Show Me the Money

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FA1110_ShowMeTheMoney

Doing your homework and being on top of financials helps build credibility and secure funding

Recently, Foodservice and Hospitality met with Ed Khediguian, vice-president of GE Financial to determine what lenders are looking for in the current economic environment. As long-standing partners in the restaurant community, the financial experts are specialists in the field, dedicated to providing industry knowledge, focused services and tailored financial solutions to customers — both at the franchisor and franchisee level.

F&H: For restaurateurs struggling to do renovations or hoping to expand or add units, how difficult has it been to secure additional financing?

Ed Khediguian: This is largely dependent on the borrower. We live in a age where there is tremendous opportunity to capitalize on the market. It’s a time where the age-old adage “cash is king” means more than ever before. For those restaurateurs who safeguarded and invested in their business and put some cash aside, and/or renovated and invested in their business during the boom and are yielding, securing additional financing should not be a problem. If they were able to weather the economic storm, then a cash-flow lender like GE Franchise Finance will allow them to capitalize on that value and extract that cash flow from their operations to add units, complete renovations and upgrades or refinance their existing loans without difficulty.

However, renovations on under-performing units can sometimes be tricky, and the focus of any lender would be to ensure any additional debt can be serviced by the location at a comfortable level. Having realistic (modest) projections for growth post-renovation is key. For someone building additional units at this time, it always helps a lender to be able to secure existing locations as part of any new-build financing.

F&H: What are the most important criteria the financing community looks at when considering whether a restaurant candidate is worthy of receiving financing?

EK: The main criteria when evaluating any type of financing is as follows. First, you need to have capable management. For established operators this means demonstrating performance of existing restaurants; for new owners it means having a strong restaurant background. Secondly, liquidity/net worth are critical to ensuring owners have the upfront equity requirement and the ability to inject funds to support cash flow if required. It’s not uncommon to see a team comprised of a strong restaurant manager and a small investor group fit both criteria. Branding is crucial, i.e. what is the chosen brand and where does it sit in its life cycle from a trend/performance perspective. Third, how does it sit within the subject market location and competitive landscape, and both the operational and development financial model for profitability and sustainability? And, finally, you need to consider financing structure and borrower’s equity contribution.

F&H: What is the typical timeline someone should look at in terms of applying or asking for financing and receiving funds?

EK: As a good rule of thumb, you want to give yourself ample time at the onset to prepare a proper financing package to provide to lenders — organization of materials is key to the speed of which the transaction can close. Typically, between one to two months from inception to funding is a good benchmark. This will allow you time to compare proposals and properly weigh and evaluate your financing options. We would recommend seeking financing for new-build construction as soon as the site is secured and the construction budget finalized.

In the current environment, lenders need more time than they did in the past to perform additional due diligence, so expect decision-making and funding to take longer. And, expect to provide much more detailed information than you would have pre-recession.

F&H: There’s been a great deal of speculation as to whether interest rates will rise over the next six months. What are your thoughts on this subject?

EK: They will go up or they might go down. There are suggestions that, given the softer-than-expected inflation rate reported in August at 1.7 per cent (versus the 1.9 per cent expectations), the Bank of Canada may pause its interest-rate hiking campaign. There are further expectations that the bank will hold off on hikes for the next few months since the economic recovery appears to be slowing much faster than anticipated, triggered by the slowing signs the housing market is showing. Nothing is certain, but the bank might hedge inflationary risks by moving rates up pre-emptively. What has improved since the height of the credit crisis in 2008 has been the reduction of commercial risk spreads. The cost of money for commercial credits, which have little to do with government bond risk and costs, peaked in 2008 with a combination of the recession and financial market liquidity issues, have come down as the financial system has stabilized.

F&H: Are we moving into a more buoyant market, or are you expecting the downturn to continue?

EK: Canada has outperformed all of its G7 peers since the end of 2009. The pace at which we have revived our economy far exceeds that of any other country in the world. That said, projections for the second part of the year indicate that the economy will crawl forward by about 1.5 per cent, followed by a slower-than-expected growth of 1.9 per cent next year — one full point below the Bank of Canada’s expectations. This is being driven by the cooling housing market, sluggish U.S. growth and decreased consumer spending in Canada. Even at slower-than-expected growth levels, this is still growth — just moderate growth — but it’s headed in the right direction.

We’ve been tracking the same-store-sales performance of all of the publicly traded restaurant entities in Canada. It looks like the industry bottomed-out in Q3 2009, with most companies finally seeing system-wide growth or at least a slowdown in the rate of decline as of Q2 2010. We’re optimistic these trends will continue for the year with modest growth in the restaurant industry overall.

