By Sveta Lasco, Junior Research Analyst
We can learn a lot about how resilient a franchise system is by looking at its performance across a full economic cycle. By now we are all familiar with the path leading to the last recession where loose credit standards led to an overly aggressive housing lending market. That fast-paced lending, combined with accommodating monetary policies gave incentives to take (or give) more debt than was economically supportable and the bubble burst.
What it meant for home borrowers was diminished home values with a resulting decrease in equity values, an important source of financial support for potential franchisees. It also increased economic uncertainty for potential franchisees, leading to a slowdown in business model growth. In the wake of loan losses, business lenders started practicing stricter underwriting guidelines and the average person with deteriorated home equity found it much harder to pursue franchise business opportunities. Needless to say, the financial crises left the franchising market with lower expectations of unit sales, along with weak and often declining unit revenues. Unit closures for many brands became a significant credit issue for continued access to capital.
Franchising is often viewed as counter-cyclical when it comes to the lending environment, yet this recession was like no other. Going through a weak economic recovery, tighter regulatory oversight, and self-imposed restrictions on lending made banks much more selective of franchise sectors. “Deleveraging” the consumer became the new theme. It was estimated that SBA default rates were 19.3% between 2006 and 2010. As a result of tighter lending and to encourage franchise sales, innovative franchisors began offering their own financing programs to qualified borrowers.
Lenders need to make loans to make money. Unfortunately, as the economy slowly improved, increasing demand for franchise borrowing has not meant a loosening of underwriting restrictions. Quite the contrary, most lenders, for both regulatory and conservative lending purposes, increasingly looked for additional underwriting due diligence on the franchise borrower, the franchise brand associated with the borrower, and the industry sector where the brand is operating. In this manner, lenders gained insights into the whole picture related to business loan risk.
In the current economic climate lenders are prepared to screen and monitor not only potential franchisees but also the brands and industry sectors that are part of the loan application. This has evolved into a comprehensive franchise credit report. The best application of this comprehensive credit analysis is the FUND Report, which incorporates standardized franchise performance metrics such as historical success rates, average unit revenues (AUR), unit economics, and the franchisor’s financial statement strength, among many others. These financial metrics are key to measuring the past performance of a brand and to forecast the near-term success not only of the franchisees but also of franchisors and entire franchise systems. FUND Reports give comparative credit risk insights into how the franchise system would be able to weather a potential downturn, helping lenders make better credit decisions, supporting lender risk management systems, and providing a standardized basis for making capital reserve decisions and demonstrating due diligence for regulatory reviews.
FRANdata compiled a list of five high performing brands that navigated the recession and thrived in the recovery. Interested in learning more about what makes these brands resilient? Request for a free sample FUND Report on any one of these brands by emailing us at firstname.lastname@example.org .
For more information check out the FUND page.