Growth | July 2013 | By Kevin Hardy

The New Norm

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Papa Murphy's slowed restaurant expansion due to the down economy in 2008.
When the Great Recession slowed down bank lending, Papa Murphy’s was forced to slow down expansion. papa murphy's
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In addition to short-term capital, restaurant operators can find an array of other creative options to fund new projects.

The crowdfunding site Foodstart.com recently launched to help restaurant and food-truck owners raise small amounts from friends and family online. Instead of a cash return, backers receive perks like free dessert, discounts, and workshops. In addition, in April, Business Financial Services announced an $82 million line of credit that it and Wells Fargo Capital Finance made available to small and medium-sized businesses to help fill the void for businesses whose credit needs remain unaddressed by traditional banks. And private equity firms are showing an interest in playing a part in restaurant growth.

Atlanta-based BIP Opportunities Fund LP, for example, bought a minority interest in the Pan Asian fast-casual chain Tin Drum AsiaCafé to get its aggressive growth plan going. Other quick serves, like Bojangles’, have been wholly purchased by private equity firms.

Jack Slye, principal at the Philadelphia-based private equity firm LLR Partners, says restaurant operators are growing increasingly interested in private equity groups as an alternative to slow and steady growth or franchising models because it’s much easier to grow quickly with a huge infusion of cash.

LLR has been kicking the tires of emerging restaurant concepts, especially mid-level quick serves and fast casuals. The company hasn’t bought into a concept yet, but Slye says it’s only a matter of time before it invests in the restaurant realm for the first time. Given unit economics and the strength of the segment, he says, quick-serve and fast-casual concepts remain a solid investment.

“We found a bunch of great companies we like,” he says. “We think there are a lot of companies out there that are very attractive.”

For all the new ways to drum up cash, restaurant operators say it’s still the small and regional banks that shoulder most of the growth in the quick-service segment. But a few years ago, those institutions weren’t lending at all, says Mike Brown, a Jersey Mike’s Subs franchisee and area director in California.

“We opened five stores in three years with no traditional financing,” he says. “We managed to build those restaurants with duct tape and chewing gum.”

A 35-year veteran of the quick-service franchise business, Brown borrowed from friends and credit cards and used his own cash to open stores from 2009 to 2012. Things have improved dramatically since, and he now gets multiple loan offers when looking to open new stores.

In fact, the whole company is having better luck finding financing.

“That’s primarily because we’re growing with existing franchisees and new franchisees that are coming in from other brands that already have a track record and assets,” says Jersey Mike’s president Hoyt Jones.

With a tougher lending market, Small Business Administration loans are also helping to boost quick-serve growth. Backing from the SBA offers much-desired assurance to other lenders. Last year, the SBA backed about $2.3 billion in restaurant loans—nearly $500 million more than in 2010.

“Banks are looking for a guarantee,” says Kevin King, Papa Murphy’s chief development officer.

King says lenders are requiring more documentation and are scrutinizing applicants more closely since the credit crisis. It may not be that banks have changed their rules on lending, he says, but that they are merely enforcing the rules they already had on the books.

Even at its most severe, the recession didn’t entirely halt Papa Murphy’s growth. The brand plans to open 125 new stores in 2013. “It just slowed it down because of the amount of time it took to get financing,” King says. “It takes some getting used to what the new process is going to be.”

Similarly, it seems that more brands are adapting to the new normal. Growth in limited-service chains stagnated in 2010 and 2011, but in 2012, brands in Technomic’s Top 500 Chain Restaurants added more than 3,500 units, a 2.2 percent increase over 2011.

“We have seen a large uptick in the last year or so in regards to new small-business requests for [quick-service] companies,” says Doug Cullinan, senior vice president of Cornerstone Bank’s small-business capital group. “I think that’s just a function of more people being willing to take the plunge into small business.”

Since the credit crash, Cullinan says, Cornerstone Bank has relied more on SBA loans.

“We’re not really looking at applicants differently. We’re just focusing more on the SBA process,” he says. “The bank gets some guarantee and some comfort on the loan. But more importantly, the borrowers get some favorable terms.”

He says a brand’s history also plays a central role in the approval process. Without existing units and experience to lean on, he says, applicants should have independent wealth and a strong credit rating if they expect to find financing.

Some business rookies, though, are still finding a way in. For example, newcomers are buying back into the Bennigan’s brand, which filed for Chapter 7 bankruptcy in 2008. That move shuttered dozens of corporate restaurants.

CEO Paul Mangiamele says the 85-unit company, which was previously all casual but which recently debuted a fast-casual model, is now opening about a store a month, some in the company’s old locations and some in the remnants of other closed chain restaurants. He says new franchisees are finding resourceful ways for funding growth, like dipping into retirement accounts or taking out home equity lines of credit.

But the financial market is indeed getting easier to navigate, Mangiamele says; potential investors and lenders have started approaching the company about financing growth.

“The climate has been very difficult the last several years,” he says. “This is the first time that I’ve seen that glimmer of hope.”

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