Do you agree with the claim we have too many restaurants -- and the evidence in this article?
Are we due for a shakeout -- because it has been so long in coming, have people in the industry forgotten what it will be like?
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Here is an interesting article about compliance.
The following is the complete text of the letter, published at the SEC, Marcato Capital Management wrote to Buffalo Wild Wings, dated August 17, 2016.
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The introduction of fresh talent at both the Board and management levels. The Company must improve its experience and sophistication in areas of restaurant operations, franchise system development, corporate finance, and capital markets. We are confident that the Board would benefit from adding independent directors with operating experience in the restaurant industry, in particular with a franchised restaurant concept. We note that no current director has direct restaurant operating experience outside of the CEO. We would also stress that any changes to the Board should only be made after consultation with interested shareholders, and we would view any unilateral action to change the composition of the Board as a hostile act of entrenchment.
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A greater focus on operational excellence within Buffalo Wild Wings' core business. The Company must improve in key operational areas such as food quality, price/value perception, speed of service, technology implementation, food cost optimization, and labor engineering - all areas where it is substantially underperforming its potential, and, that if improved, can drastically help restore the Company's customer value proposition. Efforts to drive "growth" primarily through new unit openings and franchisee acquisitions currently take unwarranted precedence over maximizing same-store sales and restaurant-level margin opportunities at core Buffalo Wild Wings. Over the long-term, neither system growth nor franchisee acquisitions will be able to compensate for a decline in the profitability of the core concept.
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Cessation of "emerging brands" growth plans. Buffalo Wild Wings' continued success is not an inevitability; as such, we believe the Company should remain singularly focused on its largest earnings driver rather than placing wild bets, however small, on hit-or-miss "growth drivers"-- particularly those in the highly competitive, non-core, fast casual space. Experiments with new restaurant concepts are distracting management from advancing Buffalo Wild Wings' core brand. At this point in time, any corporate resources, be they personnel, capital, or attention, would be better allocated to addressing the operational improvement opportunities at core Buffalo Wild Wings.
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A profound increase in urgency, follow-through, and accountability. A review of past years' earnings reports reveals a number of Company "priorities" that have since dragged on without meaningful progress, the most obvious example being the bungled roll out of table-side order and pay functionality. The commentary in the current period regarding the near-term goals
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for these programs is the same that it was two and three years ago despite the Company having missed its initial execution objectives. Even now, management is content to highlight the opportunity while very little tangible progress has been achieved. This issue is representative of a much larger issue of management's persistent failure to execute and the Board's failure to hold management accountable.
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5)
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An audit of managerial decision tools and a reconciliation of business outcomes as compared to forecasts. Despite frequent assurance from management of the use of DCF- and IRR-based forecasts to approve investments such as remodel campaigns, new unit openings, or acquisitions, our experience with retail and restaurant businesses has taught us that those processes can be highly flawed. We take seriously the tendencies of development staff to reverse-engineer projections to achieve a stated hurdle rate or highlight data with a selection bias to support past decisions. The Board must review past capital investments to ensure that outcomes compare favorably with the underwriting process. We recommend starting with an assessment of the Company's large franchisee acquisition in 2015, which based on all available data, has been an unmitigated disaster. That such an obviously misguided decision could be made under the guise of rigorous analysis underscores the weaknesses in the Company's capital allocation processes and need to commit to a disciplined capital allocation program.
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Your CFO has the ability to play a very important role in your quest to make your company successful. But it's an opportunity that goes untapped in too many companies.
Part of my mission in this blog, and in my consulting work, is to change that.
The key is to bring your CFO into the core of how you create credibility and trust with your Board of Directors, shareholders, and lenders. You have a network of people who are interested in, or invested in, your financial success. Make sure your CFO plays a leading role in helping you develop that credibility and trust.
It starts with taking a more strategic approach to how you manage the financial side of your business. Smart financial management is made up of these three components.
This is where you can turn the role of CFO, and the role of your accounting function as a whole, into a strategic asset. You want to transform their role into one of helping you create trust and respect and away from the old view of accounting as just gatekeepers and people who are just a cost center.
Begin evaluating the CFO role, and the accounting function as a whole, in each of these three areas.
Confidence
The foundation for success in managing the financial side of the business is captured in this one word - confidence.
You have a very unique opportunity to build confidence, trust and credibility with everyone who has a stake in the financial success of the company - your management team, lenders, investors and shareholders.
They need to have confidence in the financial information they receive and have confidence in the people who provide that information.
A lack of confidence from that group of people is a big warning sign that your accounting function is letting you down.
Note: Here is an interactive, graphical dashboard you can use to grade the confidence level each group has in you and your accounting function. Check it out. It's a fun tool.
Insight
Next, the information you provide about the financial side of your business needs to be insightful. Too many CFOs fall short here because they see their role as just preparing financial statements... or just preparing a tax return... or creating an analysis schedule you asked them to prepare.
Insight goes way past that. It's about providing information that helps management make better decisions. It's about providing information to lenders and investors to help them better understand the key drivers of performance.
Financial information that is insightful and helpful is an important part of creating confidence and trust in their eyes.
Accuracy and Speed
And the third component has to do with the accuracy and the speed with which you provide financial information. Provide slow and inaccurate information and you kill your credibility. No one will trust your numbers if you do that.
And nothing kills your credibility more than providing financial information that is inaccurate or tends to bounce around and change.
But when you provide accurate information and you provide it quickly after the end of the month, and you do that consistently month to month, you set yourself out as a company that has its act together. Lenders and investors love that and it will help you forge a strong relationship with them that will last a long, long time.
(The Monthly Confidence Package is an important tool I use every month to grow that kind of strong relationship. Here is an article I wrote for the Business Bank of Texas that talks in more detail about the components of the Monthly Confidence Package.)
Where Do You Stand?
In an upcoming post I'll share an assessment tool to help you evaluate your accounting and financial function based on those three key result areas.
And I'll go into more detail about how a strong accounting function will make your life easier and help you win financially in the game of business.
Let's make sure your accounting function is doing its part to help you grow your business.
That's the smart (and fun) approach!
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Small business today generally refers to businesses generating under $3 million in annual sales. That's not so small to most people. And big business was small business at one time. The challenge is "how do you get there from here"? The financing community is about to get some real financial assistance-and it's called Factoring. Traditionally, start-ups use the Small Business Loan as seed capital, and this still remains the ideal, lowest risk choice.
Once up and running however, the issues of cash flow, funding growth, dealing with seasonal slumps and the like, become the day to day issues that determine the financial stability and future potential of the company.
The present financing options available to serve these purposes are (1) traditional bank financing, and (2) additional private investment. Each of these options achieves the goal of providing funds to your business but as is always true, there are associated costs.
Bank financing has the nasty side effect of burdening your business with additional debt, not only capital repayment but additional debt by way of interest.
If the goal is to fund growth, taking on additional debt certainly takes a chunk out of the disposable funds available to finance that growth and affects the financial position of the company for years to come. The application process is long and cumbersome. The delay between the time of submission of the application to disbursement is substantial as well, putting extra constraints on the timing of your financing needs. And...what if traditional bank financing is not an option for you? In some cases, you may not be creditworthy, many have used up your available credit limit, or be in violation of debt/equity ratios.
The other common route is private investment. In these cases, the injection of capital is given in return for an equity interest in the business. There are a variety of forms this can take but suffice it to say, that the end result is a dilution of your equity in the company that you have built. While often a great choice for large corporations, the effects are more widely experienced in small companies, especially family run or owner operated businesses.
Diluting equity, or granting an ownership interest to an outside party generally waters down the value of all shares and creates a situation where one shareholder has a preferred status and priority in payment over the original investors. As well, it often creates a loss of control over the decision making processes depending on the clout of the private investor and the amount of money invested. These are serious hidden costs.
So, what now? You can't go to the bank because you are at your credit limit and you don't' want a private investor, but you just got this huge $10 million dollar deal and you need to build a warehouse. Well, there's a new financial hero to the rescue and its name is "Factoring". To say it's new is really a mistake since it has been around since the days of the Roman Empire. The United States factors 50 times as many transactions as Canada and over $1 trillion in sales is factored worldwide annually. In the United States, many banks even have factoring divisions. Some scandals in the United States have left factoring with a undeserved tarnished reputation. In fact, it is a champion of small business and an essential tool in the arsenal of financing options.
Factoring involves the sale of accounts receivable at a discount. Essentially, you sell the receivables that are due to you by your customers to a "factor", who discounts the value of them and pays you in advance. The discount depends on many factors but is generally between 3-6% for a pre-negotiated period of time and a fraction of that thereafter. In essence you are raising funds not on the basis of your creditworthiness but that of your customers. So you may not be able to get credit but as long as your customers are creditworthy you can leverage that to raise funds for your own business.
For example, you may do home stereo installations and work from your truck, but your customer could be Future Shop! BUT, here's the beauty, you have not created the extra burden of debt, nor have you diluted your equity. Yes, you have taken a hit up-front, but, the money did not come out of your pocket and is a cost of doing business. The important thing is that it allowed you to fulfill your main goal of getting financing in a timely manner and being able to take advantage of a growth opportunity that would have otherwise evaded you.
The same line of reasoning works for seasonal businesses who need to maintain a continual cash flow to fund operations. This is a great tool for that! Now, I must confess that I came upon this discovery because I have a client in this field, but sincerely (and morally), this is no sales pitch, it's an honest opinion, because the beauty of this little known source of financing was like a secret that was too good not to share.
The legalities of this financing are equally as simple. If bank financing is in place then all that is required is that the bank give up its first ranking security on the receivable being factored. The bank is generally amenable to as it still has security on everything else. The factor then takes the place of the bank on that receivable and takes security much in the same the bank would. Furthermore, because there are no interest charges on your money, none of the banking legislation is applicable, making the entire transaction simpler all around. The charges you pay are discount fees, the cost of having your money now and avoiding all the burdens of other methods of financing. Second mortgage anyone?
I think what you will find most surprising is that factoring is highly endorsed by financial professionals, including banks. It makes a lot of sense though that they should. Business clients have many needs and professionals, be it lawyers, accountants or bankers need to respond to them. Banks like that it keeps their clients financially afloat when they cannot help them. Small and medium businesses often fail because of short term cash flow problems, not because business is bad!
Traditional bank financing and private investment can never be replaced. They are the cornerstones of corporate finance. The problem is getting to the point where you can truly benefit from their value. Small business to medium, and medium to large, factoring is fulfilling an untapped niche in the financial industry.
While it takes a lot of (paper) work away from us lawyers, I am still all for it. I guess the secret's out of the bag!
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Last April 5, 2012, President Obama signed into law the "Jumpstart Our Business Startups" Act (the JOBS Act) The intended purpose of the JOBS Act is to spur job creation by small companies and start-ups by relaxing the regulatory burdens of raising capital. In this article, we focus on Title III of the JOBS Act, otherwise known as "crowdfunding," and how franchisors and franchisees are uniquely suited to take advantage of this new registration exemption under the Securities Act of 1933, as amended, to sell unregistered securities to the public.
