How franchise financing has changed, and where it might be going next.
Franchising has been around for more than a 150 years (since 1851, not coincidentally), and in that time, the business model has endured seismic economic shifts, both domestic and global, and evolved through countless permutations. In the middle of the 20th century, franchising settled into the mode it is still most commonly associated with now, as the first wave of quick-service restaurants turned to a franchise model. But the finer points of the industry have not stopped evolving. In just the past ten years, technology has transformed the way franchisors approach lead generation, development sites and a host of other internal and customer-facing operations. In that same timeframe, the U.S. economy has slowly bounced back from a devastating recession. Small business lenders are opening their pockets to a wider pool of candidates, and franchisors are eager to invest in development. But no boon time lasts forever.
We asked four franchise financing experts what the lending landscape looks like today, and where it might be headed next. Here’s what they had to say.
Lenders are betting on brands
“I think a lot of lenders are thinking more programmatically,” said Mike Rozman, the CEO and co-founder of BoeFly, an online marketplace that connects commercial investors with lenders. “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. That’s a strategy that’s been bubbling up for a little while.”
The brands that lenders choose is often determined by size, says Craig T. Weichmann, Vice President of Pinnacle Commercial Capital.
“Generally speaking, there are three tiers of franchise brands, which depend largely on the size of the brand,” Weichmann said. “From a lenders 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.”
A rising-rate environment
For years after the Great Recession, interest rates were kept low in an effort to spur economic growth. Now that the economy has stabilized, the Federal Reserve has started to raise interest rates to stave off inflation. As a result, taking out small business loans is becoming a more expensive proposition, even as access to capital remains abundant.
“We’re in a rising-rate environment, which will likely start to put some pressure on franchisees, especially if they have meaningful capital expenditures like remodels on the books,” said Erik Herrmann, Managing Director and Head of Restaurant Investment Group for CapitalSpring.
Franchisees are selling.
As interest rates rise, business owners are seeing a greater incentive to sell, says Brian Frank, Senior Vice President and Group Head of Franchise Finance for Texas Capital Bank.
“I think you are going to continue to see franchisee-to-franchisee sales,” Frank said. “There is a first generation of franchisees that have been doing this for a long time and there’s an opportunity to sell. As interest rates rise… the labor market is tight, and there’s higher pressure on minimum wage. As franchisees are forced to better manage costs, financing is going to become an even bigger focus moving forward.”
Lenders are taking risks.
For banks and lenders, a growing economy makes it easy to take to take on a larger portfolio of loans. Too easy, according to Weichmann.
“We’ve moved into an era of what some people see as easy money,” he said. “For the last decade, rates have been extremely low and the growth of the industry has been strong, as has been the performance of operators. But with that kind of easy money, it’s easy to become careless and make loans that you shouldn’t be making, which we’re seeing from a lot of institutions right now.”
Franchises are more selective
While banks and lenders are taking on more projects, franchisors are becoming more careful with who they bring into their system, vetting prospective franchisees based on their goals, skills and experience rather than their access to capital.
“[Franchisors are] being much more selective,” said Rozman. “It used to be that they would sign up anyone who could sign a check. Now they are much more careful to make sure they are selecting owners who have the wherewithal to actually run the units, which is definitely a good thing for both franchises and franchisees.”