As we approach the first anniversary of the beginning of the COVID-19 crisis, many businesses, including franchises, have to review their financing and, in many cases, increase their borrowings in order to continue operations after long periods of significant declines in traffic and, for many, mandatory closures.
Refinancing a franchised business, however, raises a number of issues and challenges unique to franchising, including the following:
Maintaining an adequate equity investment
It is rare for a franchised business to succeed in the medium to long term if it cannot rely on an appropriate equity investment from its owner(s).
Despite the unfortunate consequences of the recent crisis, it is important for a franchisor that the partners or shareholders of the franchisee still maintain a sufficient capital (or equity) investment to keep their business in operation and to ensure that the franchisee's obligations to the franchisor, its employees, suppliers, lessor, lenders and other creditors are met.
Some franchisors also require, in their franchise agreements, their franchisees to maintain several financial ratios to ensure the financial sustainability of their franchised businesses.
The reasons for refinancing
Especially under the actual circumstances, it is quite normal that a franchisee would want to increase its financing or to obtain new financing to ensure the continuity of its business.
However, the franchisor will want to ensure that the increased or new indebtedness is for the purpose of the franchised business and not for the personal use of the owners or for other activities carried on by the owners, which may unnecessarily (and at a very bad time) financially weaken the franchised business.
The impact of refinancing on the profitability prospects of the franchised business
Of course, a franchisor will also want to ensure that an increase in the debt of a franchised business will not impose a financial burden on it in the medium or long term that would jeopardize its prospects of profitability.
As a well-known proverb in the financial world puts it, you don't throw good money after bad.
It is therefore important for both the franchisor and the franchisee to ensure that any refinancing or new loan can be repaid within a reasonable time frame without jeopardizing the profitability prospects of the franchised business.
If not, the franchisor and franchisee should jointly seek a better solution than refinancing or new borrowing.
The impact of refinancing on the foreseeable obligations of the franchisee
To survive in this business world where change is now the norm and where, in many fields of activity, customer loyalty is never really acquired, a franchisee must, from time to time, make various, and sometimes significant, investments in his business.
These include maintaining the appearance of the franchised business, periodic renovations, replacement and addition of equipment and technological tools, modifications and changes required by the market or the franchisor, etc.
When refinancing or borrowing, it is therefore important to take these foreseeable obligations into account in order to properly evaluate the impact of the refinancing or new borrowing on the franchised business and to ensure that the franchisee will be able, when it becomes necessary, to meet its obligations to reinvest in its business.
The cost of financing and its repayment
A serious franchisor is also concerned about the cost of financing (interest and other associated costs), as well as its repayment.
It will therefore support his franchisee in order to encourage the repayment, according to a reasonable schedule, of this financing or refinancing.
To this end, many franchisors will assist their franchisees implement measures to support, or even accelerate, such repayment, which measures may include putting some limits on certain expenses of the franchised business as well as on compensation, dividends and repayment of advances or capital to its shareholders.
The source(s) of funding
Unlike an independent business where the entrepreneur is the only one who has to assume the risks and the consequences of difficulties with a lender or creditor, a franchised business is part of a network that may also be affected by difficulties between a franchisee and its lender or creditor.
These difficulties can quickly become more complicated, and difficult to manage, when the lender is not a bank or a financial institution experienced in business lending.
For this reason, many franchisors require that any refinancing, or new borrowing, made by a franchisee be obtained from a recognized financial institution or an institutional lender familiar with this type of financing.
Some franchisors have also entered into various agreements with one or more banks or financial institutions such as, for example, a financing program for their franchisees, a collaboration agreement, a buy-back agreement, etc.
The purpose of these agreements is to make it easier for their franchisees to obtain financing and, also, to allow for a healthy collaboration between the financial institution and the franchisor in the event of difficulties encountered by a franchisee in fulfilling its financial obligations, and this, in the interest of the franchised business as well as in the interest of the franchisor and the franchise network.
The securities to be granted and the preservation of the franchisor's rights
Another area of interest to a franchisor is the securities granted by a franchisee to obtain a new loan or refinancing.
The enforcement of a security on the assets of the franchised business or on the franchisee's shares could result in those assets or shares eventually being acquired by persons other than the franchisor, a franchisee of the network or a person previously approved by the franchisor without the franchisor being able to do anything about it.
Therefore, the franchisor will want to ensure as much as possible that its rights and the interests of the network are protected in case of the enforcement of security interests granted by the franchisee.
Often, at the time of a refinancing, the assets of the franchised business are already subject to various security interests, including in favour of a financial institution, of the lessor of the franchised business location and of the franchisor.
A refinancing may therefore require the franchisor to agree to assign, in whole or in part, priority over the security it holds in favour of the new lender, thereby increasing somewhat its risk level in the event of a franchisee failure.
This will have the effect of making any serious franchisor more attentive to the various issues mentioned above and to want to monitor even more closely the repayment by the franchisee of such additional loan.
Ideally, franchisor and franchisee should work closely together when the financial situation of the franchised business requires additional debt financing. This is in the best interests of the franchisor and the franchisee and, more importantly, in the best interests of the entire franchise system.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
