For financiers, backing the right brand is every bit as important as backing the right investor.
The vast majority of franchise investments are financed by loans. Whether you are an experienced franchise investor adding a new brand to your portfolio or an aspiring business owner preparing to open your first shop, if you are purchasing a franchise unit, there’s a good chance you are going to look for third-party financing.
Most investors expect to be vetted when applying for a loan. Banks and other lenders want a clear picture of the candidate’s financial history and projections, business plans, professional experience and host of other factors before awarding a loan.
What some investors don’t know is just how heavily lenders weigh the health of the brand in their decision. Some lenders will rule out certain franchise brands as a matter of course, regardless of the financial standing of the investor. Those same lenders may leap at the opportunity to finance an investment in a high-rated brand even if the investor is seen as a riskier candidate.
Mike Rozman, the CEO and co-founder of BoeFly, an online marketplace that connects commercial investors with lenders, says that kind of brand-oriented lending “has been bubbling up for a while.”
“I think a lot of lenders are thinking more programmatically,” Rozman said. “They want to evaluate a franchise brand, rather than the investor, and get comfortable with the system as a whole. Once lenders are comfortable with a concept or brand, they start lending within that brand or concept.”
Many lenders maintain lists of brands that they will finance. If a candidate wants to invest in a brand that isn’t on the list, the lender won’t even consider the proposal, according Erik Herrmann, Managing Director and Head of Restaurant Investment Group for CapitalSpring, a restaurant-focused investment group.
“What you often find with a lot of the more conventional lenders in the market is that most of them kind of live and die by brand lists,” Herrmann said. “So bigger banks may only be able to lend into five or 10 brands depending on their screening protocols. If you are a franchisee operating in a system that’s not on that list, you may have challenges accessing the capital you need.”
According to Craig T. Weichmann, Vice President of Pinnacle Commercial Capital, much of the selection process for those brand lists comes down to size.
“Generally speaking, there are three tiers of franchise brands, which depend largely on the size of the brand,” Weichmann said. “From a lender’s perspective, size is traditionally seen as very important. The biggest banks typically focus on the largest, tier-one brands. Right now, at the top of the heap is Taco Bell. That’s a premier loan that every brand clamors to get a shot at.”
But that strict adherence to brand lists by larger banks provides potentially lucrative openings for brands who are less dogmatic in their approach.
Weichmann points to a shakeup in brand ratings this year when Nation’s Restaurant News ranked Domino’s above Pizza Hut in its annual Top 200 report for the first time. Where many banks saw Pizza Hut’s slip as a reason to stop financing deals with that brand, Weichmann says Pinnacle Commercial Capital saw an opportunity to pick up valuable deals that others are ignoring.
“There have been some warning signs that Pizza Hut was slipping for a while, and now banks are wondering if they should be financing Pizza Hut deals," he said. "But those rankings can represent superficial slips, so if we have an investor who wants to purchase a block of Pizza Huts, we’re not going to rule it out. We want to learn more about who the franchisee is, what kind of game plan they have and if they are cutting the appropriate deal with the brand.”
Franchise investors looking for a loan to invest in a smaller-name brand are by no means out of luck, they just have to dig a little deeper. Many lenders specialize in certain industries and segments, and those companies are likely to be more interested in the quality of the deal than the brand’s ranking against other franchises.
CapitalSpring, for instance, is “not so much in the business of picking brands that we want to be in,” Herrmann said. “We invest only in the restaurant space. We’ve invested in 50 different brands and thousands of restaurants over the past 13 years. So we know the space. We’ve seen every angle of it. We have encountered all of the challenges that our franchisee partners are likely to face. We have a strategic perspective that other lenders don’t have. Compare that to a conventional lender operating across multiple industries, and it’s just a completely different level of engagement.”
As larger lending institutions continue to work within established brand lists, loans for top-rated brands are increasingly the easiest to secure. For now, franchise investors working with smaller or lower-rated brands will likely have to find institutions more explicitly aligned with their segment.