Assisting the Financially Troubled Franchisee

In any franchise system, a franchisee may experience financial difficulty and need to go through a financial "workout." Although each situation presents different challenges depending upon the size of the franchisee's business, the capital structure, condition of facilities, operating capacity, real

Information is Essential

If a franchisor is to assist a franchisee through financial difficulty, there must be a thorough assessment of the franchisee's financial condition and financial structure. The need for a full and frank disclosure of accurate financial information by the franchisee cannot be overstated. At the outset, a review of the franchisee's operating statement may reveal inefficiencies, such as low margins, high labor, or high general and administrative costs, that can be addressed quickly and provide an immediate and positive impact on cash flow. In addition, helping the franchisee better understand and operate his business will build a sturdier platform for long term success.

A flow of accurate information, and transparency in the franchisee's financial structure, is also necessary because most workouts will require the franchisor and the franchisee's lender (and often other creditors) to make financial concessions. It is unreasonable to expect such concessions unless the parties are confident, for instance, that the franchisee's financial difficulty is not exacerbated by things such as excessive management fees or above-market rent paid to affiliated companies. Creditors should also be able to determine whether the franchisee is able to invest additional capital into the business. Write offs by the lender and franchisor are, in effect, an investment in the franchisee's business, which they will not make if they suspect the franchisee has substantial liquid assets outside of the franchised business.

Share the Pain

In a workout, the franchisor, franchisee and creditors presumably believe that the highest value of the business is as a going concern operating the franchised concept. Thus, they should work toward an end that allows the franchisee to survive over the long term. The real work, of course, lies in getting to a solution where the franchisee is appropriately capitalized and fairly able to meet its projected future obligations, including debt service, taxes, franchise payments and all necessary, capital expenditures.

A successful workout often will require a franchisee's lender to restructure the franchisee's debt, by writing off principal or reamortizing the loan (lowering the interest rate and extending the term of the loan). The lender is likely to condition any debt restructuring on the franchisor making other financial concessions or contributions that will improve the franchisee's financial condition. In turn, it is reasonable for the franchisor and lender to expect that the franchisee will "share the pain" to the fullest extent possible in the workout.

A Long Term Solution is the Goal

A critical step in any workout is for the parties to agree upon realistic projections for the future performance of the franchisee's business. These projections will almost always show that, without some financial assistance, the franchisee will not he able to meet its obligations over the long term. The science of the workout is determining how much financial assistance the franchisee needs to have a viable long-term business. The art of the workout is deciding who provides it and in what amount.

Once the parties agree on long-term projections for the franchisee's business, the workout begins to take shape. The model will produce a certain amount of cash to pay debt, and the restructured business should only carry an amount of debt that can reasonably be serviced. This is often where the negotiations really begin. For example, reducing the franchisee's draw, or foregoing capital improvements required under the franchise agreement, will create more cash to service debt, and the lender's write off can be less. The franchisee, of course, is not keen to take less for what is likely more work in the future, and the franchisor may not be willing to have outlets fall below system standards due to lack of capital investment. There are innumerable variables that will be in play at this stage, and this is the "white water" of workout negotiations.

The financial projections for the franchisee's business, especially future sales, must be realistic, if not conservative. Nothing will doom a workout more quickly or completely than "best case" sales projections. To this same end, failing to provide for adequate capital investment in facilities and systems is almost always a death knell for the franchise business. While these realities may require larger creditor write offs at the beginning of the process, the lender and franchisor may get some protection through senior subordinated notes or "claw-back" notes that allow them to share in the upside if the business performs better than projected.

The Franchisor's Contributions

A franchisor's financial contribution to a franchisee workout will vary depending upon the quality of the franchisee as an operator, the strategic value of the market or the specific locations, and the contributions of the franchisee and other creditors. Some of the ways a franchisor may support a financially-troubled franchisee are:

* Writing off past due franchise payments or rent,

* Providing rent relief if the franchisor is a landlord,

* Deferring or waiving contractually-required capital improvements,

* Agreeing to closures of units, or buying units from the franchisee,

* Making loans secured by real estate or structuring sale-leaseback transactions for real estate owned by the franchisee,

* Early renewals or extensions of franchise agreements to facilitate lenders extending loan terms,

* Providing guarantees or credit enhancements to lenders or critical suppliers.

While this list is not exhaustive, it shows that there is a broad range of ways a franchisor can assist financially in a franchisee workout.

The End as a Beginning

Every successful workout will be grounded upon full disclosure of accurate financial information. The parties then must agree on realistic projections of the future performance of the business, and commit to share the pain so that the franchisee has a fair chance at long term-success. While any workout requires concessions from every side, the workout process is almost always the best result for the franchisee, the franchisor and all creditors.

W. Barry Blum is senior vice president and deputy general counsel of Burger King Corp. He can be reached at 305-378-7804. Michael Elliott is managing director of the Franchisee Financial Restructuring Program for Burger King Corp. He can he reached at 305-378-3590.