Capital Options – Regulated Senior Lenders

Established franchisees have seen financing and capitalization alternatives blossom during the past few years. Traditional capital using straight senior financing and embedded equity or external equity capital has evolved to become only one of many alternatives for companies looking to grow.

But it’s important for franchisees to have a firm understanding of their business’s goals and growth strategies, including generic growth plans, remodeling projects (required and elective), and opportunities to expand through acquisitions, says Carty Davis, a boutique investment bank partner who has completed hundreds of transactions in the multi-unit franchise and restaurant space.

He recently wrote about the importance of understanding the differences between the various types of lenders and capital providers and how to pinpoint the ones that might work best. Here’s what he says about one type of capital provider:

Regulated senior lenders are still the most common type of capital provider among tier-one franchisees and established brands. While pricing is attractive, underwriting standards are tight with minimal flexibility on pro forma adjustments outside of the normal course of business. Lease adjusted leverage (LAL) is the primary financial indicator used to measure borrowers, and clients must tightly manage covenant compliance. The maximum LAL is typically set at 6x leverage for accredited borrowers, with tighter requirements as size and credit risk change. Underwriting conditions also can change based on portfolio stress within the bank. This can cause lenders to tighten their underwriting standards, which leads to more onerous diligence requests and extended timetables for approvals and amendments. Amortization with a regulated senior lender can range anywhere from 7 to 20 years depending on the mix of owned and leased real estate assets. Most traditional senior loan facilities also include a development line of credit typically used to access capital for remodeling and new development. A hedging instrument, such as an interest rate swap, is also generally required to fix part of the rate for variable rate loans. A regulated senior credit facility may be the right choice for franchisees with modest leverage and growth plans and no major anticipated changes in the business.