Crowdfunding enables small or start-up businesses that may not have access to traditional methods of capital financing to raise capital via the Internet and social media, typically from small-dollar investors.1
At first glance, crowdfunding appears to be an innovative and easy way for start-ups to obtain financing by using the vast reach of the internet. However, Congress's concerns over investor protection and fraud prevention are evident throughout Title III. Issuers, brokers and funding portals must comply with substantial informational disclosure requirements and undertake affirmative fraud prevention measures.2
Aspiring crowdfunding issuers should note that the JOBS Act requires the Securities and Exchange Commission (SEC) to adopt "such rules as the [SEC] determines may be necessary or appropriate for the protection of investors" within 270 days after the JOBS Act being signed into law. Thus, the SEC, which openly expressed its opposition to crowdfunding prior to the passage of the JOBS Act (including criticism by SEC Chairwoman Mary Schapiro that crowdfunding regulation would be akin to "walking backwards"), will most likely implement burdensome compliance and disclosure requirements.3
Why is this good news for franchises? Unlike other potential issuers, franchisors, and to a lesser extent franchisees, are already subject to rigorous disclosure requirements.4 Much of the disclosure mandated by Title III is already encompassed in a franchise disclosure document ("FDD").5
Therefore, while complying with the extensive disclosure requirements of the JOBS Act may be cost prohibitive and time consuming for most startups, franchisors will have a leg up in that they've already prepared most of the disclosure.6 From the franchisee side, much of the business planning, financial reporting and financial statement preparation mandated by a franchisor can provide the disclosure necessary to meet the likely standards, or at least provide the basis for rapid development of the necessary information.
The basics of crowdfunding are fairly simple. Crowdfunding offerings are capped at $1 million per year. The issuer must be a U.S. company and cannot be a reporting (i.e., filer of periodic reports under the Securities Exchange Act of 1934) or investment company. There are caps on annual investment amounts for investors.
Investors with an annual income or net worth below $100,000 may only be permitted to invest, in the aggregate, the greater of $2,000 or 5 percent of such investor's annual income or net worth. For an investor with an annual income or net worth greater than $100,000, the aggregate annual investment is limited to 10 percent of such investor's annual income or net worth, with a maximum aggregate amount capped at $100,000. Except under certain circumstances, crowdfunded securities are restricted securities with a one-year holding period.
Conducting a crowdfunding offering requires substantial issuer and offering information disclosure. Issuers are required to file certain information with the SEC, and must provide the same to potential investors and intermediaries, including information regarding their business, ownership and capital structure, and the offering itself. A condensed version of some of the issuer disclosure requirements and liability risks appears below.
Issuers must make an initial filing with the SEC which contains, among other things, (i) name, legal status, physical and website addresses; (ii) the names of directors, officers and 20 percent stockholders; (iii) a business plan and description of the business; (iv) financial information, which, depending on the size of the offering, may only include a certified income tax return for an offering of $100,000 or less, or audited financial statements for offerings of $500,000 or more; (v) a description of the purpose and intended use of the offering proceeds, the target offering amount, the price of the securities and the method of their valuation; (vi) the ownership and capital structure of the business, including the terms of the offered securities as well as each class of the issuer's securities, a description of how the issuer's principal stockholders' rights could negatively affect the purchasers of the crowdfunded securities, risks associated with minority ownership and examples of how future securities will be valued; and (vii) any other information required by the SEC.
At least once a year, issuers must also file with the SEC and provide to investors their financial statements and reports of results of operations, as the SEC deems appropriate.
Purchasers of crowdfunded securities will have a private right of action against an issuer's officers or directors for material misstatements and omissions in connection with the offering. An issuer will be liable if it makes an untrue statement of a material fact or omits a material fact required to be stated or necessary to make a statement not misleading, provided the purchaser did not know of the untruth or omission.
Though crowdfunded securities are considered "covered securities," and thus not required to be registered with any state agency, an issuer will still be liable under state securities laws prohibiting fraudulent or unlawful conduct in connection with a securities transaction.
Issuers are also prohibited from advertising the terms of a crowdfunding offering, except for notices directing investors to the funding portal or broker, and may not compensate any thirdparty promoters without disclosing the compensation to investors.
Does this mean that a franchisor can slap a new coversheet on an FDD and launch a crowdfunding offering? No, but with a modest supplement describing the corporate documents and attributes not otherwise covered in the FDD, a franchisor can be quickly compliant with the likely SEC rules and the launch of the offering will be achieved more quickly. Additional considerations will include obtaining consent from the auditors to use the franchisor's financial statements and audit opinion for such purpose, and creation of an investor questionnaire, modeled in many respects on the franchise application, that will elicit the eligibility and limitations of potential investors.
How often does a franchisee ask whether he or she can invest in the franchisor? With public companies, the answer is simple. With a new or small franchisor, the answer is usually not often, because the franchise and securities offering are separate. Crowdfunding offers franchisors the opportunity to consider paired or "paperclip" offerings, where the prospective franchisee is also offered the opportunity to invest in the franchisor's equity.7
Existing franchisees who are successful and committed to the success of the franchise concept offer another readily available pool of potential investors. The FDD Item 20 information about franchisee contact information is a potentially useful tool for a crowdfunding offering.8 The regular communications vehicles between franchisor and franchisee offer the opportunity to promote the offering to a group of potential investors without the need for any public solicitation. That communication pipeline, together with the franchisor's extranet accessible only to franchisees with authorized access, could be a major benefit for the issuer-franchisor.
From a legal theory perspective, the legal duties, obligations and interests of the parties in a crowdfunded franchisor where franchisees are participating investors will need some further thought and guidance. The franchisor and its officers are not fiduciaries for its franchisees, but the officers are indeed fiduciaries for their franchisee-investors and the franchisor. Will a franchisee who is an investor be able to assert an aggressive position under the franchise agreement that can harm the franchisor without liability to co-investors? Defining these roles and the associated legal conduct standards will evolve as SEC enabling regulations permit crowdfunding to commence.
1.JOBS Act: Crowdfunding Summary, Practical Law Company (last visited Jun. 8, 2012).
2. See H.R. 3606 §§ 302(b), 304(a).
3. Benn Protess, Regulator Seeks Feedback on JOBS Act, NYTimes.com (Apr. 11, 2012, 4:16 PM),
4. FTC Disclosure Requirements and Prohibitions Concerning Franchising, 16 C.F.R. § 436.5 (2012).
5. Compare H.R. 3606 § 302(b), with 16 C.F.R. § 436.5 (2012).
7. Franchisors would need to review and comply with state securities laws, often administered by the same regulatory authority as franchising in merit review registration states, before undertaking such an offering.
8. 16 C.F.R. § 436.5(t)(4) (requiring disclosure of "the names, and the address and telephone number of each of their outlets"). Franchise agreements routinely designate a legal notice contact for official notices, which is another source of the information.
Mr. Buckberg focuses his practice on representing franchisors and multi-unit franchisees in franchising, governance and other transactions. Ms. Jumper practices in the areas of corporate, securities and franchise law. This article originally appeared here.
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Franchisees who invest in publicly held companies should have a line of communications with the investors in their system that is uninterrupted by corporate management.
After forty years of successful growth the McDonald's restaurant system hit some potholes in the 1990s. Coincidentally we had just launched Franchise Equity Group and were in a position to monitor the trauma that the second generation of McDonald's managers were inflicting on the system.
After our efforts in the interests of McDonald's franchisees were mentioned in the major media we were contacted by Wall Street analysts and institutional investors. Working with these people was an extraordinary learning experience.
At that time McDonald's had been an NYSE listed company for over thirty years, had a market cap of over $30 Billion, and yet there was an stunning lack of knowledge among investors. Our discussions covered franchisee profitability, the results of an unrealistic growth program intended to impress investors, management's history, franchisee morale, and other basic topics.
Over these past fifteen years I've had the pleasure of assisting many investors in learning about not only McDonald's but the franchised industry in general.
Franchisees in publicly held brands should develop the philosophy that the corporate people (who are temporary employees) don't own the company.
The only significant investors in the brand are franchisees and shareholders - two entities that should be in constant communication.
FAQs About Franchisees Communicating With Investors.
1. Should franchisees attempt to influence the value of the corporate stock?
Absolutely not - If your brand is to be a good opportunity for franchisees it must be healthy at all levels. However, problems develop when management uses short term strategies that might help the share price but damage franchisees. Think about this activity as the education of investors for the long term health of the entire system
2. know my business intimately but don't know much about high finance and Wall Street?
Hey, join the club. I've rarely been asked about a stock price or P/E, ratios. The analysts want to know about commodity costs, minimum wage issues, management changes, remodeling programs, franchisee debt, etc.
3. How will corporate management feel about franchisees chatting with investors?
They won't like it but won't say much. This activity is most effective in those franchise systems where management controls 100% of the information about the franchised side of the business. In those cases they've told investors franchisees are supportive of management's initiatives and there is complete "alignment"between management and franchisees. Of course they want franchisees voiceless.
4. Will I be divulging proprietary information?
If you think you are walking around with a lot of proprietary information you should consider canceling that speech to the local Kiwanis Club. Discerning franchisees would never divulge information that would benefit their competitors.
5. Do Wall Street analysts care about my personal success as a franchisee?
Not so much - But they want to know if the corporate initiatives will be successful and if resistance to management's direction might retard corporate growth. As analysts they understand the franchise model must be a good investment but they
won't fuss over every franchisee's survival. Especially if all they hear is corporate's side of the story.
In summary, most publicly held franchised systems operate with a few corporate people strutting around like they own the brand while the real investors are franchisees and shareholders. In most cases management has been successful in building a towering wall between the true owners of the brand.
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QUESTION: I would like to protect my small business assets from those who might file frivolous lawsuits like slander, personal liability, etc. Is a LLC the best option to protect small business assets?
ANSWER: For most assets and businesses, a Limited Liability Company ("LLC") is your best option. Similar to other limited liability entities, so long as proper accounting and other formalities are followed, LLC's and Corporations both offer asset protection from Company creditors and judgment holders (i.e., inside creditors).
Unlike Corporations, however, LLC's also offers unparalleled asset protection from personal judgments and creditors (i.e., outside creditors).
So, if someone were to win a lawsuit against you personally, they could not take away the assets inside the LLC.
Setup properly, what the personal creditor would receive is a "charging order" against your Membership Interest.
A charging order does not give the creditor management rights over the LLC. At most, they would be entitled to any distributions made out of the LLC, if any.
It is strictly up to the LLC Manager whether or not to make distributions.
Let's say the LLC made $50,000 in profits and you (as the Manager) decided to keep it all in the LLC and reinvest it. In other words, no distributions were made.
The creditor holding the charging order cannot participate in management, and therefore, cannot force a distribution or liquidation of the LLC assets. In addition, there is a strong possibility if the charging order is foreclosed on, the creditor would owe the IRS income tax on any Company income. Ouch!
