Trends in Financing Franchise Systems:
Will Franchises continue to find willing lenders?
(This article appeared in the October 2002 edition of Franchising World)
By Henry Price
As we move into the fourth quarter, franchisees should continue to find capital but in the hands of fewer lenders. Continued consolidation in the financial services industry and more players exiting the market will result in fewer lenders who offer franchise financing. With renewed focus on credit quality this smaller number of lenders will use more conservative underwriting and less aggressive behavior to originate deals. Banks will continue their tightening their credit standards, partially in reaction to the increasing number of defaults and downgrades that have occurred over the past six months.
On the other hand the down economy has led to more people turning to franchising. Driven by corporate downsizing or the fear of losing their jobs because of the uncertainty in the economy people are seeking ways to take control of their destiny. For many individuals, franchising may be their ticket to personal independence and the end of the fear of losing their job. At Business Lenders we're seeing more franchise loan applications from people leaving their corporate jobs for the chance to run their own business but under the safer umbrella of a proven systems and brand name that can reduce the risks associated with starting a new business.
Taking the Big Step
We recently approved two loan applications from borrowers who had been downsized from their corporate jobs and opted to pursue franchise opportunities. These two friends who had over twenty years in sales at a large insurance company were teaming up to purchase a fitness franchise. In another example a corporate IT manager decided to leave his position to purchase a check cashing franchise.
These types of borrowers make great loan applicants especially for SBA guaranteed loans. They tend to have more savings, more equity in their homes and other assets that can be used to secure the loan especially in start-up situations. They also typically have retirement savings accounts that can be used as additional back-up for the loan if needed.
We're also seeing more lenders form strategic partnerships with franchise companies. Lenders are often able to reduce origination costs because they have a steady stream of origination opportunities from the franchisor and often these savings are passed on to franchisees. In addition, some franchise systems have already been pre-approved by the lender. This means that a good deal of the work that lenders have to do to understand a particular franchise system is already done. As a result the loan process can be completed in a shorter time than is usually the case if the franchisor had not been pre-approved by a lender.
The number of franchise concepts is expected to continue growing particularly as more overseas outfits establish a presence in the U.S. Financing for a good portion of this expanding wave of franchises is expected to come from non-bank lenders.
Opportunities Rather Than Risks
Non-bank SBA lenders will continue to offer loans to start-ups or to businesses such as restaurants and hotels from which banks have been known to shy away. The SBA welcomes these constituencies, as well as other entrepreneurial borrowers. Non-bank SBA lenders often view loans to franchisees as opportunities rather than risks.
To coincide with varying goals of prospective franchisees and the purposes for which they need to borrow, SBA non-bank lenders offer loans of varying amounts and terms. Most will lend up to $1 million, with typical terms being 10 years for working capital, 15 years for useful life for equipment, 25 years for real estate, or a blended rate combining all three for multi-purpose loans and more flexible repayment forms.
Long-term SBA loans can offer low monthly payments, so borrowers needn't fear being strapped. Also, there are no balloons and no call provisions, and other than a small pre-payment fee for very early payment of long-term loans of 5 years or more, there are no other fees or penalties, allowing borrowers to remit more than their monthly payment to pay down their loan either a bit or a chunk at a time.
Non-bank SBA lenders who specialize in franchise lending are uniquely positioned to offer advice on two fronts. First, because they know the market and have done their own due diligence they are able to advise prospective franchisees on the balance sheet strength of particular franchisors, helping the prospect with considerations such as industry stability and franchisor reliability. Secondly, SBA non-bank lenders who specialize in franchise lending are able to guide each loan carefully.
Non-bank lenders will continue to provide access to financing that is not available from conventional lenders however borrowers will find fewer players to choose from. SBA non-bank lenders present a viable alternative to these franchisees and others who don't typically qualify for conventional financing. Franchise businesses, which are difficult for banks to finance because they are in industries that fall outside the bank's risk profile, will continue to find a willing listener in non-bank lenders.
Henry Price is a Senior Vice President Director of the Franchise Lending Unit of Business Lenders a non-bank SBA preferred lender. For more information, visit www.businesslenders.com or call 877-34LOANS Ex. 200.
