Franchising Can Mitigate Risk, Even For Riskier Industries

Jessica SarterFranchise Finance

Bob Melberth logo

Restaurants are among the riskiest start-up businesses, even for experienced businesspersons. I financed several when I was in the commercial mortgage banking business and had abysmal results. All of the non-franchised restaurants failed within the first two years.

 

One restaurant failed after four months because the owner ran out of working capital. Another didn’t make it because of inadequate parking. I financed a fine-dining restaurant for a gourmet chef who made mouthwatering food but had little financial management experience. It failed in less than a year.

 

I learned from my mistakes and financed a new restaurant for an experienced owner with a history of industry success. But that did not work either. He catered to a young and fickle drinking crowd because the margins were more profitable. As a result, he paid less attention to his food menu. When a trendier watering hole opened in the neighborhood, his customers’ loyalty waned and the bar-hoppers patronized the new place. My borrower’s business failed.

 

All of these loans were partially guaranteed by the U.S. Small Business Administration and the agency buffered some of our losses. Even so, I stopped making restaurant loans without the backing of a proven franchise brand.

 

Choosing a successful brand and getting an SBA guarantee are important keys to successful franchise lending for startups. To my surprise, however, four restaurant brands are among the worst 14 of SBA’s Franchise Failure by Brand 2011. The list does not include the franchises purchased for all cash or conventionally financed.

 

Bob Melberth logoSo I asked Bob Melberth, a franchising coach, consultant and broker with The Entrepreneur’s Source why some restaurant franchises fail. The former McDonald’s executive says food industry experience is an important prerequisite for restaurants even though it may not be for other types of franchises. Another reason for failure may be the franchise brand skimping on support staff, he says.

 

Even when franchisees choose a successful brand, Melberth says the number one reason that borrowers default is because “failed partnerships, including marriages caused the most business failures.” And “second is poor cash management and under capitalization.”

 

Melberth says studies show that over 90 percent of franchisees are “still in business after ten years.” He says that successful brands have “a proven business system, support from the franchisor and the franchisee community.”

 

That is why BoeFly and the International Franchise Association formed a strategic partnership to help entrepreneurs find and finance the franchise brand most suited to their needs. According to IFA, more franchise financing is needed to close a $2 billion gap between would-be franchisees and the amount of funding available. The trade association says by closing the gap, 94,000 jobs would be created.

 

BoeFly, in turn, is the online matchmaking platform that connects its over 2,200 lenders with franchise buyers and small-business borrowers nationwide. Conventional and SBA lenders are seamlessly linked with loan applicants that meet their profile. Some of BoeFly’s lenders also participate in rural loans backed by the U.S. Department of Agriculture and a menu of state and municipal funding programs. Qualified borrowers get multiple offers and choose the one that best suits their needs.

 

Underwriting the borrower’s qualifications continues to be paramount for lenders even when the loan applicant chooses a successful franchise brand. Likewise, franchise coach Melberth says it is the case for diligent franchise brands. “I had a brand in our portfolio not talk to a prospect because he had a $240,000 net worth and their brand requires $250,000,” he says.

 

Franchising is a good alternative to starting a business from scratch without a support system. Even so, choosing the right franchise and finding financing is not always easy.

 

Jerry ChautinJerry Chautin is a former entrepreneur, commercial mortgage banker and business lender. He writes and blogs about business and real estate for several publications and is SBA’s 2006 national “Journalist of the Year.” Jerry is a volunteer business mentor with SCORE, “Mentors to America’s Small Business,” offering free business advice. Post your comments and ask questions on this Blog or send Jerry an e-mail.

Copyright © 2012 Jerry Chautin — All rights reserved.