Because a properly setup LLC's prevents outside creditors from interfering with management,and limits a Member's creditor to a charging order remedy, when faced with a LLC, lawyers usually encourage their clients to settle their claim rather than face the uncertainty and waiting-game imposed by LLC charging orders.
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1. Myth: Banks are not making new business loans.
Reality: Banks are more selective in making a new loan or renewing a loan. Banks are risk adverse and thus the borrower must be better prepared to answer the questions the bank requires. We help businesses get start-up and expansion financing nationwide.
2. Myth: SBA loans are more difficult to get because of all their regulations.
Reality: Most banks like SBA guaranteed loans as it reduces their potential loan loss risk. If a bank makes a conventional loan its risk is 100%; however with an SBA loan guaranty that risk can be reduced to 25%.
3. Myth: It takes 6 months to get an SBA loan.
Reality: Only if you approach the bank without being properly prepared. If your business plan meets the bank's requirements; you have 25% to 30% of the total funds required of your own cash, you have a FICO credit score of 680+, you have related industry experience, your business plan answers the Who, What, When, Where and Why, and your monthly financial plan is realistic an SBA Preferred Lender can approve your loan in as little as 3 to 5 business days. If the bank is not a preferred lender they must submit the package to the SBA for approval and that can take 3 to 5 weeks. We help you prepare the business plan loan package the banks need to make a loan commitment and then we take it to a bank that's interested in making you the loan.
4. Myth: Using a software based business plan helps you create a good business plan.
Reality: Business plan programs have to be everything to everyone and thus they do not get you to focus on the critical questions a bank requires. Banks are not fazed by the razzle dazzle of fancy graphs and charts...they love cold hard facts.
5. Myth: The business banker was excited about my business plan and said the bank is anxious to make new business loans. Weeks later you receive a "sorry we cannot make the loan you requested"; what happened?
Reality: Often the business banker you first meet with is a business development officer -- think sales person. Their job is to take your business plan and perform a "light" review so they do a "new business report". They have no lending authority and your business plan goes to the bank's credit analyst for an in-depth review as to its feasibility. Banks compare your business plan financials to similar type businesses and if your plan is too optimistic or conservative it's rejected.
6. Myth: If one bank declines my loan request will all banks decline it?
Reality: Definitely not. If your business plan meets the bank's requirements; you have 25% to 30% of the total funds required of your own cash, you have a FICO credit score of 680+, you have related industry experience, your business plan answers the Who, What, When, Where and Why, and your monthly financial plan is realistic, a bank may still decline your loan. BUT they may decline your loan not because of your business but because they are risk adverse due to loan losses (won't do loans to startup businesses) or they have a large concentration of loans to your industry.
7. Myth: If you have a great business plan and it answers the Who, What, When, Where, and Why and you have the cash to invest, good credit and related industry experience, you still get funded.
Reality: Often it's because your lifestyle requires more income than your business can generate (especially if it's the first year of a startup business). If your current or last job provided you $100,000 of pretax income and your new business can at best provide $36,000 the first 2-3 years, where will the extra money come from to pay your lifestyle expenses?
8. Myth: Banks want you to have medical insurance.
Actually it's True: Why because if you or family members were to require health care and you did not have medical insurance, banks know that you would use the loan's working capital to pay the medical bills -- leaving the business not enough money to pay bills on time, buy inventory and marketing; a receipt for failure.
9. Myth: If you have 10% of the total funds required to open and operate your business and you have a solid business plan you will get funded.
Reality: Banks must minimize loan loss risk. Without 25% to 30% of your funds in the business the bank is effectively "buying" you a business. The bank would have nearly all of the risk and you would have all of the upside reward. The most the bank would get would be the interest if you were successful. Banks help you finance your loan but are not your equity partner!
10. Myth: SBA loans don't require collateral.
Reality: As a guideline the SBA only requires collateral on the loan if it's available. Banks are free to have more stringent requirements and most do. Most banks won't do an SBA loan without 25% to 75% of the loan collateralized. Conversely, most banks require conventional loans to be 100% to 150% collateralized depending on risk.
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(1) Who is then paying for expansion, or for commodities;
McDonald's (MCD) has made franchisee owner/operator cash flow (EBITDA) narrative in several recent calls, and DPZ did once.
Here are six factors that could be asked by the sell-side community and reported by companies to improve investor disclosure:
Disclosure: When I originally wrote this almost 2.5 years ago this was true: "I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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Recently, we've been talking about the different types of buyers we work with and how the buyer market has changed during the past few years; some good and some "to be determined".
In this article, we talk about the private equity group (aka PEG) of buyers and what that means to sellers of smaller privately owned businesses like yours.
There's been a lot of news recently about PEGs, mostly in a political and tax related context (e.g., Mitt Romney's success as a partner with Bain Capital and the income tax rate he pays). We'll stay away from that. That's a whole other discussion!
What is a PEG?
They've been around since the 70s starting as larger, "mega" buyout firms (Bain, etc.)
They are investors who have private funds (a combination of personal funds and investor funds) to invest and are seeking alternative investment opportunities (i.e., privately owned businesses) where financial returns can "beat the market"
They buy companies across all industries and usually want a 100% ownership, or at least a majority ownership (51%) in the companies they buy.
They typically buy mature, established companies - not early-stage or startup businesses.
The goal of the PEG is to improve and grow the company with a goal to "exit" their investment in the next 5-10 years, at which time they return the gains to their investors and "close the fund".
What's this mean to you?
Here's the change that's going on. In the last 3 years, we've talked with numerous nationally based PEGs who are investing in smaller privately owned businesses. A typical investment opportunity is a company with:
Specifically, the PEGs we've talked to and met with are interested in businesses we represent in the following markets:
If you are considering selling your business, especially in one of these industries, we believe that, in the right circumstances, PEGs are a legitimate pool of potential buyers that should be considered.
As we've pointed out, the buyer pool is constantly changing and much more diverse than it was 3 years ago.
Today's business seller needs to be more aware than ever of how the pool is changing and what impact this has on potential sales opportunities.
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Last July 2014, Bloomberg Businessweek had a detailed cover story about Burger King's (NYSE:BKW) leadership.
It's not much of a useful analytical piece. The piece did not move the market, the Bloomberg editorial standard. Deep analytics must not sell anymore in our time-starved span of attention. The piece is Wall Street personality and issue focused.
Franchised Restaurant companies require a lot more investor due diligence, on both the equity and bond investor side, and on the franchisee side. And I want to talk about that.
First, franchisors don't release their franchisee financials results other than same store sales. 100% franchisors like DineEquity (NYSE:DIN), Burger King and Tim Hortons (NYSE:THI) don't release a single franchise operations number.
Popeyes (NASDAQ:PLKI) alone of the publicly traded group releases franchisee EBITDAR - EBITDA less rent.
Some limited clues may be possible from the 10Q/10K statements and the franchisors' Franchise Disclosure Document that details unit opens/closes.
The 10Qs/10Ks don't detail why units open or close, but the FDD broadly classifies closings into categories.
The same store sales metric is more visible.
But to focus in isolation as Businessweek tried (Burger King's same store sales exceeded McDonald's) is flawed: a .5% same store sales gain on a $2.7 million sales base yields a much more healthy picture than 2.0% on $1.0M store AUV base.
Actually, both comps and unit opens/closings need to be examined together, it's very possible to open a lot of stores but realize negative same store sales trends (Five Guys, Smashburger are best recent examples, experiencing both conditions).
Positive same store sales are nice, but are they profitable sales (might not be if discounting is involved) and are they high enough (restaurants need about 2% growth per year typically to cover inflation).
Bad debt expense, the value of franchise royalties not paid to the franchisor and eventually aged and reported, is also a poor, lagging metric. Once bad debt expense is posted, it's really late in the business cycle, the franchise model problem is very intense, the horse is out of the barn.
Franchisees don't talk much - they are afraid to and told not to, and are constrained from communicating via franchise agreements. More research and due diligence is needed. Consider the 3G Capital and Fortress experience, their astoundingly bad 2012 Quiznos investment ($350 million investor group loss and counting).
Getting franchisee EBITDA is great (it is possible, but you have to dig and hire the right people) but it's only half of the story. Restaurants are capital expenditure (CAPEX) intense and some measure of after tax, after debt service, after loan amortization economic gain or loss number is needed.
As usual, business analysis is not what you read on the cuff - it's not what you expect, it's what you inspect.
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When you're buying a franchise you probably need money - most buyers do - and numerous lenders are lining up, especially at franchise expos, to be of service. One option that buyers often overlook is leasing, and it's worth your time to check out the possibilities.
If you're investing in a franchise that includes equipment, such as a POS system, or ovens and appliances for the kitchen, or if you need a truck, such as a van, you may be better off leasing than borrowing. Leasing equipment is the equivalent of "renting" the equipment, which means that you won't take money from your working capital to buy the equipment.
With a lease, you get to use the equipment and pay monthly, and at the end of the lease you can acquire the equipment, or upgrade it and roll the package into another lease.
Here are eight reasons why you should consider a lease when you start a franchise:
1. Hold on to your working capital.
Cash on hand is a huge advantage.
2. Claim a tax benefit.
Section 179 of the U.S. Internal Revenue Service Code allows you to write off a percentage of a monthly lease payment.
3. FICO requirements are usually lower for leasing.
There's less risk with a lease so credit rating requirements may be lower.
4. There are no prepayment penalties.
If it turns out you've got extra cash on hand, pay off the lease without a penalty.
5. You can choose the term.
24 to 60 months. This helps you keep the payment amount in line with your cash flow.
6. If you're expanding your business by opening a second unit, you may be able to use the first business to guarantee the lease and not have to sign a personal guarantee.
7. Securing a lease may be faster than securing a loan.
Especially, if you're leasing an equipment package or a vehicle that's recommended by a franchisor. Leasing companies like franchise deals.
8. Closing costs are minimal.
Almost always less than $500.
There are few disadvantages to a lease.
Of course, you still need to provide personal financial information and provide a variety of documents to the lender, but this is all the easier when you're buying a franchise. Savvy franchisors develop relationships with leasing companies to expedite franchise sales and development.
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You'll find more information about franchise financing in my Amazon best-seller: 12 Amazing Franchise Opportunities for 2015. Chapter 2 is titled Funding Your Franchise Acquisition.
"I made contact with both firms and it was abundantly clear to me that after several conversations, Walker Business Advisory was hands down the better of the 2 firms. My questions were answered in a concise and clear fashion.They had an in-depth knowledge of the structure, the laws and the process. They have a platform that is unique i.e. they shoulder all responsibility and liability for matters that relate to the plan. Their process is totally turnkey. There are two real important parts of their plan.1. They have a Safe Harbor 401(k) with 15 different investment options and 5 asset allocations.2. They are the fiduciaries and trustees of the plan.All of this is can be accomplished for the same price as their competitors. If you take into consideration all that they do, they are dollar for dollar less expensive. I would like to thank Brian for introducing me to Fred Whitlock and Monty Walker. Fred was exceptional in explaining the product, service and process."As previously referenced, my wife and I are CPAs and Monty, also a CPA, shed light on areas we were not familiar with and provided the solutions................nothing short of amazing!Now it is great to have clients like this.Why does that matter to you? Because if you are as smart as these two CPA's, you probably still don't know why is it important to design a plan with: a Safe Harbor and why being a fiduciary is necessary.If you think that you need to know more, then just ask for more.For the 5 Most Fascinating Stories in Franchising, a weekly report, click here & sign up.
