— By Carty Davis —
The evolving restaurant facility, changing priorities in CAPEX and capital through and post-COVID.
As regulations and mandates end, owners and operators continue to adapt to a post-COVID society. Declining COVID cases and vaccine availability on a large scale show hints of the virus fading into the past, which is encouraging to business owners and the overall economy. While COVID may be on the decline, consumer behaviors, preferences and the distribution systems that support these evolving consumer tastes are here to stay.
Carty Davis, C Squared Advisors
The quick-service restaurant segment has outperformed its counterparts in the casual, family or fine dining segments throughout COVID. Drive-thru capabilities, third-party delivery and mobile order applications were already in place, allowing operators to be nimble to regulation changes and take advantage of new customers seeking dining options. Restaurants in the casual and family dining segments that have seen success during the pandemic have been resilient by offering off-premise alternatives to counter dining restrictions. The brands that prospered were those that had a well-defined and user-friendly digital platform combined with efficient distribution options.
Franchisees of national brands with the financial support of franchisors, suppliers and “most” lending partners have been better equipped to stay the course, in spite of the economic downturn over the last year. Now, franchise concepts that have maneuvered well through the uncertainty of COVID will begin to focus on evolving remodels, capital improvements and reengineered drive-thrus and other distribution upgrades. In the past, many restaurant concepts have focused on creating bright, clean attractive stores; however the next wave of changes will include capital intensive changes such as adding or enhancing drive-thrus, improvements to online ordering platforms, and pickup/delivery friendly stores for off-premises dining.
As government programs including PPP, EIDL and Main Street Lending provided much needed relief to owners and operators, these “safety nets” continue to help as many operators have received or are in the process of applying for PPP forgiveness. Owners and operators should now focus on managing capital structures and borrowing requirements. Just as brands and franchisees have experienced varying levels of success throughout COVID, performance has also been mixed among different lenders and other capital providers. With varying levels of performance among capital providers, borrowers and operators are presented with both challenges and opportunities.
In many cases, franchise owners have been able to delay remodels and capital investments. Depending on the concept, though, we anticipate increasing capital requirements and facility upgrades as brands and operators focus on refining their business model to meet the evolving demands of customers post-COVID.
In addition, as real estate markets change and new and different opportunities emerge from closed locations, credit demands will also increase and evolve. All these developments should be addressed with credit partners to gauge their interest in supporting franchisees’ capital needs and at what level. Owners should have a backup plan as most businesses are operating under unprecedented times as it relates to planning and budgeting and securing the necessary capital for anticipated increases in CAPEX requirements and the timing of the implementation.
Franchisees should prioritize finalizing and reviewing capital needs for existing operations, image and drive-thru upgrades, new development and conversion opportunities. In addition, acquisition-minded franchise operators will see various opportunities, including distressed and turnaround situations, market and geography driven options, and franchisor influenced deals. We are also seeing COVID change how certain owners and partners view the business. The timing may be ideal to explore a new capital structure to accommodate the changing dynamics of ownership and reinvestment levels. All these developments, constraints and opportunities necessitate a thorough review of your existing capital structure and potential alternatives. Capital partners should be able to support both short term plans for upgrades and new opportunities — whether it be new unit development or acquisitions. It is essential for franchisees to finalize their 2021 and 2022 capital plans before assessing lender and capital relationships.
While, many lenders have stated it is business as usual for existing clients and new credit opportunities, we have witnessed a clear delineation in what opportunities lenders will underwrite or even consider versus what their public statements indicate. If a concept has not shown resilience throughout the pandemic, future credit requests may likely be limited. Borrowers can expect tighter credit standards, higher pricing spreads and tighter covenants. For new unit development and acquisitions, higher cash equity requirements will be the norm. In reviewing capital plans with credit and capital partners, it is crucial to understand how they view the new landscape, how they will support your business, and whether the time is right to search for a new financial partner. Industry advisory firms can help access and determine deal financing certainty given their knowledge of the franchise and multi-unit lending landscape and lenders.
As borrowers review capitalization plans and alternatives, the conversation should not be limited to lender relationships. As new economic realities impact your business, it has made today the ideal time to consider other opportunities in your capitalization structure. Real estate portfolios present opportunities in exercising options to purchase. In other cases, the sale of real estate can allow franchise owners to buy out partners, accelerate development or pursue an opportunity that was unavailable pre-COVID. In addition, as the post-COVID landscape becomes more certain, there will be continuing opportunities in your real estate portfolio to renegotiate leases or relocate units to better locations within a trade area.
In summary, as we evolve into a post-COVID world, focus on your capital structure. What worked before COVID may not be the ideal scenario today. Plan a review of all capital relationships, including senior and junior lenders, equity partners and your real estate portfolio. Ask questions and present hypothetical opportunities to credit and equity partners. If you are uncomfortable reviewing alternatives, engage a professional to help guide the process and review “real alternatives.” The current environment necessitates these discussions and dialogue. Put your plan together and start the conversations today.
— Carty Davis is a partner with C Squared Advisors, a boutique investment bank that has completed hundreds of transactions in the multi-unit franchise and restaurant space. He is based in Pinehurst, North Carolina.