Financing a Foodservice Franchise: Play your Cards Right
Canadian Business Franchise
Published July/Aug 2005
There’s just something about owning a restaurant that’s appealing: the energy, the sociability, the profit opportunities…
But for many who try to get their dream restaurant up and running, they often come up against a hard dose of reality -- they can’t get a loan from the bank.
This is one of the principal reasons why more than 35% of restaurant sales are from franchise operations* – and why that number is increasing. Many aspiring restaurateurs have learned that lenders have comprehensive requirements of their prospective borrowers – requirements that one potential restaurant owner – or even a small team of would-be owners – would have difficulty meeting.
The backing of a solid franchise company raises the odds of securing financing – which is why people are drawn to foodservice franchises. But having a franchisor behind you doesn’t guarantee that you’ll get what you need. If you want to win the financing game, you have to play your cards right.
Full house: Personal track record of success
When it comes to showing a prospective bank lender a winning hand, a track record of success can win the round. For Dave and Karen Compton, the new owner-managers of a Turtle Jack’s Muskoka Grill at Weston and Rutherford roads in Vaughan, Ontario, a family business with a 59-year history proved to be their ‘full house.’
Dave had been working in his father’s Bradford IGA store since he was 12 years old. In 1994, Dave and Karen assumed the ownership of the store and carried on the family’s successful tradition -- until they sold the business in 2003.
*CANAM Franchise Development Group
There are similarities between the grocery business and the restaurant business and their experience went a long way to convincing the bank that they had what it took to make their new franchise successful. “Handling food and inventories, dealing with customers – we had dealt with all of those tasks in our previous business,” says Karen. “And we had 150 on staff at IGA; here at Turtle Jack’s right now we have 75. So there wasn’t a huge leap from one business to the next.”
Depending upon the amount of the loan that a prospective franchisee is looking for, most lenders will expect at least five years of experience operating a foodservice operation. If you don’t have a track record, you may have to build one. So, for example, if your dream is to operate a licensed restaurant but you don’t have sufficient experience running this type of business, then you may want to consider starting small – possibly with a takeout/delivery franchise. When you acquire sufficient expertise, you can sell your franchise and move up to a more complex operation.
What kind of investment do foodservice franchises require? Depending upon the type of operation, you might invest from $200,000 for a simple fast food concept to more than $1million for a licensed freestanding full-service restaurant. These investments generally require bank loans in the range of $100,000 to $500,000. Here’s how a typical restaurant might be financed.
Prospective franchisees Mary and Joe need $1million in start-up financing to open Dream-Come-True Restaurant. Landlord inducements require $200,000; Mary and Joe will finish the construction of a building to their own specifications and then lease space from the landlord. The landlord expects a five-year lease guarantee plus another five-year lease renewal option.
They also need $800,000 for furniture, fixtures, equipment, leaseholds and pre-opening costs (such as inventory, staff training and cash flow for about four to six weeks). Of this $800,000, Mary and Joe must contribute $400,000 in unencumbered cash -- money that is not borrowed nor used to secure a loan.
The other $400,000 in financing is in the form of loans from the bank. The first $250,000 is a loan through the federal government’s Canada Small Business Financing Program. This will help to finance fixed assets. This program enables businesses whose gross revenue does not exceed $5 million during the fiscal year in which they apply, to obtain term loans and capital leases of up to $250,000. The business applies for a loan or lease to participating financial institutions or leasing companies. The federal government guarantees 85% of the lender's losses in the event of default.
The other $150,000 is in the form of a term loan. Banks usually require that these are secured with personal guarantees by the shareholders of the franchise – in this case, Mary and Joe.
It’s important to keep in mind that banks are in the business of making money – not losing it. They want reassurances that those who borrow funds will pay back their loans. Along with personal guarantees, they want to see a successful business track record.
Straight flush: Successful Franchisor
For Rick Irvine, who has been operating an A&W franchise on Woodlawn Road West in Guelph, Ontario for the past year, the winning hand he played to secure a bank loan was allying with an established, respected franchisor.
Rick was introduced to A&W when he saw an ad in the newspaper for franchise opportunities. Long intrigued by the fast food business, Rick visited the company’s website (www.aw.ca). He liked what he saw and completed the online application form. Rick had 11 years of experience operating a grocery franchise, but he wasn’t sure if he would qualify for an A&W franchise. While the company does not require franchisees to have previous restaurant experience, A&W is looking for individuals with “a strong financial rating and the ability to invest in and support a restaurant.”
Rick applied, had a number of interviews, liked what he heard and those he met and decided that the company’s expansion plans were “something I wanted to be a part of.” Fortunately, when it came time to finance his new franchise, he found A&W was his ‘straight flush.’ “I had never had to go to the bank previously to borrow funds and I was the sole investor in this franchise. But the people from A&W were very supportive. They directed me as to how to secure the financing I needed. They put me in touch with the representatives of the banks where they had ‘preferred customer status.’ And they put together a package for me with pretty much everything the bank needed. The deal came together quite smoothly.”
Royal flush: Established Banking Relationship
A&W has over 650 locations in Canada and has been operating since 1956; this gives bankers a long track record to assess when deciding whether to finance a prospective franchisee. But not all franchisors are as able or willing as A&W to help franchisees secure bank financing. If you are considering a smaller or newer franchise company, it helps to have your own established banking relationship.
For Dave and Karen Compton, who wanted to “get in on the ground floor and grow with a company,” the young Tortoise Restaurant Group Inc. could not offer the same financing foundation as A&W. The Burlington-based company was launched by president and CEO Jim Lishman in 1992. Jim and his team have grown the company’s holdings across southern Ontario to include Turtle Jack’s Muskoka Grill (three corporate stores and three franchises) and one T Jays Old Chicago’s Italian Grill. With four more Turtle Jack’s currently under construction and only a short company history, the Tortoise Group is not yet in a position to offer franchisees preferential financing arranged through major financial institutions.
Therefore when it came time to arrange financing, Dave and Karen sat down with the bank manager they had worked with for the past decade when they owned their previous business. The loan they requested exceeded the amount that the manager could lend from the branch, so she referred them to one of the bank’s small business loan specialists. Despite the referral and the fact that “we had obtained and paid back a series of significant loans in our previous business,” says Karen, the specialist informed them that “the bank doesn’t provide loans to restaurants.”
When the Comptons relayed this disheartening exchange to their bank manager, she went to bat for them. She arranged the loan in such a way that it could be managed through the branch. Dave and Karen’s relationship with her and her branch proved to be ‘a royal flush.’
If running a foodservice franchise operation is your dream – whether a take-out operation or a full-service licensed restaurant – be sure you have a winning hand before you approach the bank for a loan. You’ll need the right combination of a personal track record of success, a successful franchisor and an established banking relationship.
Some advice from Rick Irvine might also increase the odds in your favour: “Check out all the possibilities. Contact your own financial institution to see what it might be willing to do for you. And if the franchisor has preferred status with other institutions, talk with a representative at each one. Be sure to use all of your contacts to find the best possible deal.”
After all, winning the financing game is just like playing poker: you must have patience and learn to do the right thing at the right time.
Rick Chittley-Young, CGA, is a principal of BDO Dunwoody LLP (www.bdo.ca). One of Canada’s leading accounting and advisory firms, BDO helps entrepreneurs, family businesses, franchisors and franchisees succeed. If you have questions about this article or would like to receive BDO’s “Tax Factor” newsletter, contact Rick in the Oakville office at (905) 844-3206 or rchittley@bdo.ca.