Ever wondered how much it costs to own a McDonald's franchise. If you are interested, here are the details... direct from the McDonald's site:Acquiring a FranchiseMost Owner/Operators enter the System by purchasing an existing restaurant, either from McDonald's or from a McDonald's Owner/Operator. A small number of new operators enter the System by purchasing a new restaurant.The financial requirements vary depending on the method of acquisition.Financial Requirements/Down PaymentAn initial down payment is required when you purchase a new restaurant (40% of the total cost) or an existing restaurant (25% of the total cost). The down payment must come from non-borrowed personal resources, which include cash on hand; securities, bonds, and debentures; vested profit sharing (net of taxes); and business or real estate equity, exclusive of your personal residence.Since the total cost varies from restaurant to restaurant, the minimum amount for a down payment will vary. Generally, we require a minimum of $750,000 of non-borrowed personal resources to consider you for a franchise. Individuals with additional funds may be better prepared for additional or multi-restaurant opportunities.FinancingWe require that the buyer pay a minimum of 25% cash as a down payment toward the purchase of a restaurant. The remaining balance of the purchase price may be financed for a period of no more than seven years. While McDonald's does not offer financing, McDonald's Owner/Operators enjoy the benefits of our established relationships with many national lending institutions. We believe our Owner/Operators enjoy the lowest lending rates in the industry.Ongoing FeesDuring the term of the franchise, you pay McDonald's the following fees:
- Service fee: a monthly fee based upon the restaurant's sales performance (currently a service fee of 4.0% of monthly sales).
- Rent: a monthly base rent or percentage rent that is a percentage of monthly sales.
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Summary
- Restaurants were said today to be a leading indicator of investment market power in 2015.
- Five recognizable realities exist in the space that are both challenges and addressable opportunities.
- Insufficient restaurant profit flow through rates, M&A upside and downside, dysfunctional early IPO valuations, franchisor overfishing and CAPEX measurement are issues.
The restaurant space slogged it out in 2014.
Finally, with meaningful wisps of economic recovery seen in Q4 and more disposable income running in the system, hope of discretionary spending is seen.
Several attractive IPOs, Habit (NASDAQ:HABT), and Zoe's (NYSE:ZOES) made it through the gauntlet and with more to come in 2015 (SHAK and others).
On January 5, Jim Cramer of CNBC said that domestic restaurants are key to the market performance in 2015. That sets a high bar.
Of course a reality gap exists between Wall Street wants and needs and Main Street corporate realities. The prism restaurants operate is not really seen by Mr. Market. Looking beyond the veil, restaurants are a tough business, talk to the departed CEOs of Darden (NYSE:DRI) and Bob Evan's (NASDAQ:BOBE) about that
There are several ongoing dynamic restaurant financial realities that underpin restaurant performance.
All are realities.
All are opportunities.
And, all can be fixed & are addressable.
1. Need to manage and improve restaurant profit flow through. Also known as PV ratios, we should not have been surprised to hear that the ten year US McDonald's (NYSE:MCD) average sales per unit (AUV) grew $770,000 but flow through grew by just $70,000, or 9%. Was it all those beverages that cannibalized food? A national survey just reported the McDonald's average consumer expenditure reported at $3.88 per person, which is shockingly low.
It's a broader restaurant issue however: For a client, I recently examined three QSR brands [McDonald's, Burger King (NYSE:QSR), Wendy's (NASDAQ:WEN)] and three casual dining brands [Denny's (NASDAQ:DENN), Bob Evans and Applebee' (NYSE:DIN)] that grew average store sales only $46,000 and unit EBITDAR by only $500 between 2009 and 2014, about a 2% flow through rate. Shockingly low sales gains, even worse flow through.
Both Chili's (NYSE:EAT) and Outback (NASDAQ:BLMN) added a boatload of new menu items at or under $10 to their menus in 2014, and Chili's added their signature fajitas to its 2 for $20 menu. This exasperates the flow through problem; let's hope additional upsell initiatives kick in to maintain the average check.
This is the result of hyper food inflation, and some labor cost inflation and a lot of discounting. The fix? Multi dimensions required. Start by not listening to the ad agencies to take the fast, cheapo way out and simply discount; get staff to upsell.
2. M&A is both a value enhancer and a destructor: Both good and bad M&A are in the background and the foreground. Bad M&A can be seen considering Darden and Bob Evans this year. Good: future possible spinoff BEF foods for $400M ($413 million value estimate by Miller Tabak). Its current EBITDA baseline is only a few million dollars. Spin it and give the money to shareholders.
Bad M&A: waiting so long to dump both Red Lobster and Mimi's . Interestingly, financial disclosure and visibility of both brands by their HOLDCOs was awful. Who really knew before Darden spilled the beans in 2014 that weekly customer counts were only 3000/week? That is unacceptable for investors. The fix: the sell side and shareholders should demand better disclosure. Vote with your feet.
3. Restaurant IPO valuations need a reality check. First year restaurant IPO valuation ratings need an asterisk. There is nothing fundamentally wrong with Noodles (NASDAQ:NDLS) other than their unsustainable claim to get to 2000 US units. It's a nice, differentiated concept. They will grow but not at Chipotle (NYSE:CMG) rates. Potbelly (NASDAQ:PBPB), El Pollo Loco (NASDAQ:LOCO) and Papa Murphy's (NASDAQ:FRSH) may grow if they can grow profitability beyond their geographical base. The Chipotle of 2015 is not the Chipotle of 2006. It can't be: The US is proportionately more overloaded with more restaurants during the Noodles 2013 IPO than CMG's 2006 IPO.
First year restaurant IPO price earnings ratios and Enterprise Value to EBITDA ratios need an asterisk because they may well fall later and resume upward momentum later after the post IPO equilibrium is found and real earnings and free cash flow growth is achieved.
Why does this matter? Growing restaurant brands that are over pressured by high valuations do stupid things. Good brands need to be given a chance to grow solidly.
4. Franchise overfishing, resulting subpar restaurant cash flows in the US: earlier in 2014, when fears of US restaurant wage increases were at its peak, several industry studies noted how low restaurant franchise EBITDA flow really was: 10 to 11%. The SS&G (now BDO) restaurant data survey in December just backed that up. For investors, franchisors, franchisees and anyone else: 11% EBITDA on a $1 million AUV base isn't high enough level to service debt, cover overhead and provide funds for maintenance and remodeling capital expenditures in the amounts needed.
The US is overfished, with too many franchise restaurants. One million restaurants in the US! Until the supply issue is addressed, franchise restaurants will chase the temporary +1 or +2 same store sales customer flow that migrates from one brand to another.
Franchisors need to take responsibility for their brand's future evolution. That they don't fully can be seen in the minimum wage debate. Franchisors, notably McDonald's, Burger King/Tim Horton's and Wendy's indicated that it was their franchisees that set the wages. While technically true, it is the franchisor that is the steward of the brand. If the wage goes to $20/hour, it is the responsibility of the franchisor brand to regenerate a store level model that works.
A place to start is to rightsize store physical plants smaller to get the CAPEX lower and to find ways to thin the system of weaker operators who want or need to exit. Closely associated with this is issue poor franchisor earnings disclosure: Sell side analysts covering Dine Equity have given up asking for meaningful information about the 100% franchised brands, and we noted one intrepid sell side analyst who was a journalist earlier could not pry the Burger King international new Russia and China sales levels. This was a pillar of their stated growth strategy and a metric that should be disclosed.
5. Restaurant free cash flow matters. For a client recently, I composed a 45 year snapshot of how sales components and building size has changed over the years. Guess what: while customer traffic (transactions) has declined, the building size has not come down.
The perception gap between the signal of the profit/loss statement and the other costs, and outlays that determines free cash flow is a material problem for an industry so CAPEX heavy. This same concern applies to the "asset light" franchisors, whose franchisees are the investors and have to make a return to be viable. This is not so complicated; performance appraisal systems at any level could be rejiggered to include CAPEX. You manage what you measure.
You need $50,000 for your business. You have several choices: merchant cash advance, lease or loan.
How much does each option cost you?What would you want to pay for the use of $50,000? Here are the numbers: daily Advance payment of $445 daily, a lease payment of $1,062 monthly or a loan payment of $580 monthly? There's not much of a decision here.
Cash Flow is king.
A new SBA guaranteed bank loan program available to franchisees at 6-7% interest over 10 years and is less expensive with longer terms than equipment leasing for acquiring new equipment or fixtures or a MCA for either equipment or working capital.
The result is cheaper money.
In addition to this fresh money many franchisees will also qualify for re-writing older more expensive debt such as equipment leases, credit cards and merchant advances into lower cost and greater terms.
The loan is available to any franchisee that has been in business for over 2 years and meets reasonable credit criteria that most will meet.
By utilizing new online technology a franchisee may get pre-qualified in 5 minutes, pre-approved in 30-60 minutes and funded in as short as ten days.Call me, Bob Shaw, at 734-929-3800 to discuss your options.
I have been fortunate to meet with over 3,000 businesses over the last ten years - from start-up restaurants with big dreams, to mature chains facing tough decisions. No matter what stage a company is in, payroll is constant; it is that big number that you have to hit 26 times a year.These days, margins are getting pinched and cash flow is tighter.Here a few reasons why using a service company may help you sleep better.1. Peace of Mind - You are paying two important groups of people that frown upon mistakes - The IRS and your Employees. A service bureau takes full liability and responsibility for calculating, depositing, and filing all payroll taxes. If there is ever a payroll-related tax penalty or you get a love letter from the IRS, you are protected.
2. Back-up/Support - If you or your payroll clerk are out, sick, on vacation, etc. - you know you'll have an on-time, accurate payroll with no special arrangements. Also, by outsourcing, you're putting a tax and human resources expert on staff - protecting you from a broke government and a litigious society.
3. Cash Flow - By ACHing the funds for you directly to the IRS, you spread out your tax payments equally throughout the year. No surprises at quarter or year-end.
4. Time - Printing and signing checks, making multiple tax deposits, filing quarterlies, accurately preparing W-2's and other time-eaters. All non-revenue producing tasks - tangible hours that can instead go toward growing your business.
