— By Jon McClure —
Responsible, creative financing supporting QSRs — how to find success in a challenging economy.
How is it that with high inflation and high costs of borrowing, many QSRs owners continue to manage successful buyouts and acquisitions? One answer is creative deal structures in partnership with a responsible lender.
Jon McClure, First Franchise Capital
Inflation — while beginning to ease — is still at levels not seen since the 1980s. In an effort to rein in rising prices, the Federal Reserve raised the Federal Funds rate seven times in 2022. The most recent rate hike in December was smaller than earlier increases in 2022, as a response to December’s CPI report showing that inflation is starting to cool.
The accumulated increases over the year, however, have raised borrowing rates for businesses and consumers to levels not seen since the days of MTV’s debut and the Cabbage Patch doll craze. Yet, savvy franchise owners are finding ways to thrive and even expand.
Staying Competitive Through Smart Management
Throughout this inflationary period, QSRs as an industry have managed to stay competitive with in-home dining by keeping control of prices. The index for limited-service meals rose only 6.7% over the last 12 months, while the food-at-home index rose 12.0% over the same period. Staying lean to keep prices within reach have helped to keep customers coming through the doors and drive-thrus, benefitting the bottom line.
In a challenging economic market, many QSR owners continue to strategically look for ways to expand their franchise portfolios and/or plan for succession. Here are three questions to ask and explore.
To Grow or Not to Grow?
With average commercial interest rates at 30 plus-year highs, QSR owners may be asking whether expanding now is a good idea. While there is no perfect time to take on debt, it is still possible to take advantage of good M&A opportunities even in times of high interest rates if the benefits of the deal outweigh the cost of debt.
Are There Creative Deal Options?
One of the keys to successful expansion is exploring creative deal structures. Alicia Chandler, president of Oak Street Funding, says, “To combat the rising interest rates, we’ve seen more creative seller notes or earnout structures. We’re adjusting our underwriting process to address these adjustments and help our clients adapt to the current environment.”
What Are Some Creative Deal Arrangements?
QSR owners looking to finance expansion should consider these and other creative options:
- Longer payback period: Extending the payback period can lower payments and ease cash flow for the buyer. Sellers may welcome this option as it can offer higher long term returns in exchange for taking less up front and extending the payback period.
- Earnout rather than seller note: In this arrangement, the seller can take an earnout instead of a lump sum or pre-determined repayment schedule. This means additional seller payments are based on the future performance of the business. Thus, if the business meets agreed upon performance metrics, the seller could receive even more cash. This also helps aligns the interests of both parties.
- Excess cashflow recapture provision: An excess cash flow recapture provision can help both parties by matching the timing of additional principal repayments to periods when the borrower generates strong financial performance. Lenders define excess cash flow by a formula which may include a percentage or amount above an expected profit or EBITDA (earnings before interest, taxes, depreciation and amortization) level. If the business produces excess cash flow, the lender and borrower agree a payment of 25%, 50% or 75% of the excess cash flow amount be applied to the loan. The excess cash flow provision ends after the borrower’s debt-to-EBITDA level declines below an agreed upon level.
Who’s My Lending Partner?
Your financial partner matters. Creative deals that ignore fundamentals hurt both the borrower and the lender. Working with a responsible lender that has clearly defined credit criteria benefits all parties. In the event a borrower is turned down initially, a good lender will work with them to review fundamentals and, if appropriate, suggest improvements.
Persistence and willingness to make necessary changes to meet lender criteria are key elements in successfully obtaining financing for expansion opportunities. Working with a financially skilled and experienced lending partner can benefit QSR owners and their success in the long run.
— Jon McClure is sales director of Indianapolis-based First Franchise Capital, a First Financial Bank company, with customized loan products and services for quick-serve restaurants nationwide.