Solutions for Overcoming Distressed Economic Conditions
When a franchise operator finds themselves in unexpected economic distress but wants to maintain control, what are the potential options for renewal and financial restoration? Quite often financial restructuring is the best path to address key constituents (secured lenders, franchisors, and landlords) who can determine the ultimate success or failure of a turnaround. For example, some may be unaware or unwilling to seek help from their franchisor. However, franchise and royalty fees can often be compromised or delayed if the location is of strategic value to the franchisor and if the economic case can be made for its long term viability.
There are two key actions a business must undergo to obtain relief in a restructuring situation:
- Establish or restore credibility
- Illustrate a plan that demonstrates long term viability.
There are several ways to restore credibility and demonstrate an entrepreneur's continued commitment to a restructuring process including providing personal or corporate guarantees (if they have value) or through direct monetary contributions. Frequently these avenues are either ill-advised or have been exhausted in stabilizing the company's relationship with its lender. In these cases, hiring a sophisticated team of professionals, both legal and financial, provide a credible independent party to remove the emotion and demonstrate the merits of the turnaround to the key stakeholders. Independents have a unique ability to broker these arrangements, because their credibility is their stock-in-trade. Additionally, they provide much-needed expertise and allow an operator to focus on running their business.
Once credibility is established, the team must present a clear and compelling business plan that demonstrates positive EBITDA and sufficient cash flow to service its debt and pay the ordinary business obligations.
If a franchisee can demonstrate credibility and a plan to meet future obligations as they come due, they then have two alternatives: They can pursue a restructuring of the business or seek to monetize their investment through a sale. While some debtholders may be better served in sale, often, the owner is staring down little or no recovery.
A large expense for franchisees is real estate. How does one address real estate expenses? The typical first step is approaching the landlord with a rent reduction request. This is a significant ask and landlords are understandably hesitant to grant such requests. After all, landlords are not the franchisee's business partner and have their own business interests. Basically, it's 'we have an agreement and this your problem.'
The key in these discussions is to convince the landlord that it is a shared problem by communicating that retaining the franchisee is preferable to other alternatives and most certainly better than a non-productive, shuttered space. Primarily, landlords want to ensure the franchisee's business is viable and that rent concessions are not a stopgap measure. Landlords considering concessions oftentimes demand to review the franchisee's financials to determine past performance and the path to future profitability. For example, if the franchisee has been taking a high salary or funding other locations, why would the landlord agree to a rent concession? Franchisees should also expect to provide an updated business plan detailing true vision and a realistic path for a return to profitability. Savvy landlords will also demand to know what other entities are making concessions, e.g., the franchisor and other vendors/contractors. The franchisor's name is on the door and if it is not willing to reduce its fees, landlords will be reluctant to do so, as well. Any restructuring "pain" needs to be equally shared.
Another potential obstacle for franchisees is today's thriving real estate market, where landlords have plenty of options for alternative tenants. A landlord must be shown a tangible upside and be incentivized on the franchisee's restructuring plan.
It is human nature for business owners to want to work themselves out of a precarious situation. It's in the DNA of most entrepreneurs to take risks. Unfortunately, that typically results in seeking financial consultancy too late. We often encounter entrepreneurs who are within days of insolvency yet still do not recognize how dire the situation is.
Declining customers and diminishing cash flow are warning signs that franchisees need to monitor closely. The best time to address diminishing cash flow is when it's still positive. The earlier a franchisee identifies and acts upon a looming issue, the more options they'll have available.
Finally, for franchisees to have a chance at success, they must stay on top of innovation by constantly improving processes linked to speed of service and product quality. Top franchisees differentiate themselves by investing significant time and capital into constant improvement while staying ahead of competitors on consumer preferences.
Matthew Mason, Managing Director, leads Conway MacKenzie's Real Estate advisory practice where he assists retailers, institutional funds, lenders, and private equity investors in real estate value creation strategies around the globe.
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