Franchises Battle Credit Crunch

“First-time franchisees are having the biggest problem,” says Mehta, who also operates a Dunkin’ Donuts franchise. “Banks are more comfortable with people who have experience and a track record. But even then they’re taking a closer look. To get a loan, franchisees have to be prepared to document their claims of anticipated revenue and income.”

Mehta says things have gotten so tough that even Small Business Administration lenders—banks whose loans carry SBA repayment guarantees of 75 percent or more—are seeking greater collateral from borrowers.

Banks have also reduced the values they assign to the underlying businesses, he says. “Previously, banks would value a Dunkin’ Donuts franchise at five times earnings before interest, taxes, depreciation and amortization, and then they would loan up to 90 percent of the valuation,” he says. “Now they only value the operations at four times EBITDA, and generally limit the loan to 80 percent of the valuation.”

Mike Ghadia, a veteran franchisee who owns Papa John’s pizza outlets and Bojangles'' Famous Chicken ‘n’ Biscuits restaurants in northern New Jersey, found himself among those feeling the credit squeeze when he secured a $330,000 loan last month.

“Banks are still lending, but they’re a lot more careful and it can be tough for franchisees that don’t have a lot of experience,” says Ghadia, 41, who adds that he’s been involved as a franchisee since age 17, when he opened a Domino’s Pizza restaurant. “The bank was very cautious with my loan, even though I have a history of doing well with my stores.”

He adds that lenders prefer to see franchisees who are buying rather than leasing a store and land. “If you lease your land, then you’re likely to pay a higher [interest] rate, and the repayment period may be as short as 10 years,” he says. “If you own the land, then the rate is better and the loan is more likely to be approved for a 30-year period.”

Ted Morgan, a senior vice president and credit administrator with BNB Bank, notes that “franchises in particular are affected [by the credit crunch] because they tend to be retail establishments, and their collateral is often limited.

“Loan delinquencies in general are rising,” says Morgan, whose Fort Lee bank is an SBA lender, “and I’d say that many banks, including SBA lenders, are reining in their activities, especially with startups. At one time, an SBA guarantee was enough to secure a loan, but now banks are looking for additional collateral to cover themselves, particularly if a franchisee has limited experience.”

Darrell Johnson, CEO of Frandata, an Arlington, Va.-based company that tracks franchising activity, says franchises had a relatively easy time obtaining financing over the past five years. “Now, however, lenders have gone back to the traditional underwriting standards,” he says. “As a result, it’s harder for franchisees to get loans.”

While this development may be painful for franchisees, the long-term impact could be good for the industry and for banks, says Justin Klein, a partner in the Red Bank law firm Marks & Klein LLP that focuses on franchise law.

“In some ways, the return to traditional underwriting standards is a good thing,” says Klein, who works with new and existing franchisees on contract review, negotiations and other matters. “It means that banks are being more careful about extending financing. They’re taking a good, hard look at the system and appear to be favoring people who already have franchises and are seeking to expand, instead of the people who are jumping in without knowing a lot about the risks that can be there.”

E-mail to mdaks@njbiz.com