The 2008 financial meltdown has had a lot of bad implications for franchising, mostly by making access to capital much harder. However, it did have one good implication for the franchise business model. It strengthened it. Capitalism is all about survival of the fittest. Most would agree that many franchise brands in the first half of the past decade were focusing more on growth than quality, assuming (correctly for a while) that the economy would continue to rise and in doing so cover up weaker franchisees and even weaker brands.
All that changed after 2008. Although painful, the down economy demanded better performance, forcing weaker brands and units out. That wasn't good for underperformers, but it is very good for the business model of franchising. Performance now matters, is getting judged by prospective franchisees and lenders, and is defining winners and losers. I'm not suggesting we thank lenders for creating the economic crisis, but we should thank them for starting to require better performance in brands. Today they are saying, "If you want my money, prove that you deserve it." That statement applies equally to franchise brands as well as prospective franchisees.
Lenders and franchisors knew how to prove a prospective franchisee deserved access to credit: they had to meet certain standards regarding credit history, financial position, performance history, background, etc. Those criteria have been unchanged for many years. The bar a prospective franchisee needs to meet has moved higher since the financial crisis and moves at times unexpectedly (bedeviling franchise development officers), but the criteria (things like FICO score and liquidity) have been the same throughout.
The problem in this recovery period is that no one, neither lenders nor franchisors, knew exactly how to prove that a franchise brand deserved access to credit. We all had to learn. Intuitively, lenders knew that a franchise brand's history of unit, system, and franchisor performance should be a good indicator of whether future loans would get repaid. After all, that is why lenders relied on SBA loan performance data. They knew SBA data were not very accurate and therefore a poor indicator of the future. They just didn't have a better means of assessing franchise brand risk until Bank Credit Reports (BCRs) were developed for that specific purpose.
BCRs, developed with years of input from lenders and franchisors, are addressing whether a franchise brand deserves access to credit. For now, that's the essential answer to a lender's underwriting concern. As we get further into the recovery, lenders will begin to widen their credit box and standards for better-performing brands. Then BCRs will be used to address both absolute access and the relative credit risk a particular brand represents, and therefore how loans to a particular franchise brand should be structured and priced.
That brings me to the main topic: how a website will change lender/franchise brand interaction. Most franchise lending today is done by smaller banks. They don't underwrite brands before they have an active loan application. When lenders receive a small-business loan application, they have a limited amount of time and resources to complete the underwriting. For non-franchise borrowers, that means they have very little with which to build a case for expected performance. The best they can do is look at some general small-business performance outcomes by NAICS code or other broad industry categories.
BCRs were a game changer because they provide information about very similar borrowers through unit and system analysis. Now think how timely and efficient the underwriting process would be if lenders had a place to go to obtain not only BCRs but all relevant information about a brand: 1) summary information relevant to lenders about every active franchise brand; 2) FDDs; 3) BCRs; 4) SBA Registry approval status, addendums required, and certificates of no change; 5) industry reports; and 6) other pertinent information.
If all of this information were controlled by an objective third party and made available to lenders, it would become a standard underwriting step in the lending process. It would do something that no other small business lending tools (franchise and non-franchise alike) could hope to do: provide performance history for borrowers and units that look and function almost identically--in other words, the performance history of specific brands.
That's how the new Franchise Registry website, launching in May, will transform franchise lending and help make franchise lending more attractive than non-franchise small business lending--with better risk information.
But wait, there's even more. The new Franchise Registry website will provide lenders with prospecting tools to find brands that meet their desired underwriting characteristics. It also will give lenders the ability to contact prospective franchise borrowers from those brands--and it will put the power of making those connections in the hands of franchisors, who can, at various stages in the development process, allow lenders to find and approach new and existing franchisees. This even bigger game changer will alter how lenders sell their lending services to the franchise community. Stay tuned. It's coming.
Darrell Johnson is president and CEO of FRANdata, an independent research company supplying information and analysis for the franchising sector since 1989. He can be reached at 703-740-4700 or email@example.com.
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