That’s basically what one restaurateur pitched to patrons in order to entice them to help put up the cash for a future location, according to Isidore (Izzy) Kharasch, president of foodservice consulting firm Hospitality Works, Inc. The celebrated yarn has it that, several years ago, the owner of a breakfast quick-serve startup was having trouble raising capital for her next location. After being turned down by banks and tapping the friends-and-family well dry, the owner turned to her own customers for help.

Kharasch says that investors were promised two dollars in restaurant cash for every dollar they invested in the new unit. Several apparently signed up. “Once the restaurant opened, they were able to eat there everyday,” he says.

While this might not appear to be the most sophisticated way to raise capital for expansion—in fact, Kharasch won’t provide the name of the establishment, as it’s not something the owner will want to publicize—it does illustrate the lengths some quick-serve chain operators will go to grow.

Thankfully, most operators don’t have to take such drastic measures to expand their concept. But the last few years haven’t exactly been smooth sailing on the money-borrowing front for quick-serve chains. “The credit availability in the last three years is as tight as it’s been in the last 20 years,” says Carty Davis, principle, The Cypress Group, an investment banking and advisory service firm specializing in restaurant chains based in Englewood, Colorado.

Rewind to the late ’90s when there was a tremendous amount of capital available. Rates, terms, and conditions were extremely flexible—to the point where things were a little too relaxed, according to Davis. “The industry took advantage of those products and there was an over-leveraged situation within the multi-unit restaurant industry,” he says. “That phenomenon came to a very abrupt end in the middle of 2001.”

The potent mix of massive defaults, lower loan yields, and degenerating economics for the securitized loan industry (reducing the availability of capital), combined with the overall softness in the quick-serve industry and a general economic downturn translated into a situation wherein many lenders exited the industry altogether. In other words, the lending heyday was over.

That doesn’t mean that the situation is so overly cautious that loans are impossible to come by unless you’re fortunate enough to have the standing of, say, Yum! brands. It has been a challenging few years, but, according to Dean Zuccarello, CEO of The Cypress Group, there’s been a subtle shift in the lending marketplace over the past several months. “There has been a gradual improvement in the marketplace,” he says.

The availability of senior debt capital hit a low point somewhere between late ’02 and mid-’03, Zuccarello says. However, there was a surge in availability of growth capital late last year. Several new capital sources have entered the market—with non-traditional sources of senior capital, such as hedge funds, sale-leaseback, and even SBA (Small Business Association) loans—and there have been some modest changes in underwriting criteria from traditional lenders such as GE Franchise Finance, American Commerical Capital, Bank of America, and CitiCapital.

A sign that the tide may have indeed turned came early this year with news from GE Franchise Finance—the 300–pound gorilla in the quick-serve lending marketplace. [And QSR’s partner in the QSR 50—Ed.] Its franchise division (which provides financing for more than 3,000 franchise operators in 15,000 locations in the U.S. and Canada) announced it would be injecting two $500-million pools of restaurant loans into the secondary market. “These securitizations show that there is still a market for restaurant loans and GE will be freeing capacity on its balance sheet for new restaurant exposure,” says Davis.

While tier-one chains tend to demand more traditional senior debt financing, there has been an evolution away from higher levels of senior debt into greater levels of equity, according to Davis. Sometimes it’s a matter of mix-and-match to find the right formula for the right client. For example, in some cases, mezzanine capital—a hybrid capital instrument that combines a higher coupon debt instrument (usually structured as interest only) with a warrant for a nominal piece of the company’s equity—is used to balance the return expectations and risk profile of pure senior debt.

There is still concern for emerging concepts seeking capital in this climate, but a healthy brand will find the support it needs, says Zuccarello. For example, The Cypress Group is busy raising equity for Bear Rock Café, which has 30 locations in nine states and has development agreements to build an additional 140 franchised locations over the next three to five years. “It is on a very steep growth curve,” Zuccarello says.

