Franchisors Offer Franchisee Financing

It used to be that prospective franchisees positioned to start a franchise business would secure financing from a bank, but more of these people are finding banks unwilling …

It used to be that prospective franchisees positioned to start a franchise business would secure financing from a bank, but more of these people are finding banks unwilling to lend to them. This is putting the squeeze on parent companies and now some of them are creating lending opportunities for interested investors by partnering with banks to guarantee against losses or other otherwise secure funding. Some of these franchises include Marco’s Pizza, Weed Man, Fastsigns and the UPS Store. Critics argue this could create conflict between franchisors and franchisees, but options remain limited in the struggling U.S. economy. For more on this continue reading the following article from TheStreet.

A lack of capital and uncertain economy is deterring franchisees from opening locations and wreaking havoc on parent companies’ growth plans. If the banks aren’t doling out money, how will they ever expand and hire?

One way is for a company to take financing in-house — whether by partnering with banks, creating financing arms to help franchisees through the lending process or securing private equity financing on more acceptable terms.

Not everyone’s in love with the idea.

“It’s okay for a franchisor to finance a small portion of the total investment, like the franchise fee, but I don’t feel that franchisors should become the actual lenders,” says Joel Libava, a franchise-acquisition consultant and author of Become a Franchise Owner!. “Great franchisors focus on franchisee profitability; that helps to grow a system.”

Instead, companies should be managing the process to make sure loans get approved and that “no stone is left unturned to make sure that franchisees can actually get funded,” Libava says.

But whatever form the help takes, it’s timely. According to the State of Small Business report by Pepperdine University’s Graziadio School of Business and Management, 35% of respondents who tried to raise capital in the past 12 months applied for bank loan — and only half succeeded in getting bank financing. The report, released Monday, surveyed 10,637 privately held businesses.

Here are five franchises that offer help to new and existing franchisees.

1. Marco’s Pizza
After decades of slow growth, Marco’s Pizza rebooted the franchise in 2004 when restaurant chain expert Jack Butorac, who has played a part in the expansion of Yum! Brands’(YUM) KFC, Chi-Chi’s and Tumbleweed, acquired the company.

Same-store sales at Marco’s are up 8.7% this year. As a result, the company looks increasingly good to franchise investors, and Marco’s has been ramping up expansion plans.

“It’s very important to us to have great product quality,” CFO Ken Switzer says. “That’s one of the things in attracting franchise prospects in the last few years. When you have positive same-store sales like this, there are very satisfied franchisees.”

Marco’s Pizza has 263 stores but has sold the rights to 1,200 and is on track to open as many as 65 by the end of the year. It plans to have close to 400 stores by the end of 2012.

Even with that momentum, franchisees are having a hard time gaining access to funding.

“No matter how great the product is, no matter how much support the franchisees have, if you don’t help with financing, there is only a limited number of stores you’re going to be able to open, because only a relatively small number of people have enough cash from savings to build their businesses,” Switzer says.

The company is doing what it can to get franchisees the funding help they need by, among other things, dedicating a team to help franchisees find appropriate lending programs — and advertising it on the Marco’s Web site. Besides offering assistance for SBA and conventional loans, the company has a captive leasing program and private equity funds available to qualified borrowers.

In 2009, the company formed Marco’s Assurance to provide a third-party guarantee to banks. It takes about $250,000 in hard costs to build out one store, and Marco’s Assurance will guarantee up to $50,000 of that if the franchisee defaults. The subsidiary will also provide funding to relocate a store if needed. Marco’s has so far issued about 25 third-party guarantees.

“I have a goal, and that is: If a banker is going to make one loan this year I want them to make it to our franchisee because it’s the lowest risk they can make,” Switzer says. “We have an internal goal to make sure we’re the easy choice to say yes to. And more and more of our franchisees are obtaining conventional financing.” Marco’s is searching for a national institution that could be considered a lender of choice to its franchisees.

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In August, the company launched its latest assistance program for franchisees by offering AmTrust Financial ServicesAFSI Personal Guarantee Insurance. The insurance policy will guarantee up to 70% of a franchisee’s loan in the event of a default.

“It’s just another part of the tools in the toolbox to help our franchisees and to make sure the financing is at the best terms available,” Switzer says. “Some lenders offer very high interest rates or fast amortization [terms] — that makes it difficult for them to grow and expand. We’re trying to make sure we guide our franchisees to get the best possible terms.”

2. Weed Man
Lawn care company Weed Man launched a plan last month to lend to franchisees looking to expand or build their businesses.

“We had great [franchisee] candidates with equity, but couldn’t get money from banks,” says Jennifer Lemcke, COO of Weed Man USA.

Typical start-up costs for a Weed Man franchise can be up to $50,000, which includes the franchise fee, training, computer system and purchase of a truck and equipment.

The company believes the lifetime personal rate of return on the franchises more than makes up for the upfront investment Weed Man would make — up to $40,000, Lemcke says. Weed Man has completed two deals since launching the program.

Weed Man began franchising in the U.S. in 1996. The company has sold agreements for 256 territories in the U.S., with the potential for 1,600. Weed Man has a lot of room for expansion, but “we’re looking to be halfway sold out in the next 10 years,” Lemcke says. “We are kind of the hidden gem of franchising.”

“A lot of people overlook the lawn care industry,” she says. “Once you get a customer [there is an 80% to 85% chance] of renewal year after year. It’s also been known to be recession-proof because people are staying home more.”

Last year, sales rose 15%. The company is on track for 20% sales growth in 2011, Lemcke says.

