Financial Summit. The New Normal. Part One. Part Two

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1 Financial Summit Part One What is the New Normal? What are lenders looking for: Franchisors Franchisees What are reasonable development schedules for lenders? What did the stimulus stimulate for franchising? Part Two Leverage Ratios and Debt Service ratios Is Private Equity right for my company? What will it cost? What is the reality on Roll Over Business Startups (ROBS)? Leveraging deferred compensation to fund reimaging strategies The New Normal Conventional Markets Selective lending to very strong franchise concepts Rates are up to 9%-14% Availability to multi-unit operators that are thriving in the current climate only 50%-60% advance rates/ outside collateral required Leasing Alternatives: Available for expansion and re-imaging programs Rates from 9%-20% depending on credit Limited availability for start-up equipment packages 15%++ interest rates 1

2 The New Normal SBA Lending Pricing SBA Loans are capped at rates that are currently below the market rates for commercial loans. Secondary Market The guaranteed portion of SBA loans are sometimes sold on the market. This market has been eviscerated by the credit meltdown. The market has self corrected, and is working properly without any help from Uncle Sam! Guarantee Faith Loans submitted to the SBA for repurchase have seen their guarantees invalidated due to a technical or subjective breach. Lenders rely on the guarantee in making SBA loans, as they are almost always under-collateralized. The New Normal- Best Practices Make your brand bank friendly Read your FDD with your banker hat on Bank Credit Report FranData Lender Addendum Your FDD is not your friend Enhance credit if you can Prequalify prospects correctly FICO is only a guide Real Injection funds, not borrowed Spousal income or post closing liquidity needed Resume issues, especially in food sector Industry/ Geography Issues Food Sector Moratorium by many lenders Major tightening on start ups moratorium by some lenders Size Matters! Most lenders have minimum loan sizes of >$200k Areas with big housing issues are being looked at negatively by lenders, unfortunately, many of these areas are where franchisor growth has historically been targeted. 2

3 How to get access to capital when demand > supply? Understand What s Happening Lender conservatism dominates Most lenders today are less experienced franchise lenders Preferred lender model is 20 th century concept Lenders are cherry-picking Development Schedules & Lenders Lenders may not approve unit #2 up front Lenders will not want to see unit #2 progressing until: Unit #1 us open for 12 months Unit #1 is cash flow positive and paying 1.3X debt service + owners salary Unit #3 can generally start after cash flow is sufficient from units 1&2 to service all debt CLEAN books and records from franchisee. What did the stimulus stimulate? SBA Lending 90% Guarantee Removal of borrower fees Change in size limitations Loan amount raising to $?MM Higher Regulatory oversight Conventional Lending Higher Regulatory oversight Bank Failures/conservatism 3

4 What Type of Financing is right for my investment size? < $100k CASH + 401k $100k - $200k Above + HELOC $200k-$2MM Above + SBA Loan $2MM+ Conventional lenders or SBA? Practical Applications by a Franchisor Ken Switzer CFO Credit Crisis Effects- Demand for funds is higher than supply So, banks can be, and are picky to whom they lend They are seeking to improve the Risk vs. Reward relationship 4

5 How Lenders Are Seeking to Improve the Risk / Reward Relationship Seeking borrowers with less perceived risk Seeking business models with less perceived risk How Lenders Seek to Reduce Risk with Borrowers: Higher equity required Higher credit scores Higher Cash Flow coverage required (Creates a larger margin of error) Seek borrowers with more experience Seek a secondary source of repayment How Lenders Seek to Reduce Risk due to the Business Model: With Franchisors that are historically successful With Franchisors that they believe will help insure they (the lender) get paid With Franchisors that go the extra mile to insure franchisee success 5

6 Lenders Seeking More Equity: 30% equity now seen as minimum Higher equity is more consistent with historical trends, but pendulum may have over-reached (20% down days gone) Higher equity ratio does reduce total debt service and lender risk What Lenders Are Asking for to Reduce Perceived Risk With Borrowers And What Franchisors Can Do If Higher Equity Required Contribute equity to franchisee via initial franchise fee reduction or gift Help find partners (but screen them) Analyze every line of PFS for hidden cash Don t forget 401k conversion programs Form a Private Equity fund to contribute equity on a for profit basis 6

7 Lenders Seeking Higher Cash Flow Coverage Ratios Due to uncertainty, lenders want a greater margin of error Greater scrutiny of Pro-forma s and assumptions (takes more time to do deal) Typically, EBITDA of 1.25 or more times debt service (and some look at EBITDAR) If Higher Cash Flow Coverage Required Try to lengthen initial amortization period Revisit the business model (Are you doing everything you can to improve cash flow?) Require higher leasehold improvement allowances from landlord Consider corporate buy-down of interest rate Lenders Seeking a Secondary Source of Repayment From other stores or businesses Spousal income Third party guarantees (who can repay from cash flow and not sell assets) 7