Bank of America’s Restaurant Finance Group also tends to deal with the larger franchisees (10 or more units) and has organized programs for prime brands, such as Yum! brands, Wendy’s, Sonic, Krispy Kreme, and Panera Bread. In addition, it has a group that works specifically with restaurant operating companies and a separate program altogether that takes care of financing McDonald’s system franchisees—traditionally smaller relative to other brands, so they have their own profitability-risk profiles.

“For the national tier-one brands, capital is readily available for smart deals,” says Quinn Hall, senior vice president and credit products manager for the division in Atlanta, Georgia. But the non-major players and the startups still have a tough time, he adds.

For the first few units, an operator can probably land SBA lending or rely on family and friends, he says. But where does that leave the more modest multi-unit owners?

There is indeed a gap somewhere between the second store and the tenth, according to Randy Schultz, senior vice president and market executive for the division. “There seems to be a no-man’s land.” The real hurdle tends to come when trying to move beyond that initial growth spurt. “How do you get from that second unit to five or 10 where you gain the interest of the national specialized lenders?” Schultz asks. “That’s more difficult.”

Bank of America’s Restaurant Finance Group recognizes that there is opportunity in trying to find a way to fill this void. In fact, it is currently trying to develop a template that would provide capital to smaller concerns. But it isn’t easy. “There’s more risk in the market,” he says. “Their needs have to be met,  but we need financing that is easy to structure.” The plan is to design a model that takes into account the increased risk to that segment and the higher cost to deliver product. He estimates that the bank should have something in place to meet this need within the next year.

The environment is one in which the strong get stronger while the not-as-strong can struggle to move forward, says Michael Shepardson, president of CNL Advisory Services and executive vice president of CNL Restaurant Capital in Orlando, Florida. “The market is segmented,” he says. The strong franchise players generally warrant several bids from various lenders, while the emerging concepts, second-tier, or simply more leveraged players have fewer options, he says. However, he too is optimistic about the changing conditions. He points to the fact that same-store sales in the first quarter of ’04 showed significant increases for the vast majority of concepts. “That’s spectacular when you think about what most concepts have done in 2000–2002,” he says.

The advantages to this strategy are obvious. Because real estate valuations have hit a 25-year high, an operator can sell his or her property for a nice chunk of change, meaning that extra out-of-pocket capital might not be necessary. It’s also a good first step for long-time operators interested in backing off from the industry. “It’s a wonderful thing for those operators who have been in the business for 20–30 years and want a few years left but want to start taking equity out of the business,” Shepardson says.

There are drawbacks, however. The most obvious flaw to this strategy is that the operator is giving up a major asset—real estate. Many restaurant operators are entrepreneurs who take great comfort in owning that asset, Shepardson says. “It’s a comfort thing.”

Another downside—for the lender, this time—is that sale-leaseback relationships are more removed. As a traditional debt provider, technical defaults—where cash flow coverage isn’t at the expected level—can be an early warning signal that things are amiss. By addressing the situation at the first hint of a technical default, the thinking goes, an impending monetary default can be avoided. There’s no such omen for sale-leaseback deals. “You oftentimes don’t find out as the landlord that the operator has a problem until it’s too late,” Shepardson says.

But sale-leaseback is so hot right now (there are about four providers of sale-leaseback capital aggressively pursuing the market, according to Shepardson) that these deals might be impossible to resist for concepts intent on growth. While these deals generally take up to 120 days, CNL recently had a request from a large client for a $40–million sale-leaseback deal that turned around in five days.

But the popularity of sale-leasebacks won’t last forever, warns Brad Saltz, director of the hospitality services division of SS&G Financial Services, based in Cincinnati, Ohio. “It’s continued much longer than everybody thought it would because interest rates have continued to remain low,” he says. “Like anything else, it will probably go in cycles.” He says that the market is probably overheated already, and, if it continues on this trajectory, it may even face the same over-lending hazard that plagued other capital generators in the past. “It will probably reverse at some point.”

However, he does see the same loosening up in the past few months that other insiders have noticed. “You still have to be credit-worthy to justify the credit,” he says.

SS&G works with small- to medium-sized multi-unit operators, primarily franchises. “Franchisees tend to have a better situation because they’re perceived as being part of a system that has a track record,” he says. “It’s harder for independents.”