5. Other Features - Once the payroll engine is in place, you open up possibilities for direct deposit, time and attendance/POS integration, human resources assistance, pay-as-you-go workers compensation, archived electronic reports and pay-stubs and much more.In the end, not only can you focus on what you do best, you can shift energy toward learning and embracing new revenue-producing tools such as social media, that brings money in, so you're ready for when it's time to send it back out.When a C-corporation sells an asset and the corporation's owner goes to work for the buyer, there may be an incentive for the parties to pay the owner a higher salary than the market will bear, as disguised payments for the asset. That's because the purchaser can currently deduct salary, but must capitalize any purchase payments.
At the same time, there may be a trap: if the payments are found to be in substance purchase payments to the selling C-corporation, the payments will face double taxation, once at the corporate level and again upon distribution as dividends.
In H&M, Inc. v. Commissioner, T.C. Memo 2012-290 (October 15, 2012), H&M, Inc. agreed to sell its insurance business to a local bank and competitor. Under the purchase agreement, H&M agreed to sell "all files, customer lists, insurance agency or brokerage contracts, the name of [the insurance business], and all the goodwill of [the insurance business]" for $20,000.
The deal was contingent upon the agreement by H&M's owner - Mr. Schmeets - to work for the buyer for six-years and also enter into a covenant not-to-compete for a period of 15 years. Under these latter agreements, Schmeets would receive over $600,000 during the six years. The agreement was later modified, so that some of the compensation would be deferred, would earn interest, and would be payable to Schmeets' estate in the event that Schmeets died.
The Court found that there had been no appraisal of H&M's assets prior to entering into the agreement. In fact, the buyer didn't even examine H&M's financial records. In addition, prior to the sale, H&M had paid Schmeets a salary of about $29,000 per year.
The IRS argued that Schmeets' wages were actually disguised payments to H&M for the sale of the business and urged the Court to apply the "substance-over-form doctrine" to recharacterize the transaction.
While lamenting the parties' failure to adequately document the transaction, the Tax Court rejected the IRS' position. To demonstrate that the business was worth more than $20,000, the IRS would need to show that the assets were undervalued. But the only intangible that the IRS pointed to as being undervalued was the goodwill of the business.
Generally, there is no salable goodwill where the business depends upon the personal relationships of a key individual, unless there is an agreement that prevents that individual from taking his relationships, reputation and skills elsewhere.
Here, "there was convincing testimony that . . . . no one knew insurance better than Schmeets." Furthermore, Schmeets had no agreement with H&M (of which he was the sole owner, incidentally) that would have prevented him from going to work elsewhere. Thus, the business' goodwill had no value.
The Court also gave "no weight" to the opinion of the IRS' expert, who opined that Schmeets' new salary was excessive, since the expert ignored Schmeets' particular skills and level of experience.
Finally, the Court noted that, in negotiating the sale and related agreements, there was "virtually no discussion" about the tax consequences of the transaction.
The employment relationship was motivated by Schmeets' desire for guaranteed employment and the buyer's desire to harness his skills, not for "massaging the paperwork for its tax consequences."
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In the franchise finance world, the most discussed number is the EBITDA--EBBADABADOO as some call it. EBITDA is earnings before interest, taxes, depreciation and amortization. It is really a sub-total to the income statement. It is earnings without any charges for cost of funds, taxes or capital spending.
EBITDA's use began popularized as a credit metric, used in the 1980s M&A and credit analysis world--to test for adequacy of debt coverage. EBITDA is often the common denominator to track and report company buyout values: the acquisition enterprise value to EBITDA ratio is a very commonly reported metric. So much so that that's where the focus goes. And its use as a simple business valuation tool: the company is worth some multiple of EBITDA; the higher the multiple, the higher the price, and vice versa.
In the franchising space, where franchisors might report a simple EBITDA payback for an investment, or report EBITDA value in their franchise disclosure document item 19 section. The special problem there is this EBITDA is stated in terms of the restaurant level profit only--before overhead. Really, the problem is this: EBITDA doesn't show the whole picture. It is a sub-total. It doesn't show full costing.
EBITDA alone as the metric misses at least eight costs and expenses, that are vital to know, calculate and consider in operating and valuing the business as a cash and value producer. Using a business segment such as a store, restaurant or hotel as an example, here are the eight required reductions to EBITDA that must be subtracted, listed in order of magnitude of the cash outlay, to really get to operating economic profit.
- Interest expense: the cost of the debt must be calculated. Interest is amount borrowed times the interest rate times the number of years. One can have rising EBITDA but still go broke.
- Principal repayment: the business cash flow itself should contribute to the ability to pay back the principal debt. That often is in a 5 or 7 year maturity note and is another very large cost that must be considered.
- Future year's major renovation/remodeling: once the storefront is built, it has to be renewed and refreshed in a regular cycle, often every 5-10 years, via capital expenditures (CAPEX). That often is 10-30% of the total initial investment, or more, over time.
- Taxes, both state and federal: Financial analysis often is done on a pre-tax basis as there are so many complicating factors. But the reality is the marginal tax rate is about 40%.
- New technology and business mandates: aside from the existing storefront that must be maintained, new technology, and new business innovation CAPEX must be funded to remain competitive. Example: new POS systems for restaurants, new technology for hotels.
- Overhead: if the EBITDA value is stated in terms of a business sub-component, like a store, or restaurant or hotel, some level of overhead contribution must be covered by the EBITDA actually generated. Generally, there are no cash registers in the back office, and it is a cost center.
- Maintenance CAPEX: for customer facing businesses (retailers, restaurants, hotels, especially) some renovation of the customer and storefronts must occur every year and does not appear in the EBITDA calculations. New carpets, broken windows, you get the idea. In the restaurant space, a good number might be 2% of sales.
- And finally, new expansion must be covered by the EBITDA generation, to some level. New store development is often a requirement in franchise agreements, and new market development necessary. While new funds can be borrowed or inserted, the existing business must generate some new money for the expansion.
You might say...these other costs and expenses are common sense, they should show up in the detailed cash flow models that should be constructed. Or they can be pro-rata allocated. But how times does this really happen? The EBITDA metric becomes like the book title....or the bumper sticker that gets placed on the car. You really do have to read further or look under the hood. And the saying is true...whatever you think you see in EBITDA...you need more.
Two weeks ago, McDonald's (MCD) announced it planned to refranchise up to 1500 units out of Europe and Asia Pacific, and announced a series of increased dividends and share buy back plans. In 2013, Wendy's (WEN) announced refranchising of 450 units in its non core markets.In 2012, Burger King (BKW) and Jack in the Box (JACK) kicked into serious refranchising, so much so that Burger King (BKW) now only owns and operates the 52 units in Miami out of a 13,667 worldwide unit total.Even Starbucks (SBUX) is finally franchising its flagship Starbucks brand, refranchising units in the UK and Ireland. YUM has been furiously refranchising since the mid 2000s but intends to keep China Company operated.Franchising has a high percentage margin--McDonald's has an 83% worldwide franchisee operations margin, and is among the highest. YUM's David Novak seems to confirm that when he says "we love franchising--it's the highest possible margin business we can be in. "The debate in restaurant circles about the proper mix of company and franchised units has been legendary. In the 1970s and 1980s, the trend was towards company owned locations. In the 1990s, as return on invested capital (ROIC) and awareness of free cash flow--profit less capital expenditures-- expanded, refranchising picked up.See GE Capital's presentation slide below, from a presentation Managing Director Todd Jones gave last week, which has some telling comments on this topic:
Refranchsing means the company thinks it can make more on the royalties, and on rent surcharges (if it owns the real estate) and by reducing G&A and capital expenditures (CAPEX), versus operating the unit.In my view, most times, refranchising involves weaker profit stores, lower than a magic profitability toggle point and typically involves weaker brands or weaker geographies in a brand.Therefore, investors may like it, especially in the short term. But who is it good for?Benefits of refranchising
- Refranchising should lower debt, to allow for special dividends or to improve credit ratings, to ultimately lower interest expense.
Business is business. Every number and signal needs to be scrutinized. Refranchising is both a bullish and bearish indicator at the same time. It is not a panacea.
Ironically, in reaction to the McDonald's plans last week, Wall Street was not happy. They hoped for more catalysts to juice the stock higher.Kudos once again go to Popeye's Louisiana Kitchen Inc. (PLKI) not only for a good Quarter One 2014 earnings results reported just last evening, but also for continuing the practice of being the only publicly traded restaurant franchisor that I'm aware of that reports its franchisees cash flow proxy number.Popeye's reports franchisee EBITDAR--earnings before interest, taxes, depreciation and rent.It's only a semi useful metric, as it misses rent and related expense, but also debt service and capital expenditures (CAPEX). Depreciation expense is an inperfect proxy for CAPEX.In the first quarter of 2014, Popeyes franchisee community had an EBITDAR of 21.3%, compared to a 20.1% for the prior year. Franchisee same store sales were up 4.3%. Many more costs and expenses need to be subtracted to arrive at franchisee real economic gain, but at least it is some number.Popeye's EBITDAR number is about 3.7% percentage points better than the GE Capital QSR survey sample published earlier this spring. Of course, you have to look at both dollars and percentages, per store to analyze fully.Other franchisors do not want to talk about franchisee numbers. They don't have them, or the numbers are not good. Sometimes, franchisors are afraid and don't want to know them. But in any case, they should have them or should care.Compare the Popeye's treatment to that of an article published by The Street's Laurie Kulikowski last week timed for Small Business Week.Titled "Looking for an Investment-- Here are Eight of the Best Franchises". The Street collaborated with a franchise survey group that surveys franchisee satisfaction.Not a single point of "return on investment" data or quantification was listed, despite that the survey had a "financial return satisfaction metric".Satisfaction is nice, but what about making money? Not a useful article.Sloppy staff work perhaps. But the franchisor should have the numbers. You manage what you measure.Or, as my first boss in QSR operations drilled: "It's not what you expect, it's what you inspect."Overview:
- Some Red Lobster levers for improvement exist.
To any close observer of the ongoing Darden (DRI) conflict as it has unfolded with its opponent activists Barington, and Starboard since late 2013, a Red Lobster sale to private equity was not a shocking outcome.
