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How to tell when a chain is going bankrupt—before everybody else

If you’re going to be the guy who buys that chain that’s fallen on hard times—but might be profitable in your hands—you’ve got to be ready to act early and fast. If you wait until bankruptcy is declared, you’re probably too late.

So you need to know the signs of a distressed property, which were outlined in a panel discussion at the Restaurant Leadership Conference. Symptoms can include a history of declining sales, clients and cash flow. This often happens when operators get too fixated on margins instead of cash. You try to keep your 32 percent margin at the cost of higher menu prices, lower quality and lower customer counts.

Another sign is excessive leverage. “If you try to combine high growth with high leverage, it’s a recipe for disaster,” said Gene Baldwin, a financial consultant with CRG Partners. “When you hit high leverage it becomes a management distraction and you start postponing cap ex,” or capital expenditures.

Another sign is a high percentage of unprofitable restaurants. “If a chain has 20 percent or more restaurants in negative cash flow, that’s a problem,” said Baldwin. Also look for dark restaurants, lots of management turnover and dramatic changes in marketing programs, from brand identification to deep discounting.

“Talk to suppliers,” said Rod Guinn, who specializes in restaurants for investment banking firm FocalPoint. “It isn’t always reliable or accurate. But if you talk across a spectrum of suppliers, it may give you insight.”

Guinn also suggested talking to people who have left the company, with the understanding that they may have left for reasons other than a restaurant’s decline. Franchisors may be interested in sharing information about distressed franchisees, as well.

Finally, keep an eye on lenders. If lenders stop supporting a chain or franchisee, it might be a sign the properties are on their way down.

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