How to Out Smart the Credit Market
When banks wanted a third-party guarantee who didn’t have to sell their house to repay franchisee loans, Ken Switzer, CFO of Marco's Pizza, stepped in with an unusual idea. As a result of the frozen credit market, Switzer developed Marco's Assurance, which offers a $50,000 guarantee on franchisees' loans. The idea helped the company grow despite the recession, and Switzer is looking to get other brands involved in 2011.
How does Marco’s finance its growth in today’s market when loans are close to impossible to secure?
There have been a number of programs we’ve developed over the last couple years to support our growth. Back in 2007, we recognized that traditional banking sources might not always be available, so even before the meltdown in the banking world, we started our own capital leasing company. We use that to lease complete stores to franchisees. They put down a 25 percent down payment or deposit, and we lease them the rest of the store and all the depreciable assets. We did that so that we could fund the transactions that couldn’t be funded through traditional SBA loans at that point in time.
What is Marco’s doing to help its franchisees secure traditional loans?
Banks are looking for more equity. They want more like 40-50 percent down instead of 20 percent. So I started a venture capital fund, which we call Marco’s Capital, to make pure equity investments in franchise stores.
We said to our franchisees, “Look, we’re willing to make you a franchisee, and we’re willing to bet on you.” We’ll invest anywhere from $50,000 to $100,000 of pure equity through our private equity fund to invest in those franchisees. I found a lot of investors, people who had invested in Marco’s and our franchisees before, and we offered a private placement in Marco’s Capital.
The initial fund draw was $500,000.
Besides offering capital, what else did Marco’s do?
The other thing banks were looking for was a secondary source of a repayment of the loan. They wanted a third-party guarantee who didn’t have to sell their house. It didn’t do banks any good to have a mortgage on their books.
So as a solution I went to them and said, “What if there was something like an insurance company that could guarantee franchisee financing, at least in part? There would be real money, a real balance sheet behind the franchisees. Would that help?” They, of course, said yes.
So what we formed was Marco’s Assurance, which is a subsidiary or Marco’s Franchising, that will guarantee $50,000 of a typical $200,000 loan. So the bank now has equipment as collateral, they have the franchisee’s signature, and they have $50,000 coming from Marco’s Assurance.
Is that a viable option for other brands?
For those franchisors that really believe their success is tied to their franchisees, the answer is yes.
For those franchisors that just want to get a piece of the sales and aren’t concerned with the success of their franchisees, the answer is no.
But what about companies that can’t afford that?
What’s happened is that brands from across the country are exploring the idea of a nationwide, multifranchisor loan assurance fund—similar to private mortgage insurance. The idea is a dozen franchisors get together and go to a company like Nationwide or State Farm and have them administer and manage it, but they back it up. Then we get a company like FRANdata to assign risk ratings. I’ve been talking about that to a number of franchisors.
So the typical franchisor who doesn’t have the time to do what we’ve done at Marco’s, they could latch onto this with their system. I think any franchisor that really believes in their business model can do this and propel their growth.
Are you concerned at all with the increase risk with all these programs?
It is something that I had to justify to our management team. We looked at our loss history and developed a loss-history assumption to make sure we funded that potential loss up front by deferring a portion of our franchise fees and royalties into Marco’s Assurance. So it will never come as a surprise on the income statement.
Who should not do this type of program?
If the franchisors have a bad business model, they should stick with just taking a cut of the royalties.
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