F&H: The restaurant business is typically viewed as a high-risk industry. What can operators looking for financing do to improve how they are viewed by the financing community?

EK: The biggest thing an operator can do to win confidence with a lender is to be on top of their financials. Being able to complete a full monthly P&L statement in a timely manner is very important to track, not only sales performance, but COGS and labour ratios, so that operators can react quickly and respond accordingly. When approaching a lender for financing, having this up-to-date information can build credibility, showing the owner is in tune with the business and monitoring all aspects of performance.

Here are some tips: Show stabilized operating margins and respond to decreases in sales with a reduction in variable expenses. Additionally, it’s important to implement a marketing/operating strategy and to demonstrate attempts are being made to reduce capital costs on renovations and expansion. As always, you should have a cushion of equity set aside for cash injection in the business. Of course, having an experienced team with demonstrated foodservice management capabilities is always a good idea.

F&H: Are certain types of restaurants viewed as better risks (i.e. branded chains compared to independents)?

EK: There are pros and cons to both, and so many variables have to be examined to make a proper comparison of the two — it really comes down to proper evaluation of the opportunity and what works best for the operator.

Our focus is solely on the franchised brands since they have a proven system of operations, marketing support, location due diligence and management capability. We’re interested in working with both large national franchise concepts and smaller regional systems in growth mode.

The value in a franchise name, from an investor’s perspective, is being able to identify and underwrite to a proven economic, operating and marketing model, which can be recreated with proven success. Independents, with a limited ability to provide evidence to justify projects, will either receive a much lower loan (LTV) or will be limited to the ability of borrowers personally to repay debts.

F&H: Are certain types of projects viewed in a more positive light — expansion of an existing successful restaurant compared to a restaurant opening?

EK: From a lending perspective, investing in a new-build is a bigger and riskier [move]. The lender is relying solely on projections for sales and earnings. Comfort is obtained from adequate due diligence with respect to the location and traffic generators and a belief that management has the skill set to be an efficient operator. But that doesn’t mean a new-build is viewed negatively, it just means it will need to be reviewed more thoroughly. In some cases, securing financing for existing restaurants can be tough, too. Another problem can arise when an owner’s compensation comes from various sources, or if there are various one-time costs to consider.

Expansion/renovation of a successful restaurant is viewed as much less risky. The ability to quantify actual demand at a specific location takes away much of the guess work in terms of whether a local market will support a concept.

F&H: How different is your company compared to other financing companies in how it deals with those looking for financing?

EK: First, the representatives at GE are exclusively dedicated to the restaurant space. They are specialized in financing restaurants and are aligned to service, either full-service, quick-service or regional brands across Canada. We build relationships with franchisors to better understand their business, and this means we can focus on the specific transaction information with any new client.

Second, GE’s valuation approach is based on cash flow. Most banks look at funding based on the appraisal of assets, and on an existing older restaurant the asset value is likely low. By taking the cash-flow approach, it is the EBITDA generated by a business, which determines value. This allows us to be highly flexible in deal structuring; in most cases we can offer higher advance rates.

F&H: What kind of advice would you give to someone aspiring to open a new restaurant in this economically challenged market?

EK: Even in a healthy economy, the restaurant failure rate is grim, but in a recession, the industry is even more unforgiving. My advice would be to equip yourself with the right tools from the get-go. Build a solid foundation. Restaurateurs require in-depth knowledge about much more than just food. It’s also about marketing, financing and people skills.

Take on working partners who have skills you may not have to build a strong foundation. But that’s only half of the equation; the other side is making sure you have sufficient capital. Make sure you have enough capital to make it through the first six months of opening — this is where having working partners can really help get the business off the ground.

Secondly, make sure you have a solid concept: The restaurant industry may have taken a hit, but the segment that has outperformed the rest is fast-casual. This is mainly because it offers a good product at a more affordable price-point. If customers see value in what they’re eating, and don’t feel the taste and experience are compromised for the lower price, they will keep going back.

In a challenged economy, it’s also important to cut unnecessary spending. Banks have tightened lending, which means you have to get more out of every dollar you spend. Cut unnecessary spending on things that don’t add value to the customer. Get back to basics: fresh food, fresh ingredients and a focus on customer experience and satisfaction is always a great recipe for success. Finally, it’s all about information. Do as much research as possible. Talk to existing restaurant operators in your local market and if looking at a franchise, dive deep into the system and contact other franchisees. They will be able to give you an indication about whether your region is recovering and whether the brand is poised to get back on track.

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