Consider:Private equity has dry powder--unallocated funds-- available that it must put to use to earn a fee. Golden Gate had owned three restaurant brands and continues to own one, California Pizza Kitchen.Darden, which was in trouble since at least 2007 trying to hit a 15% EPS model with the mature Red Lobster and Olive Garden restaurant brands, bought a lot of restaurant concepts at high price in 2008-2013, and wound up with a lot of debt. As the rate of casual dining traffic decline fell after the Great Recession, (Darden noted the casual dining overall space traffic fell 18% versus the peak) and core earnings fell, it had both dividends and buyback demands going up at the same time. A true cash flow squeeze resulted.Darden had remodeled the entire Red Lobster chain by 2013 and needed to get some money out of its investment. (Why it remodeled Red Lobster first versus Olive Garden is a fascinating question.)Red Lobster had underlying real estate that could be levered to lower the effective Golden Gate purchase price.The question, is what now to do with Red Lobster? What are the "Lobster Levers"?On the positive side, the brand ratings are not weak. It ranks roughly in the middle of the pack via the 2014 Brand Keys Customer Loyalty index but near the top of the 2013 Q4 Goldman Sachs Brand Equity Survey. The downside is there are no other national seafood players to steal market share from. Bonefish (Bloomin Brands) (BLMN) is just growing and Joe's (Ignite Restaurant Group) (IRG) has built its own crab niche.It's not going to work its way out of trouble with more $10 television advertising that it has been pounding way with this week. It's going to have rent to pay. Darden has noted Red Lobster's customer base indexes older and lower income than the most desirable casual dining peers; it's got 706 units in an overbuilt US restaurant space. Keeping the same units and doing the same thing won't solve anything.But what it can do is the following:Close some units. Now that it is private and protected from the intense investment community focus on every metric, it can examine its store base. Note that American Realty executed sale leasebacks on 500 of the 706 units. A number of units were excluded for a reason, some were leased, some undesirable to do so.Red Lobster reached its unit count peak in the US in 1996, at 729 units. It then closed 75 stores over the next four years, to arrive at 654 units in 2000, to then slowly grow again until 2013. The natural US unit cap seems to be much smaller than 700. A privately held company can work this.With a rather low 9% reported adjusted brand EBITDA, the law of large numbers is there must be a number of units that are in the lower profit quadrant that upon closure, could result in positive cannibalization, and will improve the overall brand average profile.Test and rebrand. Maybe because it was part of the central heritage of Darden, other than remodeling or wood grilling, there has been no real new concept ideation for years. A self serve Red Lobster lunch platform and Red Lobster/Olive Garden combo stores were tested recently and were a total waste of time and money. Such poor quality tests are indicated of a big concept ideation problem. Too much seafood on the menu and a very low level of alcohol sales are indicative of the problems.Work international. All of its peers are. Darden just began a brief foray into ex-Canada international and franchising in 2013. As late as 2013! Missing the international opportunity was a great strategic flaw. The US is filled up with restaurants. Can't Red Lobster work internationally, somewhere?Work franchising, joint and limited partnerships. Darden's problems with franchising went all the way back to a failed franchised venture in the 1970s. Franchising is difficult, well funded and capitalized franchisees have to be found. Darden said they didn't have the expertise. But it can be found. A new management mindset embracing franchising has to be developed. It can work in casual/fine dining: Ruth Chris (RUTH) has had 50% of its stores franchised to solid players forever, and Cheesecake Factory (CAKE) is working franchising and joint venture partnerships to get its international growth jump started. The Cheesecake founder, restaurant operator, David Overton "got it", but not Darden.Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.Summary - 3 Points
Darden was sued in 2009 for a SEC 10b5 claim of unreasonable earnings claims coming from the RARE acquisition, but the Orlando Federal Court dismissed the action in 2009; given the high bar to securities litigation initial motions in the era after the 1995 Litigation Reform Act.
Full disclosure: I worked a special investigation of Darden's earnings projections after the RARE acquisition and didn't see how then how the acquisition synergies were "reasonable".
Guess what happened.
We are now where we are.Darden faced the circumstances of slowing casual dining sales and traffic-which Darden itself did not create, but tolerated-- this weakness was apparent in 2007, before the Great Recession-but also having remodeled Red Lobster, now remodeling Olive Garden and putting a load on CAPEX, building very costly new restaurants--$5-6 million per box, pressure to increase dividends and buybacks...and covering the interest from the RARE, Eddie Vs and Yard House purchases. Check out the following Barington slide:
DRI's stock performance lagged in 2012 and 2013.
Barington pounced and was right on some of its calls in its introductory volley on December 17, 2013:
The Barington pitch was pretty logical until it got to two points:· Spin off the so called high growth brands-Capital Grill, Seasons 52, Bahama Breeze, Yard House, Eddie V-the entire DRI Specialty restaurant group, and· Spin off the owned restaurant real estate into a REIT or sell the underling land.While they weren't operators (Barington had some experience with the now fading Lone Star Steakhouse and the Pep Boys auto oil change chain as investor), they could read balance sheets and saw the company owned a lot of store real estate. Owning real estate was a restaurant financing and development strategy. In the early days it provided a veneer of security for the bankers but it also provided for a great mode of control: there were no landlords to hassle with, no step rent increases in the outyears or costly lease terminations should a site have to be closed. Working restaurant litigation matters as a one element of my consulting practice, I can testify that among the most common are real estate disputes.Analytical Problems
In conference calls, Darden said that its Specialty Restaurant Group was profitable and could stand on its own. That was a bad admission, because almost certainly, that profit basis was an EBITDA value and not a free cash flow basis, which would have covered the CAPEX and debt service cost to build $5 million boxes. Restaurants don't highlight that metric.Barington and Starboard have endlessly speculated on what a Darden REIT could trade for. Of course, there are no restaurant REITS to provide comparables.See the following video from Howard Penny of Hedgeye, supporting Starboard and his super long call on Darden. Note that he touts the potential value of the REIT.Starboard issued a 100 page "Darden Real Estate Primer". Despite all this, Barington and Starboard have failed to prepare analysis on the following key points:1. What is the projected free cash flow profile for the outyears for a separated Olive garden/Red Lobster, and Specialty Restaurant Group?2. What is a realistic REIT cash flow profile for some crappy real estate that Darden owns and needs to get out of? How much will Darden be liable in payments to the REIT?It's not as simple as the Barington slide below, shows:
Restaurants and Real EstateMcDonald's (MCD) and Tim Horton's (THI) also are real estate centric, for the control and for the potential for real estate margin. Once the property is paid for, then it's practically a 100% profit flow through. As Jonathon Maze, Editor of the Restaurant Finance Monitor pointed out recently, "restaurant executives tend to take a longer view of real estate. It's a safety value; providing the company flexibility with options should things get bad."
The activists want short term gain, as does Wall Street generally. They tend to talk about "unlocking value". But over what time? Not many contemporary restaurant chains have such real estate intense balance sheets, as restaurant construction and land costs both rose in the 1990s-2000s.The implication in their pitch is that because the real estate is owned and because DRI does not pay cash rent, that it is somehow "sheltering" or incentivizing its RL and OG underperformance. From my long corporate staff experience, the corporate staff members who drive this-don't understand these intricacies at all. See the Starboard slide:
Memo to Starboard: any EBITDA metric is a very poor metric to judge performance.Opinion:
So the real estate can be sold and proceeds generated to generate a big one time dividend, or a first time restaurant REIT will make big news splash. Good for 2015 or 2016 or when this is pulled off. But two questions are raised:(1) Will the decoupling of the real estate fix the problems at Darden?(2) What will you, Darden, do for me tomorrow?The answer to Question One is almost certainly not. In fact, losing control of the real estate to either a REIT or a landlord owner should make it more difficult to reposition either Red Lobster or Olive Garden. Population and retail/restaurant trade patterns shift in the US, and there are too many casual dining restaurants now. That is one of Red Lobsters and Olive Garden's realities that Darden failed to address. While the land has value forever, many restaurant sites have an effective peak economic life of 20-25 years.In terms of Question Two, it seems not clear. The activists have failed to lay out future year cash flows with and without real estate rents, and with and without portfolio breakage. They are talking the REIT valuation in one hundred page detail, however. Wrong entity to think about. Can Darden really close stores and not be stuck with big lease make whole payments? Darden hasn't laid it out clear case either.If it's a church or a dollar store that comes in to backfill some closed Darden sites (two of Darden's closed sites in Indianapolis are that), think about being disappointed, either in the REIT, or decreased cash flow from Darden's core business.In the franchise finance world, the most discussed number is the EBITDA--EBBADABADOO as some call it.EBITDA is earnings before interest, taxes, depreciation and amortization. It is really a sub-total to the income statement. It is earnings without any charges for cost of funds, taxes or capital spending.EBITDA's use began popularized as a credit metric, used in the 1980s M&A and credit analysis world--to test for adequacy of debt coverage.EBITDA is often the common denominator to track and report company buyout values: the acquisition enterprise value to EBITDA ratio is a very commonly reported metric. So much so that that's where the focus goes.And its use as a simple business valuation tool: the company is worth some multiple of EBITDA; the higher the multiple, the higher the price, and vice versa.In the franchising space, where franchisors might report a simple EBITDA payback for an investment, or report EBITDA value in their franchise disclosure document item 19 section.The special problem there is this EBITDA is stated in terms of the restaurant level profit only--before overhead.Really, the problem is this: EBITDA doesn't show the whole picture. It is a sub-total. It doesn't show full costing.EBITDA alone as the metric misses at least eight costs and expenses, that are vital to know, calculate and consider in operating and valuing the business as a cash and value producer.Using a business segment such as a store, restaurant or hotel as an example, here are the eight required reductions to EBITDA that must be subtracted, listed in order of magnitude of the cash outlay, to really get to operating economic profit.
In the old days, Accountants could help you understand what happened during the past months and years but they could also help you understand your productive capacity--which is really about your future ability to continue to operate and produce revenues and profits.
This was possible because of an elegant solution to capital expenditures with a benefit beyond the current operating year. Instead of being expensed, these investments are capitalized on a balance sheet.
Over time the net effect of these tangible capital expenditures (adding new investment and subtracting depreciation) showed whether the company was continuing to invest in building and maintaining its factories, equipment and infrastructure.
With the shift that we so often talk about from the tangible to the intangible economy, this changed.
Intangible capital expenditure is largely treated as a current year expense even when it will have a benefit beyond the current operating year. No big deal, you may be saying.
But cumulatively, it's been a huge deal.
It's how the balance sheets of most American companies have gotten completely out of whack. Given the steady investment in intangibles over decades, today the average balance sheet explains just 20% of the company's corporate value.
This is true for public franchisors, also.
We've gotten used to this issue and, as a consequence, the balance sheet is useful only for understanding current assets, current liabilities and equity. But there are no numbers for the intangible infrastructure, the intangible assets.
This means that it's nearly impossible to get a sense of the productive capacity of a company by looking at its balance sheet.
(And that there are few norms for talking about these assets outside the balance sheet short of, well, talking about them.
But as the Coloplast experiment shows (and our own experience tells us), talking about something and measuring it systematically are very different activities.
And, guess what? Narrative isn't nearly as effective as measurements.)
Why is this a problem? Because the future of your business depends on it.
You are like businesspeople in the industrial era who needed to know how much they could produce at what cost and what investment would be to add productive capacity and--here's the big one: how well the factory is working.
You need to answer the same questions for your intangible infrastructure. So what's a businessperson to do?
Learn to measure your intangibles.
Start with an inventory, build a working model of how they fit together and then measure them.
Are you a businessperson who wants to looks forward? We have open source tools to help you do much of this and we also offer a platform for easy measurement, all at www.smarter-companies.com.
On July 25, 2013, Starbucks (SBUX) delivered a Q3 double beat and stellar worldwide comparable sales (comps) of +8% (+9% in the U.S.)
Some analysts were concerned about the SBUX Q4 forecast of a mid-single digit comp. The high comps were said to be a kind of spike. SBUX explained that mid single-digit comps were likely in Q4.
