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Borrowing outside the box

Finding growth capital in unlikely places

Marco’s Pizza, of Toledo, Ohio, is a chain with 195 units and big plans. In the teeth of the recession, same-store sales climbed 3.2 percent in the first quarter. It has contracts to open 50 stores this year and 80 the next. The only missing ingredient is capital.

A few years back, its franchisees were putting 20 percent equity into new stores. In this year of credit crunch, lenders are asking up to 50 percent equity—beyond the means of many borrowers. To bridge that gap, chief financial officer Ken Switzer devised a new solution: his own private equity fund.

Marco’s raised $5 million through a private placement, from investors who already owned percentages of the chain. The fund will put up $50,000 to $100,000 for new stores, making it easier for franchisees to borrow the rest. Other Marco’s affiliates help them apply for bank loans or lease pre-built stores.

“The private equity fund is a great tool to help spur our growth,” says Switzer. “The franchisees obtain equity investments, which work out to 20 percent of the total ownership of the stores. The investors ultimately receive a share of profits in the stores.” 

Welcome to the brave new world of restaurant finance. In the good old days—a couple of years ago—the money spigot flowed freely from national lenders. GE Capital alone had a franchise loan portfolio of $13 billion, and Bank of America had $7 billion.

Now, that tap has slowed to a trickle, to all but the largest customers, say restaurant finance professionals. GE Capital did not respond to an interview request for this story. Bank of America managing director Brian Geraghty says he’s actively making loans, but adds, “We’re looking for companies that are really focused on inner operations, not ideas of expansion if they are very leveraged. It is a challenging environment to be a leveraged restaurant company with a business plan looking to expand right now.”

But finance abhors a vacuum. Amid hints of an economic recovery, restaurant financiers say sources of capital are sprouting in the gaps left by national lenders. Here are some fresh financing strategies operators are using.

Think regional, not national.

Dean Zuccarello, CEO of investment bank The Cypress Group in Englewood, Colorado, recently arranged a restaurant loan from a bank that wasn’t on his radar a few years ago: Bank of Atlanta. “In periods like this,” he says, “you see the emergence of new players. People will see the opportunity in the marketplace.”

Another of those players is Main Street Bank of Houston. In the past year, it’s doubled its portfolio of restaurant loans, to $30 million, says Lex Lane, national sales manager for franchise finance.

Like many regional banks, he has a specialty. His is conversions. For strong operators who buy units from weak chains, he’ll lend up to 90 percent of a store’s value, up to $750,000. “There’s a real gap in the market for loans of zero to $5 million,” says Lane. “I hope, as the economy gets better, we’ll get more.”

Loot from the landlord.

“There’s never been a better time to negotiate with landlords to get tenant improvement dollars to finance buildouts,” says San Francisco foodservice financial consultant Mark Saltzgaber.

In Minneapolis, eight-unit Parasole Restaurant Holdings is building two new high-end casual dining eateries in strip shopping centers. Its landlords are putting up $200 a square foot to build out the spaces.

“I like to talk about a restaurant being the anchor for some underperforming strip centers,” says CEO Dennis Monroe. “They’re sought after, because they draw other people.”

Hit up the seller. If a chain is hungry to unload some weak stores, it might agree to be your lender, taking an IOU in place of some cash. Says Wally Butkus, principal of Restaurant Research in Redding, Connecticut, “The seller is wanting to get out, and they’ll take part of the risk by taking part of the financing.”

A note is just one form of seller financing, says David Epstein, principal of the J.H. Chapman Group in Rosemont, Illinois. Other forms include deferring payment for a set period of time; earnouts, in which the seller gets future payments based on the buyer’s earnings; and contingent payments, which are made only if the buyer hits certain financial targets. Says Epstein, “We’re seeing more creative ways for sellers to reach values a buyer can’t pay in cash.”

Rebooting the SBA.

Uncle Sam is spending $730 billion in economic stimulus money to jump-start Small Business Administration lending by banks. The SBA has temporarily eliminated loan fees and raised loan guarantees from 75 percent up to 90 percent.

We’re seeing some signs of recovery,” says Don Johnson, a principal at Diamond Financial in Raleigh, North Carolina, which helps restaurants find SBA loans. “More SBA loans are closing, and more loans are getting sold on the secondary market.”

Add equity investors. Creating your own equity fund is just one way to bring investors on board. Since August, when the San Francisco private-equity firm Friedman Fleischer & Lowe spent a reported $300 million to buy the 1,650-unit Church’s Chicken chain, restaurant financiers are getting renewed inquiries from equity funds.

Others are creating specialty equity pools that target foodservice. Veteran investment banker Craig Weichmann of Austin, Texas, is rounding up money for a fund called Brazos River Advisors. Unlike most equity funds, which buy
controlling shares, he plans to buy minority stakes in five to seven restaurant growth concepts. “Several restaurants will participate in one funding,” he says.

Hire a scout.

One problem with the new sources of capital is that they’re scattered instead of centralized. Whether it’s a small SBA loan or a big chunk of private equity, it can help to hire someone who knows where to find it.

“It’s helpful to get an advisor who’s appropriate to the size business you are to help you navigate,” says Rod Guinn, a former lender with Wells Fargo and now a partner in FocalPoint Partners of Albuquerque, New Mexico. “Hire someone who has relationships with lenders and knows 20 lenders to cross off the list immediately.

“I’ve watched people try to go it alone, and after 6 to 8 months, they ask me, ‘Can you introduce you to someone who’s financing right now?

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