While access to capital remains difficult to obtain for restaurant operators looking to expand, especially in a heavily franchised segment like pizza, two executives offered creative ways to secure funding during a panel discussion at the Pizza Executive Summit this week in Chicago.
Mike Mrlik, chief executive of Austin, Texas-based Gatti’s Pizza, said financing for franchise growth has become harder to come by than ever. Not only did loans to restaurant businesses require more equity and last for shorter terms, Mrlik said, but the industry’s “big three” lenders — GE Capital, Bank of America, and Wells Fargo — cut way back on financing restaurants.
“The last two years were the toughest ever for franchise concepts,” Mrlik said.
Both Gatti’s and San Ramon, Calif.-based Straw Hat Pizza, whose president, Jonathan Fornaci, also was a speaker on the "Finance and Franchising 2010" panel, responded to a lack of traditional funding in aggressive, untraditional ways in the past few years.
“Landlords do not want empty buildings,” Mrlik said, which is why they’re willing to renegotiate longer lease terms and to get money back from landlords to update, modernize or reimage their units. They also are receptive to deals for tenant-improvement dollars, he added.
In a unit in Austin, Gatti’s agreed to pay a higher guaranteed rental rate than market value in exchange for a large tenant-improvement check from the landlord. Upgrades financed by that TI check improved sales to the point where the franchisee could pay off in 22 months the whole loan needed to get the restaurant open.
Gatti’s has 131 restaurants in 11 states, and the system is 85-percent franchised, Mrlik said. The chain has three different store prototypes, he added, including a delivery model, a pizza-buffet model and a family-entertainment model.
Straw Hat, a 100-percent franchised chain with 76 units and 22 more in development, undertook a PR campaign to contact landlords nationwide and explain the concept and its potential as an anchor to smaller shopping centers. The chain set parameters for rent and tenant-improvement money they were seeking, Fornaci said, and it soon got five to seven landlord leads a week. And those landlords were willing to negotiate favorable TI deals.
“We said, ‘Let’s let the landlords pay for our expansion,’” Fornaci said.
By targeting amenable landlords and negotiating TI funds, rent discounts and deals on equipment procurement, Fornaci said, Straw Hat has taken its costs to build new stores down from a range of $300,000 to $450,000 in 2007 to about $150,000 to $300,000 this year.
When the large traditional lenders aren’t funding growth — or canceling lines of credit even when the facilities don’t have any money drawn down, as Straw Hat’s big lender recently had done — operators should consider approaching their local banks, the panelists said.
“Regional banks are supporting better today than in the past,” Mrlik said. “If you have an established relationship with a bank in your town and you’ve done business with them, whether personal or business, you have a better tendency to get credit through them than with a bigger bank.”
He suggested franchisees try community development financial institutions, a consortium of lenders sanctioned by the federal government that provides seed money to startups in different markets. Such lenders can be found on the U.S. Treasury Department website, he added, and Gatti’s had a franchisee in Louisiana and one in Mississippi use this route successfully.
Franchisees in some rural markets may qualify for a B&I Guaranteed Loan, with similar requirements to a Small Business Administration loan, and can borrow up to $5 million, Mrlik said.
A Mississippi Gatti’s franchisee took out a $3 million loan this way, he said, and while “it is a long, tenuous process to get financing done, it can get done.”
The “old-fashioned social network”
Often a quicker way for franchisees to secure funding is to tap their “old-fashioned social network” of friends and family, which happens a lot with Straw Hat’s operators who come from certain immigrant or ethnic communities, Fornaci said.
“A lot of our operators come from different ethnic groups, and they’re first-generation Americans or new immigrants, and they’ll go out to friends and family, getting $5,000 to $10,000 from one person,” Fornaci said.
If out-of-pocket startup costs come out around $100,000 after TI arrangements and equipment financing, he said, then a franchisee would need to line up only 10 to 20 “angel investors” if they went that route.
If operators and new franchisees can buy used equipment, they should, Fornaci said.
“Let’s face it, a pizza oven that’s 30 years old for the most part still works the same way,” he said. “Things in this business really don’t wear out.”
Gently used equipment turns up at auctions, such as those where the SBA has seized a failed business, and can be had if a franchisee can pay for a whole package up front, Fornaci said. Usable equipment, from smallwares to pizza ovens, even turn up online.
In one case, a Straw Hat franchisee who opened a unit in a former Baja Fresh location in Folsom, Calif., found that the previous tenant had stripped the restaurant of most essential equipment, even taking the air conditioners out of the ceiling. That former Baja Fresh operator tried to sell those AC units on Craigslist.org, where Straw Hat’s franchisee bought them back for pennies on the dollar.
“It’s amazing what you can find on Craigslist,” Fornaci said.
Fornaci and Mrlik cautioned, of course, that buyers need to verify in person the equipment being sold online.
Avoid debt guarantees
Mrlik advised franchisors during the question and answer segment against guaranteeing franchisees’ debt to lenders. Brands have a responsibility to represent their franchisees to lenders and help them negotiate lease terms and discounts, but guaranteeing debt isn’t sustainable in the long term, he said.
“That might help some franchisees, but if you don’t have the financial wherewithal to get into business, why even try?” Mrlik said. “What’s going to happen when the economy turns back? The expectation’s going to be, ‘Where’s my discount?’ I’d rather slog through this slowly and make the business efficient for both partners so we win together.”
Contact Mark Brandau at [email protected].