CEO Howard Schultz explained that it would be irresponsible for SBUX to forecast high comps if it believed they were not attainable and that SBUX business trends were very solid.
He sharply concluded:
Now having said that, our expectations of ourselves that we are going to deliver a healthy comp growth in Q4 that our investors will be proud of. Let's get off the comp number, because it's not the issue, issue is we are building a great extraordinary endeavoring company and the comps are going to follow that.
Were the sell-side analysts right to be concerned about Starbucks' comp "slowing up?" See the below Starbucks comps chart.
My opinion: perhaps. Of course, the beginning of comps deceleration is an important investor signal and will first be seen on quarterly or monthly comps reporting. Only McDonald's (MCD) reports monthly comps.
But there are other more important questions.
In the retail and restaurant space, comp sales from year to year are given way too much emphasis in reporting and analysis. It becomes the headline bumper sticker. The metric, which strips out newly opened or closed stores that are "immature," is a proxy for business cadence and optempo momentum, and sometimes a proxy for profit flow through.
But the analytical problem is the year-to-year comp is only so meaningful. What happened last year - the base for the comp - could have been impacted by many factors such as weather, calendar shift, competitive and marketing calendar shifts and so forth. It's certainly possible to have a great 10-year, five-year or two-year comp trend, but to have a flat or modest current quarter comp calculation.
In the future, we urge investors of all sorts - and analysts - to ask more meaningful questions about the comp trend.
After getting the comp results, and a customer traffic and average ticket breakout, here are 10 more meaningful questions:
1. Did the comp achieved meet your internal budget?
2. What is the comp on a two-year basis, a five-year basis?
3. What tradeoffs to get this comp?
4. What's the comp on a rolling 12 month or rolling two-year basis?
5. How much profit flows through to the store level from this comp?
6. How much is the flow through on a percentage of incremental sales basis?
7. What is the standard, or theoretical profit flow through?
8. Is the incremental flow through attained via higher cost percentage leverage?
9. How much does incremental store level profit flow through to the corporate bottom line?
10. How does this comp affect variable compensation payout accruals?
One question to consider is whether this is a monthly period, or how many weeks were included in this comp and the prior period? The hugely symbolic and massive market cap McDonald's for instance, is still reporting on a traditional monthly basis, which makes for calendar noise, which we discussed previously on SA.
In the restaurant space, there is an inordinate amount of short-term action to maximize the comp.
Better investor and sell-side questions will enable the company to explain its rationale, and send truer & better picture to the market.
When you need an authority on understanding public franchisors, connect with me on LinkedIn - or just give me a call.
In one of the best IPO results of the year, the first restaurant IPO of the year, Noodles (NDLS) raised almost $100M and stock price more than doubled from its initial pricing at $18 to close at $36.75 on its first day. The Noodles CEO, Kevin Reddy, came from Chipotle (CMG), at an earlier stop in life.
Is Noodles the new Chipotle?
Chipotle IPO'd in June 2006. They are both fast casual concepts, Colorado based, both early movers. And there are many fundamentals comparisons. See the table below, prepared from both the Noodles and the Chipotle SEC S-1s, for their last full fiscal year before IPO, which shows the key fundamentals drivers:
Store economics look similar? Yes, in some ways:
· Fast casual operators, new buildings, new food types and popularized styles.
· Average Annual Restaurant Sales in the $1.2M to $1.4M range.
· Solid restaurant margins - Noodles now actually exceeded that of Chipotle in 2005 by 210 bpts.
· Totally or primarily company operated model.
Noodles' success demonstrates there is investor demand for new restaurant offerings and validates fast casual investor demand. I understand NDLS was twenty times oversubscribed. Catterton, Morgan Stanley and Cowen did a nice job.
The issue to keep in mind is the United States consumer space is not the same as it was in 2006.
Recession, fundamental changes in population, income, eating and dining preferences, commercial real estate site characteristics, and more U.S. restaurants in operation each year make for a more difficult 2013 and out conditions.
Noodles must deliver good quality, service, cleanliness and price/value, in a differentiated fashion, with good corporate stewardship and continue to build connections with guests, employees, investors and other stakeholders via its culture.
Mathematically, as it expands, it has to think a lot about occupancy costs. NDLS occupancy costs are now 9.9%. Chipotle's was 7.6% in 2005. Site supply is tight. Many legacy brands, the real first movers, like McDonald's and Dunkin' Brands (DNKN) got the early best U.S. sites.
Restaurants economics was built on 6-8% rent, but some restaurant operations are facing 15-20% rent for some sites. Too much push for too fast expansion will test the rent leverage especially for a $1.2 million sales concept.
The imputed IPO valuation from the NDLS IPO is already $800M, or an EV/EBITDA multiple of 26.6X. That's rich. But it's just the first day. I hope the pressure cooker investment world will take a break and give them a chance to grow smartly.
Wouldn't it be great to spend more of your time on the fun stuff in your business? The work you are uniquely gifted to do? The work that can help you increase sales, improve profitability, and grow your business into your dream of success and pride?
That's one of the key challenges we all face running a business.
We have to carve out enough time to focus on the things that matter most. We have to figure out how to focus on the things that will really move the success needle... the things that only we can do to create exciting results and dramatic improvement.
One of the obstacles in your way is the struggle... and the doubt... and the hesitancy that sets in when you are worried about your cash flow. It's a HUGE distraction.
The interesting thing I have noticed in my 28 years as an accountant and CPA is that much of that worry and struggle results from a lack of understanding about your cash flow. It's not necessarily a real cash problem.
It's that uneasy, "wake up in the middle of the night in a cold sweat", kind of feeling that is rooted in not understanding what happened to your cash last month. And not knowing how to quickly, and easily, take control of your cash flow.
There's a good chance you are in the worried category if you can't pass what I like to call The Spouse Test.
What if your spouse asked you "Honey, I noticed the business had $75,000 at the beginning of the month but only $45,000 at the end of the month. What happened to the cash?"
Your ability to answer that simple question tells you whether you understand your cash flow or not.
Profit or Loss Does Not Equal Cash Flow - I'll Prove It
Do this quick test to see if you can pass The Spouse Test.
- Grab your income statement (Profit & Loss statement - your P&L) for a recent month and look at your net income number (your profit or loss). Write that number down.
- Then calculate the change in your cash balance for the same month (by looking at the cash balance on your balance sheet as compared to the prior month). Write that number down.
- Now compare the two numbers. (I can 100% guarantee you the two numbers are different. Why? Because profit or loss DOES NOT equal cash flow.)
Now explain to your spouse what happened to the cash for the month. Explain what caused the cash balance to go up (or down).
As an example, let's say your profit last month was $23,000. And your cash balance went up by $12,000. When you can very quickly explain what happened to the cash to your spouse or business partner, you understand your cash flow. You know what's going on financially. Which means you can put financial management aside for a bit and focus your time and efforts where you can make an exciting difference in the business.
That's why understanding your cash flow is so important. So you know what's going on. So you know what to do to improve cash flow. And so you can skip past the struggle, the worry, and the doubt and go right to the high-payoff activities that only you can do in your business.
That's the ultimate reason to make sure you understand your cash flow each month.
I am doing a live webinar on June 11, 2013 that you are going to love.
- I'll show you how to understand your cash flow in less than 10 minutes, and
- I'll show you how to explain what happened to the cash in your business last month (to your spouse or business partner) in a 2-minute conversation
And this one is FREE.
Understanding your cash flow used to be a time-consuming, complicated, and frustrating task. Not anymore!
Or Click here to register NOW.
When lender experiences a default for an SBA guaranteed loan, there are several considerations the lender must review.
If a borrower defaults within 18 months of initial disbursement (or, if the final disbursement was made more than 6 months after the initial disbursement and the borrower defaults within 18 months after the final disbursement), the SBA considers the loan an "early default".
The date of default is generally determined by the first uncured payment default of 60 days or more.
However, if a borrower, during the first 18 months, has significant problems making full principal and interest payments as scheduled or is granted a payment deferment of 3 months or more, the loan is considered an "early problem" loan.
Early default and early problem loans are subject to heightened scrutiny. There are two considerations a lender needs to review.
1. Under SBA regulations, a full denial of liability is justified if the loan involves an early default, or early problem and the lender failed to provide credible evidence that it verified the borrower's financial information by comparing it to relevant IRS tax return transcripts, as required by the version of SOP 50 10 in effect at the time the loan was approved.
2. Additionally, if there was an early default or early problem loan, the lender's failure to verify and properly document a material portion of an injection of cash or non-cash assets required by the Loan Authorization raises a rebuttable presumption that the default was caused by the lack of the injection and a full denial of liability is almost always justified.
However, in both cases, a full denial may not be justified, however, if the lender provides credible evidence that the business failure was due to factors unrelated to any financial difficulties that the lender could have identified through the IRS verification process or which were caused by the lack of equity.
To rebut the presumption, the lender must provide credible evidence that the primary cause of the default was something other than the lack of the required injection or information used in the repayment analysis, e.g., the death of an irreplaceable key employee or a natural disaster that destroyed the borrower's business premises and customer-base.
As a practical matter, the failure to adequately verify equity injection or obtain IRS tax transcripts is an automatic denial of the guaranty if the SBA considers the loan to be an early problem or early default loan.
However, there are some limited circumstances in which a lender may be able to rebut the above-described presumption.
For more information on SBA loan programs, please contact us.
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We sat down with Joe Caruso and discussed franchise lending loan amounts with Joe Caruso out of Balitmore. We talked about the current deal making environment in franchising.
We focussed on deals about the $350,000 limit. Are things getting better, we wondered?
Bob Coleman: We're talking with Joe Caruso on the Strategic Committee of the International Association of Franchisees and Dealerships out of Toronto, a trade-based organization. He's also the President of the Capital Area Franchise Association. Joe, welcome; tell us about franchise lending today. What's it look like for you and your peers?
Joe Caruso: Well, at the Capital Area Franchise Association, or CAFA, we just had Steve Caldeira from the IFA in January commenting on a variety of things in franchising, but one of the most important topics was the access to capital.
Bob: Is it getting easier?
Joe: Yes, it is absolutely getting easier and the lenders that I talk to on a regular basis are saying that as well. It's getting easier for those people borrowing greater than $350,000; that $350,000 or less loan amount is still a challenge. The thing I hear recurring from originators and lenders is it costs us just as much money to originate a $350,000 loan as it does to do a $3 million loan.
Bob: Absolutely.
Joe: And the quality of the borrower, they're more organized at higher levels; they're more sophisticated; it's just easier to get the deal done and it's more profitable.
Bob: Are you seeing that the deals that are being done - are they for second and third concepts, or can we still get financing for that start-up Franchisee who's just retired on out of Boeing?