8 If Secondary Source of Repayment Sought Find a capital partner that invests and guarantees loans Consider a direct franchisor guarantee of finance program Consider an indirect guarantee of loans through loan loss program If More Experienced Franchisees Required Recruit from company owned units Lengthen training programs Focus on growth from experienced franchisees Franchisors can help Reduce Perceived Business Model Risk Document your success with FRANdata Bank Credit Report Develop a special assistance team to help struggling units that want to improve Think through what else can be done to reduce perceived risk 8

9 Guarantee Franchisee Loans Directly guarantee first dollar loss in lender Financing Program Indirectly guarantee a portion of any loss through a subsidiary or affiliate on any loan Do the Math (You may be pleasantly surprised) Remember FDD considerations Develop Relocation Programs Goal is to relocate a business with a bad location, but has good management Requires appropriate lease language Do the Math (It may have great ROI) Remember FDD considerations Develop Re-Sale Programs (of struggling locations) Don t let new sales goals interfere with the big picture. Re-selling a struggling location is cheaper than its failure. Consider a package of incentives to all low volume re-sales Franchisor should consider paying the brokerage commission ( Do the Math, it may have great ROI) 9

10 Scrutinize Every Transaction Involving Borrowed Funds Review terms of re-sales that involve borrowed funds Review terms of new store financing to insure Margin of Error High level of scrutiny of SBA loans Remember, loan defaults and franchise closures do count against you! Other Thoughts Know the lender. Franchisors should never submit unqualified applicants Consider using a loan broker as they have multiple financing options Don t go to any bank unprepared. Amateurs don t get loans today Franchisor should offer a system solution to package all loan requests And Finally Document what the Franchisor is doing to insure unit level success. Don t assume they know Do the Math on guarantees, relocation and re-sale programs. You may be pleasantly surprised Maximize unit level economics. That makes everything possible 10

11 Case Study Background Based in Charlotte, NC, Driven Brands is one of the leading franchisors in the automotive aftermarket with: Nearly $1 billion in system sales 1,500 retail locations in 7 countries plus over 300 vans providing mobile services In 2008 acquired Maaco which combined with Meineke allows us to manage two of the best known brands in the automotive aftermarket with > 90% brand awareness Financing Challenges Historically the great majority of franchisee funding was obtained through SBA National Preferred Lenders (and we all know where that has gone!) Location failure rates of 3% - 5% in line with historical averages, but skewed impact on SBA default rate cause additional financing concerns Loan size is at bottom end of desired bank financing range (particularly for Meineke) Increased requirements for industry experience 11

12 Actions Early in the credit crisis, began discussions both internally and with external advisors on proactive actions to be taken to continue flows of development funds. Identified both financial and operational tactics that could be employed that could help address the both the external and internal issues that would impact financing availability Dedicated Resource Historically, both Maaco and Meineke enjoy annual closure rates of about 4-5%, which is well below SBA averages for small businesses. But good is never good enough Enter Jerry Allen, a former Dunkin Donuts and Meineke Franchisee, with significant experience in turning around troubled businesses. Dedicated Resource The goal was to save the Center while attempting to minimize any financial loss experienced by the lenders Process: establish a relationship with the landlord, bank and vendors develop an exit strategy for the existing franchisee with the ultimate goal of a seamless transition to new ownership 12

13 Franchisee segmentation As with any mature business, there are varying levels of dealer acceptance to changes in the business model brought about by changes in consumer habits and desires. Both Maaco and Meineke developed methodologies to identify those franchisees who most closely followed the business system to determine if there was any impact on franchisee success Franchisee segmentation Maaco Certification program The certification of a center is contingent upon them achieving a number of operational hurdles that indicate Centers that perform the actions necessary to achieve certification have significantly higher sales and more importantly higher profitability and lower failure rates. Franchisee segmentation Meineke STAR Ratings Based on 27 different criteria Most objective technique Evaluates Centers on following the Meineke System One Star Centers average 2.2% of total sales in overall profitability Five Star Centers enjoy 22.6% of total sales falling to the bottom line a 10x difference in overall profitability! 13

14 Franchisee Segmentation By analyzing the performance of both brands on a segmented basis, assurance can be given to lenders (and prospects!) that the underlying business system is sound, financially viable and a worthy lending risk Lending decisions can then be made based upon the facts and circumstances of each individual Bank Credit Report Need to communicate proactive actions to banks Complicated capital structure causes financials to be confusing to lenders Bank Credit Report Engaged Frandata to prepare a Franchisee Bank Credit Report that is an independent document that can be shared with lenders and identifies: Lending trends of the brands Proactive actions to be taken to minimize lender loss Franchisor financial statement analysis 14

15 Other Financing Strategies Seek more financing from developers of Build to Suit locations (have them fund the FF&E) Significant shift in lending from national players to the local regional banks Seek creative ways to lower the cost of entry (for example, through seeking used equipment) Other Financing Strategies Much higher utilization of self-directed IRA s and other creative financing solutions Sourced more second generation space where landlord includes equipment in lease and therefore lowers cost of entry allowing an all cash deal Exploring franchisor partial loan guarantees Results Despite both the credit market difficulties and the general economic conditions, we are on pace to open as many or more locations this year in BOTH brands than either s historical averages 15