Risk Mitigation for SBA & Franchise Lenders
YOU’RE APPROVED! These are two of the most exciting words for a new franchisee to hear and for a lender to say. After painstakingly digging into the details, weighing the risks, crunching the numbers, and figuring out ratios, this milestone is the jumping off point that sets new wheels in motion. The Happy Dance begins!
Unfortunately, sometimes those wheels can drive naïve franchisees right off a cliff!
The money that was borrowed to get their business open is often eaten up (even gobbled up) by costly mistakes they had no way of knowing even existed:
- The set-up of their company was done according to advice from well-intentioned friends or family members who may not have realized the tax ramifications. If the intended corporate structure does not match the actual registration, the Tax Man will cometh! Regardless of what the money was originally borrowed for, Uncle Sam will take his cut off the top (and seldom is that ‘just a little off the top’). What remains may not be enough to actually get the doors open. As the lender, how will you get paid back?
- The Franchise Agreement has been signed – and now, so has a lease. Without realizing the role that local zoning plays in areas such as permitted uses and utility requirements, this poor franchisee unknowingly gifted $75,000 of your money to its landlord because they didn’t know what they didn’t know. With a signed lease comes the ties that bind. “I’m sorry” or “I didn’t know” won’t grant this franchisee a do-over. With a $75K haircut, will this franchisee make it? As the lender, how will you get paid back?
- A different franchisee to whom you loaned money decided that boiler-plate legal jargon in the landlord’s standard lease was standard practice and proceeded to sign the lease without proper legal representation. As luck would have it, a critical ‘out’ clause (like the inability to secure a liquor license) was conveniently missing from the landlord-friendly lease. This franchisee will still open its doors and operate the business, but with significantly lower sales because they are prohibited from serving alcohol. Will the lower sales still cover overhead costs and the monthly note on the loan you have with them? As the lender, how will you get paid back?
The list of possible ‘what ifs’ can stretch a mile long. The dollars associated with those ‘what ifs’ can easily stretch into the tens of thousands. The dance is not so happy now and if I were the lender, I would be shaking in my shoes!
“When there is a $5,000 mistake on a franchise project, the
franchisee has a problem. When there is a $100,000 worth of mistakes
on a franchise project, the lender has a problem.”
A significant portion of lenders’ due diligence comes from the very important question of ‘How will I get paid back?’ This is such an important question that it is often asked several times while running through various scenarios.
Despite all of the number crunching and due diligence that goes into approving smart loans, few lenders take the time to qualify borrowers about their knowledge and ability to actually get the doors open. This is super scary because the build-out of their location is likely the biggest reason the franchisee needs your money in the first place.
Yes, it is true that established, national brands often play more of a hands-on role with their franchisees in these key areas. With new concepts hitting the scene almost daily, there is a critical gap in the assistance that new and emerging franchisors are able to offer to their franchisees. It is not a matter of wanting to, the fact of the matter is that they have not grown large enough to be able to bring these resources in-house. This leaves franchisees to figure much of this out on their own. All the while, everyone’s fingers are crossed:
- The franchisor’s fingers are crossed because if the franchisee fails, it is not only a very public failure with consumers, it also gets reported to the FTC and becomes a disclosure to future prospective franchisees;
- The franchisee’s fingers are crossed because their life savings, their future income potential, and their livelihood are on the line – not to mention their family’s safety and security;
- As the lender, your fingers are crossed because you are really hoping that the intelligent person who brought a business plan, financial statements, and past business experience to the table is wise enough to know their construction limitations and will seek the help they need.
The Risk Mitigation Tool That Lenders Are Adding to their Toolbox
In two days and for a fraction of the cost of one mistake, the National Franchise Institute’s ESSENTIAL COMPETENCIES program is an insurance policy that helps to mitigate a lender’s risk on loans that fund the building of new locations.
Borrowers include the cost of this program into their loan;
As an incentive, some lenders are rewarding borrowers with a more favorable interest rate for participating in this program and significantly increasing the likelihood of success
Franchising is the fastest-growing method of conducting business in the world. Lenders love franchising! Lenders really love successful franchise loans.
When costly mistakes are prevented on the build-out side, franchisees significantly increase their chances of success and they are in a much better position to meet their loan obligations. The franchisor, the franchisee, and the lender all start toe tapping, gearing up for the Happy Dance.
Sessions are scheduled every six weeks in Denver and are limited to a maximum of 25 people! The ideal timing for the Essential Competencies program is after a Franchise Agreement has been signed but before the search for real estate begins (and DEFINITELY before a lease is signed!).