CIT | 5/16/16

So you need financing for your restaurants? Just like packing for a trip, you need some standard items – things to keep in mind before you pick up that phone.

There are a host of macro and microeconomic (or top down vs bottom up) reasons lenders like extending credit in the restaurant franchise space. One reason is industry growth. According to the USDA, the percentage of total food expenditures outside the home has grown from 26.3% in 1960 to 49.6% today, even though the per capita percentage of disposable income allocated to food has declined in relative terms. In fact, Americans spent more money at restaurants than at grocery stores last year for the first time since the Census Bureau started tracking that information in 1992. When times get tough, diners simply respond by trading down instead of staying home. And when Americans start saving elsewhere, like with currently low gas prices, restaurants are among the biggest beneficiaries.

While chain restaurant investments provide for attractive opportunities both to lenders (i.e., debt side) and owner/operators (i.e., equity side), they are not without risk. In the absence of hard collateral to backstop financing, lenders have to accurately assess Enterprise Values and whether a franchise borrower group will create enough free cash flow (defined as EBITDA less G&A allocation and capex captured in the P&L) to cover their annual debt servicing requirements for an acquisition, remodeling, new location, or other funding need. Multiple factors weigh into the lender’s credit decision, such as:

1. Sector Trends

Which of the main restaurant categories – full service, quick service, fast casual, and snack – are in growth mode and which are in decline? Is the Franchisor responding to, driving, or missing market changes and demands? There are always winners and losers. Although sector shifts don’t happen overnight, most lenders take an extended view regarding portfolio performance, which extends years or even decades and must be cognizant of broad trends.  Other considerations such as labor laws, supply-side input costs, demographics, household income trends, and interest rates will factor into a lender’s overall assessment of the sector.

2. The Brand

How is the system performing based on key metrics such as Same Store Sales, average unit volumes, COGS & Labor expenses and operating margins, and expected unit-level EBITDA? Is the concept performing above or below industry averages? Is the P&L insulated or susceptible to material input or COGS changes? How does the franchisee’s performance over the past three years stack up against these benchmarks?