Can You Find Financing for Your Franchise During a Recession?

Historically, the franchise industry has stood strong, growing

even during the worst of times. But the current recession has put such a noose around access to capital that even the franchise industry with its more than 3,000 concepts is struggling with the financial challenge.

A May 2009 report by FRANdata, “Small Business Lending Matrix and Analysis: The Impact of the Credit Crisis on the Franchise Sector,” estimates that 2009 might see as much as a 40 percent reduction in franchise lending, which would limit the total number of unit transactions to 10,781 new units and 16,912 transfers.

Meanwhile, Ronald Feldman, CEO of Siegel Financial Group, a company that specializes in placing financing for startup, expansion and acquisition of franchised and independent businesses with loans ranging from $250,000 to $10 million, describes the current state of franchise financing as “functionally dysfunctional.” “SBA lenders seem more interested in real estate SBA loans than business related lending,” he says. “And the conventional lenders have been squeezed out of the market and have little, if any, capital to lend.”

In an effort to ease the pain of the credit crunch, some actions have been taken. The Obama administration passed the American Recovery and Reinvestment Act which allows the Small Business Administration to raise its loan guarantee to as much as 90 percent. However, Feldman feels that the impact of this initiative is minimal. “There is no incentive in the current stimulus to excite lenders when they are capped at below-market interest rate returns with a SBA guarantee,” says Feldman, who polled about a dozen lenders and found that they would not make any loans with a 90 percent guarantee that they wouldn’t have made anyway with a 75 percent guarantee.

Action is being taken on Main Street as well as individual franchise companies take steps to attract new franchisees. From discounting and sometimes waiving the franchise fees, to refunding franchise fees if financing can’t be obtained, franchisors are offering numerous types of incentives to new franchisees. “For years, franchisors were able to sit on the sidelines and watch preferred lenders who knew the franchising industry inside and out offer up loans to their prospects,” says Darrell Johnson, president and CEO of FRANdata. “That has changed. Now most loans are being done by local lenders who have much less experience with franchises. Franchisors are having to get involved in their [franchisees’] search for capital.”

HometownTimes.com established a work-to-own program that allows incoming franchisees to pay back their franchise fees over time. “Our ability to adapt our concept in this economy has opened our opportunity to a whole new group of leads that didn’t exist until we showed our flexibility,” says Paul Baron, CEO of HometownTimes.com, who expects to add 20 new franchises this year.

Massage Heights pulled together a team of regional developers, franchisees and corporate staff to create a Finance Steering Committee in late 2008 in an effort to streamline the finance process. Glenn Franson, president and CEO of Massage Heights, reports that the company expects to award 50 franchises this year, which is on par with last year’s growth.

Wireless Zone has adjusted its business model to support the stricter financing options available, improved its real estate lease negotiations to appeal to banks, and enhanced its training methods in order to tap into potential franchisees even if they don’t have previous wireless experience. These efforts as well as what Sean Fitzgerald, national vice president of franchise development, calls the “notch down” effect, where investors are seeking franchises with lower entry costs, have put Wireless Zone on track to break 100 awarded and financed franchises this year.

While franchisors appear optimistic about the effectiveness of their incentives and efforts, experts feel that it’s still too early to really declare victory. Nevertheless, just being part of a franchise system still carries weight when you’re hunting for money. “Ultimately, many financing deals have more to do with the personal portfolio of the applicant than the details of the business they are getting into,” says Johnson. “However, lenders often consider franchised businesses a lower risk than independent businesses.”

So what’s ahead? If FRANdata’s prediction is correct and franchise lending drops by 40 percent in 2009, the ripple effect will be felt far and wide as 25,547 direct jobs and another 22,992 indirect jobs would be lost. The economy as a whole would lose a total of $5.1 billion in direct and indirect annual economic output. The franchise industry represents a very significant percentage of small businesses, and attention will need to be paid to this important sector.

Feldman sees the recovery as very gradual but at least within sight. He says, “For the second half of 2009, we see very slow thawing, and a very slow return of the SBA markets first, with conventional lending following after a recovery has been substantiated.”

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Sara Wilson is a freelance writer who specializes in issues related to small businesses.