Tight credit markets are squeezing restaurant operators, making access to external funding difficult, if not impossible, to obtain. The government's bailout plan may eventually provide relief but not for at least another six to 12 months, experts say.

Join the club, Bill. During the first two weeks of October, franchisors and franchisees of emerging concepts all suffered a similar fate—the near nonexistent availability of credit as a result of the current financial crisis. Those who could find willing lenders were required to put up more equity—and more information—to get their hands on a loan.

“It just depends on the size of the deal,” offers Jordan Krolick, who was president of Stevi B's, an Atlanta-based pizza concept that is growing through franchising, at presstime. He says the company has signed up new franchisees with loans from the Small Business Administration to finance the $400,000 to $500,000 to open a unit. “But we're finding deals are taking a little longer than they used to,” he adds.

Commercial lenders have all but closed their gates. GE Capital Solutions indicates the company was open for business but is also “much more selective given these unprecedented times,” says a GE official who spoke on the condition of anonymity.

At issue is the cost of borrowing. “Currently we are not considering [loan] applications. Capital markets are very difficult to price,” explains AIG Franchise Finance Vice President Greg Burns.

There was glimmer of hope at press time that the loan process would eventually be sped up. In mid-October, leaders of the 15 “Eurozone” nations met in Washington, D.C., to coordinate efforts to end the crisis by recapitalizing the beleaguered banking system, thereby providing liquidity for lending. They reportedly agreed to a plan that will guarantee loans between banks through 2009 and pledged to buy the preferred shares of financial firms. The U.S. Treasury Department is following suit, albeit reluctantly, by investing roughly $250 billion in shares of major investment banks.

“Government owning a stake in any private U.S. company is objectionable to most Americans—me included,” said Treasury Secretary Henry A. Paulson, yet adding that “leaving businesses and consumers without access to financing is totally unacceptable.”

The credit squeeze couldn't have arrived at a worse time. Consumer pullback has already plunged most chains into a deep downturn. Fresh City is looking at new projects very carefully. “The world is changing on a daily basis,” says CEO Larry Reinstein.

Morgan Keegan's Bob Derrington predicts franchised chains will likely begin offering waivers on development agreements as external lending is pulled back from franchisees. “The eye of the needle is getting smaller and smaller for those needing external funding,” he warns.

Pizza Fusion franchisee Harry Day will likely have trouble meeting his development agreement, which includes five pizza restaurants in Greater Denver. So far, with help from angel investors and a conventional loan, he's gotten one unit open. Day, former vice president of marketing for LongHorn Steakhouse, had hoped to open four more units over the next several years.

After all, his bank told him it would fund his agreement. Then came the meltdown, and his bankers pulled back their promise. “That's where the changes have affected me personally,” sighs Day, whose growth plan is in limbo. “Things seem to be changing every single day.”

And, some experts believe, things will not be changing for the better anytime soon. “I would be doing just about anything I could to avoid borrowing for any reason now,” declares financial adviser Jim Parish of Parish Partners, in Vancouver, Wash.

His advice: Delay expansion and turn your attention toward improving customer service and value. Parish admits his view is “super cautious” but nonetheless appropriate for a severely stretched industry. “This isn't over yet, and we haven't seen the worst,” he warns.

Hard times—and too much leverage—have already doomed the weak. Company-operated Bennigan's and Steak & Ale units have vanished from the field of dining after parent S&A Restaurant Corp. filed for Chapter 7 bankruptcy in July. Orlando, Fla.-based Shells Seafood filed for Chapter 11 protection in September, and Ruby Tuesday blamed the economy for an astonishing 95 percent decline in diluted earnings per share in its first quarter ended Sept. 2.

Even casual-dining leader Dallas-based Brinker International is offering a wrenching forecast for its fiscal year ending June 24. Officials say EPS, excluding some items, could plummet 25 percent from the same period the year before. One telling sign: Overall comparable sales dipped 4 percent at the company's four chains in its first quarter ended Sept. 24.

Stevie B's President Jordan Krolick, contractor Don Jenkins, and co-franchise owners Tom Peters and Wiley Clark examine blueprints in Cartersville, Ga. The franchisees avoided commercial lenders by paying cash for their new restaurant, currently under construction.

“That's one area of definite opportunity,” acknowledges Larry Reinstein, CEO of Fresh City, a 19-unit chain based in Needham, Mass. “But you don't know what exactly is the right deal. I mean, a great location is a great location, but where will the marketplace land in terms of occupancy costs and revenues? That's what everyone is waiting to see.”

Dan Rowe thinks he knows. “Right now the focus is on landlords and conversions of failed restaurants, where there are plenty of great deals out there to offset the cost of capital,” declares the co-founder and CEO of Fransmart, an Alexandria, Va.-based franchise development company with a portfolio of 13 restaurant brands.

Veteran restaurant executive Lou Neeb, chairman of Houston-based Mexican Restaurants, agrees: “Companies with strong balance sheets will try to negotiate leases down because [landlords] may offer extended leases or [defray] common area maintenance costs.”

Despite loan difficulties, some operators are finding favorable rent deals. ZPizza franchisee Bennett Hirsch, who is opening restaurants in San Diego and Las Vegas says he's "cautiously optimistic about getting relief from landlords."

Fransmart franchisee Bennett Hirsch of Newport Beach, Calif., says he will get “relief” from landlords at two sites where he plans to open ZPizza, an upscale pizza concept with emphasis on healthful ingredients.

Still, he isn't taking any chances when it comes to his banker. Hirsch, a marketing executive who's agreed to open ZPizza units in San Diego and Las Vegas, hired a veteran restaurant manager to help convince the lender he understands the restaurant business. “The bank wants to know about the level of management. They said, 'Tell us about the management you are bringing in and how you are running the business,'” Hirsch recalls.

Reinstein knows the feeling. While he hasn't yanked any funded projects because of the credit squeeze, he's being particularly cautious, in part because of his relationship with his bank. “It is much more of a process now. The bank hasn't said no, but they haven't said go out and spend, either,” he notes.

As for franchisees, Reinstein says, “They have to be well-capitalized to get things done. It is really about having a lot of equity to go into situations.”

Such an onerous requirement could mean new lenders—and perhaps new ways of financing deals—in the space, the experts say.

“No question. Someone will come up with new ideas of how to finance, be it some form or other of limited partnership or whatever. Stuff will happen,” offers Neeb.

“There will be new capital coming in to replace some of the capital that has left the space,” predicts Guinn. “But not as much, and therefore it will still be more restrictive.”

“Frankly, if a hedge fund—where all the money is right now—wants to get into this business, now is the time,” says Parish. Yet, he adds, no matter who is financing deals, the deals will be costlier, more intrusive and require more reporting.

Hoppe is already resigned to that scenario: “With the absence of traditional financing, the traditional way of running a franchise operation will have to be reviewed. It's no longer business as usual.”


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