

• Document what the Franchisor is doing to insure unit level success. Don’t assume “they know”

• “Do the Math” on guarantees, relocation and re-sale programs. You may be pleasantly surprised

• Maximize unit level economics. That makes everything possible

Case Study

Background

• Based in Charlotte, NC, Driven Brands is one of the leading franchisors in the automotive aftermarket with:

– Nearly $1 billion in system sales

– 1,500 retail locations in 7 countries plus over 300 vans providing mobile services

• In 2008 acquired Maaco which combined with Meineke allows us to manage two of the best known brands in the automotive

aftermarket with > 90% brand awareness

Financing Challenges

• Historically the great majority of franchisee funding was obtained through SBA National Preferred Lenders (and we all know where that has gone!) • Location failure rates of 3% - 5% in line with

historical averages, but skewed impact on SBA default rate cause additional financing concerns • Loan size is at bottom end of desired bank

financing range (particularly for Meineke) • Increased requirements for industry experience

Actions

• Early in the credit crisis, began discussions both internally and with external advisors on proactive actions to be taken to continue flows of

development funds.

• Identified both financial and operational tactics that could be employed that could help address the both the external and internal issues that would impact financing availability

Dedicated Resource

• Historically, both Maaco and Meineke enjoy annual closure rates of about 4-5%, which is well below SBA averages for small

businesses. But good is never good enough…

• Enter Jerry Allen, a former Dunkin Donuts and Meineke Franchisee, with significant experience in turning around troubled businesses.

Dedicated Resource

• The goal was to save the Center while attempting to minimize any financial loss experienced by the lenders

• Process:

– establish a relationship with the landlord, bank and vendors

– develop an exit strategy for the existing franchisee with the ultimate goal of a seamless transition to new ownership

Franchisee segmentation

• As with any mature business, there are varying levels of dealer acceptance to changes in the business model brought about by changes in consumer habits and desires.

• Both Maaco and Meineke developed

methodologies to identify those franchisees who most closely followed the business system to determine if there was any impact on franchisee success

Franchisee segmentation

• Maaco Certification program

– The certification of a center is contingent upon them achieving a number of operational hurdles that indicate

– Centers that perform the actions necessary to achieve certification have significantly higher sales and more importantly higher profitability and lower failure rates.

Franchisee segmentation

• Meineke STAR Ratings

• Based on 27 different criteria • Most objective technique

• Evaluates Centers on following the Meineke System – One Star Centers average 2.2% of total sales in

overall profitability

– Five Star Centers enjoy 22.6% of total sales falling to the bottom line … a 10x difference in overall profitability!

Franchisee Segmentation

• By analyzing the performance of both brands on a segmented basis, assurance can be given to lenders (and prospects!) that the underlying business system is sound, financially viable and a worthy lending risk • Lending decisions can then be made based

upon the facts and circumstances of each individual

Bank Credit Report

• Need to communicate proactive actions to banks

• Complicated capital structure causes financials to be confusing to lenders

Bank Credit Report

• Engaged Frandata to prepare a “Franchisee Bank Credit Report” that is an independent document that can be shared with lenders and identifies:

– Lending trends of the brands

– Proactive actions to be taken to minimize lender loss

Other Financing Strategies

• Seek more financing from developers of Build to Suit locations (have them fund the FF&E)

• Significant shift in lending from national players to the local regional banks

• Seek creative ways to lower the cost of entry (for example, through seeking used

equipment)

Other Financing Strategies

• Much higher utilization of self-directed IRA’s and other creative financing solutions • Sourced more second generation space

where landlord includes equipment in lease and therefore lowers cost of entry allowing an all cash deal

• Exploring franchisor partial loan guarantees

Results

• Despite both the credit market difficulties and the general economic conditions, we are on pace to open as many or more locations this year in BOTH brands than either’s historical averages