Multi-Unit Franchisee Magazine Issue IV, 2011 | Page 78

FranchiseMarketUpdate
By Darrell Johnson

Improve Your Financing Chances
Adapting to bankers’ evolving loan policies

L

enders establish frameworks for various types of lending: housing, personal, small business, and more. Those
frameworks are called lending policies and define the
rules and procedures for conducting a lending program. They form the basis a credit committee uses to make
loan structuring, pricing, and individual loan application decisions, and that a credit risk committee uses to make portfolio
allocation decisions (how much of the bank’s assets should be
allocated to small business, to franchised small businesses, and
to particular franchise systems).
The competition for credit cycle small business are facing is
pushing lenders toward consideration of tighter (and in some
cases different) lending policies. This tightening generally is
around the five C’s of credit—character, capital, capacity, conditions, and collateral—leading to requirements such as higher
credit scores, more equity contributions and cash reserves, and
so forth. However, we’re also seeing some different lending
policies evolving for franchising, which are emanating from a
basic understanding of franchise credit risk: There is a strong
correlation between 1) the likelihood that any franchise loan
will be repaid as expected, and 2) the credit risk history of the
associated franchise system.
Historically, lenders tried to use the FDD for such purposes.
The down economy exposed the many shortcomings of a document designed for entirely different purposes; it simply doesn’t
address credit risks. The other rudimentary holdover risk tool
from the easy credit years is the frequent use of SBA franchise
statistics, which most banks know are not very accurate.
There is a rapidly evolving solution. We are seeing the development of franchise system measures that more accurately
reflect credit risk, and which are beginning to be used effectively
to improve lender credit decisions: more detailed unit performance data than in an Item 19; franchise system performance
metrics associated with credit risk; and franchisor performance
attributes evaluated in banking terms.
Based on all the franchise credit risk work we do and the
feedback we get from lenders, here’s what I believe a typical
bank credit policy on franchise loans will look like:
1) Small-business policy for franchise lending: system
performance correlates with loan success. The performance
history of a franchise system provides a) a good basis for predicting lending outcomes of lending, and b) guidance in structuring a loan. In addition, the following should be considered.
2) Franchise unit performance: system data on unit
economics drives loan structuring. Good unit performance
data provides the foundation for a loan structure appropriate
f