Thinking of Buying a Fast-Casual Franchise? Read this report first.

Corner Office | By Deborah L. Cohen

Grass Roots Financing
In the tough credit market, quick-serves are using some unusual strategies to secure capital.
Restaurant lending gets creative.

When the going gets tough, the tough get creative with financing.

That’s the mantra of some quick-serve restaurant companies determined not to let the stagnant credit markets inhibit their abilities to expand and take advantage of attractive real estate opportunities for experienced franchisees.

With methods as varied as creating their own private equity and angel investor funds to offering microloans or just passing the hat to trusted friends and family, fast-food concepts large and small are testing a host of ways to fuel growth in the recession.

“I’m seeing franchisors become more active in participating in the process, whether providing some amounts of financing themselves or just participating through fees or other methods for a lender,” says Steve Romaniello, managing director of Roark Capital Group, an Atlanta-based private equity firm with investments in Moe’s Southwest Grill, McAlister’s Deli, and Focus Brands.

“It’s more at the grass roots level,” he says.

Franchise companies say that traditional bank loans from historic restaurant lenders such as GE Capital remain difficult to secure and government-backed SBA loans are harder to obtain. And with capital markets frozen, private-equity funding from established buyout firms is still scarce; Dow Jones reported that funds raised in the first quarter alone dropped a dramatic 81 percent to $15.5 billion—the lowest quarterly amount since 2004.

Marco’s Pizza, a Toledo, Ohio–based chain of more than 185 restaurants, is taking a multipronged approach to capital raising that is heavily weighted toward private funding, says chief executive Jack Butorac. Its strategy includes the development of an independent private-equity fund that was the brainchild of Marco’s chief financial officer Ken Switzer.

The company was able to secure capital from a group of high-net-worth individuals who are long-time supporters of the fast-growing chain, which experienced a year-long run of monthly same-store sales increases despite the difficult economy. The funds have doubled the chain’s 2009 expansion goals to about 120 restaurants from an earlier 60.

“We have a library of existing investors who believe in the Marco’s concept and in the opportunity to take advantage of the growth,” says Butorac, noting that he is not investing in the fund because such a move would be perceived as a conflict of interest. “It’s out-of-the-box thinking time,” he says.

The fund, which became available to qualified operators on June 15, raised an initial $500,000 and has a $5 million cap, Butorac says. Marco’s expects that investors will see a 9 to 15 percent return over a maximum five-year period. Franchisees receive the financing in $100,000 increments to assist with real estate down payments in exchange for a percentage of their sales based on performance. The company also arranged for a revolving line of credit from a regional bank to assist with equipment financing.

The pizza chain, which operates in 17 states, is also in discussions for a large capital infusion from an undisclosed investment firm that Butorac says approached him with a potential deal. If it is finalized, this additional equity funding would translate to another $150 million for growth, paying for everything from rent to equipment in exchange for a significant portion of the participating franchisees’ cash earnings.

“It would open up the door to significant expansion,” Butorac says.

Similarly, Vapiano, a German-based fast-casual chain of Italian-style restaurants operating about 30 units overseas and four in the U.S., recently secured a private placement of more than $50 million from a group of wealthy investors, says Dan Rowe, chief executive of Fransmart, the franchise development firm that is helping to build the brand.

“They went right to a wealthy family—somebody who saw the company when it was only a couple of units and had watched it for the last two to three years,” says Rowe, adding that the company will leverage the new funds with debt. “Internally they’re already a profitable company, but this amount of cash basically ensures that they can grow as fast as they want.”

Rowe is also working as a consultant to smaller restaurant concepts that are resorting to more basic methods of early stage capital raising: reaching out to friends and patrons. One well-established single-unit client in Virginia, whom he declined to name, put together his own group of angel investors made up entirely of long-time patrons.

“He went to 10 people, and eight said, ‘Put me on the list,’” says Rowe, noting that the deal will be structured as a general limited partnership with the restaurant owner installed as the managing partner. “The amount of money is small enough that it’s not going to kill any of these investors.”

Im seeing franchisors become more active in participating in the process, whether providing some amounts of financing themselves or just participating through fees or other methods for a lender.

Some larger franchisors with sufficient internal sources of cash are deploying their own funding programs. Denver-based sandwich chain Quiznos announced in May such an initiative for its existing franchisees to expand through microloan financing that it likens to a bridge loan from a bank.

“It allows our successful multiunit operators to consolidate markets and take on other sites,” says Todd Haavind, Quiznos’ senior director of chain management. “We really want to help our good operators expand and become successful.”

The financing, designed for the acquisition of new sites or the reopening of existing Quiznos stores, is available in amounts up to $10,000 and limited to two loans per franchisee. It can be used for start-up costs ranging from rent to equipment purchases and inventory, and will be offered at rates of 8 to 20 percent depending on credit-worthiness, Haavind says.

He expects the company will make 20 to 50 loans over a one-year period. The company, which runs more than 4,500 stores worldwide, is also taking on other initiatives to assist franchisees, such as reaching out to landlords to renegotiate leases.

“We’re pretty similar to the banks; we just have the ability to be more lenient,” Haavind says. “We’re kind of looking at it as a buyers’ market. In the downturn, if you’ve got the capital to grab opportunities, you want to grab them.”

photo courtesy: ©istockphoto.com / clu
Deborah Cohen is QSR’s former Finance reporter.