Joe: The lenders are much more interested in seasoned operators who have existing operations that want to add to their portfolio, either with the brands that they already have, or they want to add an additional brand. There's no question about that, although a lender I spoke to this week is focused on, interestingly enough, Franchisors with less than 100 locations, but more than 25; and they are willing to do first time Franchisees. And the loan amounts are just above that 350 level; they're really in the $375,000 to $500,000 loan amounts; and they're focused on that. But they're more of a niche player, and more of a boutique firm.
Bob: Great. Joe Caruso out of Toronto; thank you very much for joining us and giving us an update.
The term "Factoring" has gotten a bad reputation in the world of small business credit over the years.
Many small business owners view it as financing of a "last resort" and worry about what their employees or customers will think about the longevity of the business once they learn their employer/supplier has entered into such a financing arrangement.
While business owners should be concerned about how their customers perceive their business, entering into a factoring arrangement is rarely the "red flag" that many fear it will be due to the fact that factoring has become a much more common means of providing a company with access to working capital. The odds are excellent many of your customers are RIGHT NOW paying many of their invoices to factoring companies in lieu of their suppliers who have taken advantage of this valuable financing tool.
Since access to credit for small business owners has contracted over the last several years, it has become more challenging for small businesses to obtain traditional credit lines. Many lenders reserve these facilities for only their "best" customers, which are often defined as those who have strong profits, increasing revenue trends and high balances on deposit.
Financing may still be available to these strong companies who also have "hard assets" to pledge as collateral. These are often defined as property, plant and equipment. In other words, if you own a business with good profits and stable revenue trends and have equity in a commercial building filled with valuable equipment, you may qualify for a small business loan. However, if a business owner operates out of rented space and provides a product or service which does not require much in the way of equipment, small business loans can be elusive.
Factoring can be a convenient alternative to businesses which cannot meet today's stringent criteria for small business loans but have a strong base of customers. Under most factoring arrangements, the factoring company ignores the financial condition of the client and strictly focuses on the credit quality of their customers.
If the customers are creditworthy, there is an strong likelihood a factor will be interested in "factoring" the accounts receivable. When factoring a receivable, a business sells the right to be paid by their customer to the factoring company in order to receive the bulk of the amount due (usually 75%) shortly after issuing the invoice, with the balance, less a factoring fee, remitted to the business once their customer makes payment to the factoring company.
Fees can range from 2% - 5% of the invoice amount for each 30 days an invoice is outstanding. In other words, if a customer typically pays their invoices in about 40 days, the business would take on average about a 3% discount on their invoices in exchange for the factoring company advancing 75% of the invoice amount shortly after it is issued.
Like any industry, there are also unscrupulous factoring companies out there. It is important to ask for references and to Google the name of the factoring company you select to see what, if any, complaints are out there. Many factoring companies are run by long-time veterans of the business and are often the best choice with which to develop a financing relationship.
While many business owners fear what they do not understanding, the truth is that factoring can provide businesses which cannot yet qualify traditional bank financing with the working capital bridge they need until they can meet the standards for traditional business credit lines.
For the 5 Most Fascinating Stories in Franchising, a weekly report, click here & sign up.
Chris Lehnes is a 20 year veteran of the small business lending industry. He has held positions in commercial loan documentation, credit analysis, operations management and business development at one of the country's largest small business lenders. Currently, Chris is a Business Development Officer at Versant Funding where he provides non-recourse factoring to businesses in a wide variety of industries with annual revenue from $1 - $50 Million. You can reach Chris at 203-493-1663, [email protected], or www.ChrisLehnes.com
The restaurant space will be interesting in 2013. Sales issues, cost issues, expansion issues, franchisee issues. There are still too many restaurants in the US and x-US markets sales increases have slowed. The two industry leaders, McDonald's (MCD) and Darden (DRI), are both somewhat in the penalty box and under pressure. Here are our thoughts on 2013 issues and opportunities.
Comps Cliff Coming: In looking at 2013, it is likely restaurants will get off to a bad start. In Q4 and Q1 2013, the restaurant space will fall off a cliff of sorts: the comps bulge generated last winter. Driven then both by warmer weather, price increases, a bit lower sales of discounted items and the peak of the 2010-2011 restaurant recovery, the January-March 2012 number will be hard to beat.
The following chains will likely have the hardest sales comp comparisons in Q1. Every single chain had lower comps most recently reported than the Q1 peak, versus the most recent quarter or monthly update:
Company/symbol FY 2012, Latest Trend 2012 Q1 Jan-March Comp McDonald's +2.4% +7.3% Starbucks +7.0% +9.0% YUM (YUM) (1) -6.0% +14.0% Jack in Box (JACK) +3.1% +5.6% Chipotle, (CMG) +4.8% +12.7% Texas Roadhouse (TXRH) +3.6% +5.8% Blooming Brands (BLMN) +3.6% +5.3% Buffalo Wild Wings (BWLD) +6.0% +9.1% Panera (PNRA) +5.8% +7.7% (1) China Division only
More sales news. Traffic throughout the sector has eroded since fall 2012. In the QSR space generally, traffic now is very marginally positive and average check is 2-3% favorable, but in the overall casual dining space, traffic is negative and totally offsets about a 2.5% check increase. A few positive standouts exist, however: Texas Roadhous ,Panera, Starbucks (SBUX) and Popeye's (AFCE).
One question is why was investor disclose so poor at YUM? The China same store sales trend is so stunningly negative - large sequential decreases from +19% in FY-11 to -6% just noted this week for Q4 2012, perhaps the largest decline anywhere over such a short time.
Extreme discounting is the newest news but is really an old story. The current price spectrum of restaurant TV ads runs from $.99 grillers at Taco Bell to $11.99 thirty piece shrimp at Red Lobster. This does not portend positive for the average check. The comps cliff has affected marketing strategies everywhere via low price marketing.
Earnings standouts: Texas Roadhouse, Panera, Starbucks and Popeye's were Q3 (and Q2) positive standouts: positive sales and traffic, sales and earnings beat $.01 or more over estimate. Does prior performance guarantee future results?
Dividends are the goal. Dividends will be important in a low growth, low return world. The US restaurant market is way overdeveloped and worldwide development takes time and proper store level economics. We will be glad to see companies like Dunkin Brands (DNKN,1.80% yield), Burger King (BKW,.90% yield), and Blooming Brands (BLMN, zero yield) finally work their way out of private equity positions so that more substantial dividends can be paid. THI, another pure play 100% "capital light" franchisor, is also low at 1.70%. That there are two coffee sector players in this group is interesting. Lower coffee commodity costs advantage will accrue to the franchisees, not the corporate entities.
Some IPOs and M&A will happen. We still wonder when Noodles will be ready for its IPO. Fast casual is "hot." Another fast casual brand, Pei Wei, could be a candidate once its lower newer unit open sales problem is fixed. Jamba (JMBA) seems to be of value for those strategic buyers who need an established beverage platform.
It was clear from the 2012 SBUX and DRI transactions that the path to a rich M&A valuation is to develop a unique but mainstream product that well-heeled restaurant majors can buy for entry at rich multiples. There will be continued private equity churn, they always have fresh powder to deploy. The wave of 2006-2008 PE acquisitions will soon come due to sell.
Several Turn Arounds should be watched. Interesting that the two worldwide restaurant leaders, MCD and DRI, are both challenged. No surprise that MCD went into a new product new news tempo decline as it changed CEOs in 2012. New products news yields sales.
It will be fascinating to watch Darden work out of its current tight cash position caused by lagging big brands and resulting profit shortfall, big remodeling capital expenditure (CAPEX) requirements and now debt service for its 2012 acquisitions. Of necessity, they will look for another acquisition in 2014, once its free cash flow position improves. We wonder if BKW has the worldwide AUV sales base potential anywhere except Latin America for franchisees to expand profitably.
Restaurants must more creatively test revenue and expense solutions: Restaurants can offset negative cost pressure and difficult comps pressure by looking at revenue increases beyond price increases and cost reductions beyond food portion cuts and labor hour savings. Unique store level pricing tiers and dual wage tiers to offset Obamacare are but two examples. The industry needs to test aggressively new ideas.
Defrancising v. Refranchising company strategy divergence will continue. Those who can operate restaurants well will continue to do so, those who cannot will refranchise. Panera, Texas Roadhouse and Qdoba are building new units, converting franchisees to company operation.
Franchisors still need to improve investor reporting and franchisee disclosure if they hope the franchising "capital light" business model will be sustained. How can DineEquity (DIN), now 100% franchised, be properly analyzed if there is no franchisee profitability reporting?
Is there room for optimism? Yes. Commodity cost forecasts have come in at the low end of forecasts. Some restaurants, such as Sonic (SONC), have finally sorted out their marketing focus.
Investor Recommendations. Look for a rough first half. Be ready for and go light or short the nine companies noted above that will have a negative same store sales cliff In Q1. Restaurant space investor attractiveness will be better second half 2013. Look for potential dividend upside effects at BKW, BLMN and DNKN late in 2013. DRI likely must cut its dividend so react light/short accordingly.
If you're considering funding a startup or franchise, then you may already be ready for the huge gamble of turning a 401(k) into capital investment for a business: potentially losing the retirement account altogether. But are you committed?The method described above -- called a Rollover as Business Startup (ROBS) -- injects capital into a business from your 401(k) account. Part of the Employee Retirement Income Security Act of 1974 (ERISA), the ROBS has been popular for years.
The potential payoff is tantalizing, which is why so many aspiring entrepreneurs are willing to put all their chips on the table. Unfortunately, few realize just how difficult it is claw those chips back if they're dealt a bad hand.A mishandled ROBS is fraught with tax pitfalls. What's more, the mere act of initiating a ROBS may draw unwanted attention: this type of capital investment is immediately suspicious in the eyes of the IRS. And then you remember that it's your retirement you're betting.That retirement risk brought a longtime business client of mine to my door seeking help to unwind his ROBS. After struggling with the ROBS' administrative hassle (which is often underestimated), the reality that his entire financial future was dependent on a new business in a sputtering economy was just too much.If you're feeling the heat from a ROBS that you might want to unwind, remember that our door is always open. We'll talk you through the issues and get you where you want to go. If you're not sure, call us anyway and we'll connect you to one of the clients who we've helped out of this ERISA nightmare. They'll show you the path down from the cliff.Before signing off, I'll leave you with some background on the ROBS, pulled from a 2009 small business guide that my clients have found helpful.
Let's start with ROBS 101ROBS: For the investor in need of a green thumb.ROBS plans are touted by business brokers and franchise sellers all over the Internet and arranged by investment firms specializing in capital investment.ROBS firms charge a fee to walk clients through the process of creating a C corporation. The new corporation starts its own 401(k) plan or profit sharing plan, which must offer employees the option to purchase stock in the company. The new business owner then rolls over funds from an existing 401(k) into the newly created corporation's plan.Because the assets are moved from one tax-exempt vehicle to another, business owners avoid taxes and penalties.The sole participant in the plan (e.g., the owner of a new company) can then direct the investment of the 401(k) account balance into a purchase of employer stock in the new corporation. The transferred funds are used to either purchase a franchise or fund the new business -- essentially creating tax-free working capital.
