— By Alicia Chandler —
How to get — and keep — a franchise loan.
Equipment upgrades! Remodels! New store builds! Franchise owners need financing for many different reasons. Understanding what’s involved in obtaining a franchise loan can help make the process go more quickly and smoothly. Knowing how to stay in compliance with the loan’s covenants can help a borrower avoid penalties or technical defaults. Here’s a background on how to get and keep a franchise loan.
Get the House in Order
Many borrowers trip at the first hurdle by not having their financial house in order before applying for a loan. It’s vital to make sure the books are clean — ideally audited — and all liabilities are fully disclosed. If the business has several outstanding loans, it can help to consolidate them to make the financial picture clearer to a lender.
Borrowers should also have a clear projection of expected revenues from the existing business as well as the increase in revenue expected from the project for which the funds are being sought.
Have Documentation Ready
The basic question behind every loan decision is whether or not the borrower will be able to repay the debt. It’s a bad situation for everyone if a lender offers a loan the borrower can’t repay. Lenders will expect documentation that demonstrates the borrower’s creditworthiness, including:
• Financial statements for the past 2-3 years;
• Company tax returns for the past 2 years;
• Franchise agreement(s);
• Landlord waivers (if applicable);
• Pro-forma financials that forecast the expected future revenue; and
• Personal financial statements that establish the financial character of stakeholders.
Understand the Intangibles
Lenders must look not just at the financial health of the franchise, but also at the character and creditworthiness of the borrower and any other principles of the business. They will weigh the borrower’s personal credit score, level of experience in the business, and how involved the borrower will be in the day-to-day running of the operation, along with other intangible considerations.
The lender will also want to know about the management team. Will the franchise be in good hands? How much experience do they have? All these questions help the lender predict the future performance of the business and evaluate its ability to repay the debt.
Have a Business Plan
A comprehensive business plan strengthens any loan application and may be required by some lenders. A business plan anticipates many questions that lenders might have and provides financial projections demonstrating how the company will be able to manage the debt repayments.
A business plan will also show how the loan funds are intended to be used and how they will contribute to the franchise’s profitability.
Stay in Compliance
Being approved for a franchise loan is just the start. It’s vital to stay in compliance with the lender’s covenants and reporting requirements associated with the loan. Covenants may restrict the borrower from certain activities (negative covenants) or may require the borrower to do certain things (positive covenants). An example of a positive covenant is the requirement for a business to maintain a certain Debt-Service Coverage Ratio (DSCR) to ensure the borrower can make payments fully and on time.
Follow the 5 Cs of Credit
Lenders often refer to the 5 Cs of credit (plus “compliance,” which can be thought of as the sixth “C”). Borrowers must conform to each of these elements to stay in compliance:
1. Character: This element reflects the borrower’s history of repaying debts in the past and staying up to date with payments on the current loan.
2. Capacity: Capacity describes the ability of the borrower’s business to produce enough profit to comfortably cover the debt repayments. Adequate capacity must be maintained throughout the life of the loan for the borrower to stay in compliance.
3. Capital: This consideration represents the amount of personal assets the borrower has in the business. Lenders expect borrowers to maintain a certain level of equity in the business to remain in compliance, which will be outlined in the loan agreement.
4. Collateral: The loan agreement will stipulate how any items used as collateral (equipment, furnishings, real estate, etc.) may be handled. There may be restrictions on whether they can be disposed of or sold.
5. Conditions: Many lenders will stipulate that borrowers must notify them if any substantial changes in the conditions of their business, brand, or physical location occur. For example, if the street outside a franchise store is going to be under construction for several months making it difficult for customers to enter, the lender would need to be notified.
Start the Process
It’s never too early to talk with a lender about a loan to finance a new project. Loans can be structured for your specific needs, so reach out to a franchise-experienced and make your business idea a reality.
— Alicia Chandler is president of Indianapolis-based First Franchise Capital Corporation (FFCC), a First Financial Bank company, which provides customized financial solutions for multi-unit quick-service restaurant franchisees of best-in-class concepts nationwide.