The financing program is available only for qualified franchisees, which means they basically have cash available to build the business but are looking for a cushion while the business is in start-up mode. There’s a five-year payback schedule, with payments beginning two months after training has been completed so the franchisee has a “bit of breathing room,” she says.

“It kind of puts people at ease,” she says of the program, because it’s “subliminally telling them that we believe in this so much that we’re willing to put the cash out for you.”

3. Fastsigns
Fastsigns is a 27-year-old company making signs, decals, digital prints and other custom solutions for businesses. The company has 530 locations in the U.S. and internationally, with most being domestic, owner-operated franchises. It has targeted another 1,000 locations across the world, 350 of them for the U.S. and Canada.

Fastsigns expects to end 2011 with an another 35 locations in place and add up to 50 next year.

All-in start-up costs for one store start at $170,000 but tend to average around $200,000, the company says. After seeing franchisees struggle with financing last year, the company realized it needed to come up with a program to help before plans for growth were derailed.

Fastsigns is one of several franchised companies partnering with The Bancorp(TBBK) and Franchise America Finance to offer an expansion financing program. Bancorp (with the help of the U.S. Small Business Administration) agreed to provide up to $4 million in capital for start-up and franchise expansion.

“We have the highest [franchisee] satisfaction scores in our category, and Bancorp came in and looked at all of that data,” says Mark Jameson, senior vice president of franchise development for Fastsigns. “In partnering, we have dedicated today $6 million of funding for new centers. And because of that our new-center growth will be in record numbers. If we didn’t have the financing, that wouldn’t be the case.”

Fastsigns’ base approval criteria for funding franchisees is a minimum net worth of $250,000, a credit score of at least 680 and at least $75,000 in liquid assets. “If they meet that criteria and are approved by us for a market, they’re essentially approved by Bancorp,” Jameson says. “The process is expedited because the bank doesn’t have to be educated every time on what Fastsigns does to assure the success of our franchises and new centers.”

Fastsigns also has aggressive conversion plans. The company rolled out a program to fund the conversion of independent shops to Fastsigns franchises.

“In that case we have a program where we internally finance the franchise fee to allow them to join the system at a much lower cost. They already have the equipment,” Jameson says.

The franchise fee is reduced by $12,000 to $22,500. Independent owners who convert can finance the franchise fee with as little as $6,000 down and pay the rest over three years with 0% interest.

4. The UPS Store
The UPS Store, a subsidiary of UPS(UPS), has more than 4,700 retail locations in the U.S. and Canada, but as a result of the capital drought on franchisees, it too has had trouble meeting growth initiatives.

“One of the biggest issues facing franchisors today is credit access,” says Stuart Mathis, president of UPS Store and a member of the board of directors for the International Franchise Association. “Many franchisors are struggling to find new applicants and find new stores because they can’t get financing.”

The UPS Store finds itself squarely in the middle of the problem, Mathis says. It planned to open 120 locations this year, many smaller stores in less-traditional locations such as hotels, college campuses and military bases, but will likely get only to 90.

Stores are not cheap to open. For the largest stores in terms of square footage, all-in costs average about $250,000.

Like Fastsigns, The UPS Store worked with Bancorp Bank and Franchise America Finance to come up with a financing program for qualified franchisees. Roughly $23 million in capital was made available through the program between new store expansion and store transfers. UPS is offering a fixed rate of 6% for franchisees approved by the end of the year.

To be approved franchisees need $60,000 in liquid capital as well as good credit scores, among other credentials, the company says. UPS also offers in-house financing to multistore owners and leasing programs for owners.

5. Gold’s Gym
Years ago Gold’s Gym franchise owners were fitness buffs. Today they are businessmen.

“The type of franchisee we are seeing has totally changed from what we saw 20 years ago,” says Dave Reiseman, vice president of communications at Gold’s Gym.

“Now you’re seeing either well-capitalized players coming into the space or people who don’t necessarily have any [fitness] experience, but they look at opening the gym as a good investment opportunity,” Reiseman says.

Gold’s Gym has roughly 700 locations internationally, the majority of which are franchised, but looking at growth projections brought the company face to face with the same franchisee capital troubles. Recognizing financing is hard to get, particularly for those in the fitness industry, the company decided to play a role in securing capital and, in March, established Gold’s Gym Capital, a financing arm to help existing and future franchisees secure financing for gym locations.

“Our industry has evolved over the years and the lending community hasn’t necessarily kept up with it,” says Chuck Lemar, senior vice president for Gold’s Gym Capital. “Lenders don’t readily embrace the fitness industry, especially commercial banks. There is this misconception of what a gym owner looks like. Today it is a business and it is a business run by professional people.”

The company wants to help franchisees put together presentations that will put lenders at ease. “Our job is not just to be in the referral business, but to put together the presentation to introduce lenders to the franchisees,” Lemar says.

For larger clubs, all-in costs could be as much as $5 million. Like The UPS Store, Gold’s Gym is looking to encourage franchisees to buy smaller franchises that are more appealing to the mass market and less costly for the owner to install and run. Smaller so-called “express gyms” typically cost between $1.2 million to $1.6 million to open.

The smaller clubs take out a lot of the overhead of a larger gym model, since there are no classes or personal training, and allow the company to enter markets that may not have been a fit for the larger locations.

Gold’s Gym is also looking to encourage strong operators to expand, even with the troubling credit environment, by offering a program in which existing franchisees can get an express club financed completely with no money down.

“It lets consumers get into the game, but it also lets investors get in the game, because it’s a lot less money to open one of these up,” Reiseman says.

This article was republished with permission from TheStreet.


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