State of Restaurant Franchise Finance

Nov 27, 2023 | Insights, Restaurant Research

Wally just got back from Vegas where he attended the Restaurant Finance Monitor conference to escape the tyranny of raising his young children, get to a warm climate, shmooze, lose some money at the Casinos, and also take the pulse of the state of restaurant finance which he outlines in this post.

Q&A with Wally Butkus, Partner Restaurant Research LLC

Wally Butkus Headshot

1. How much financing is available to restaurant operators? How does it compare to past years?

Financing is available for strong brands and operators that have performed well during the last 3 years, although it comes at a much higher cost. Notably, banks are servicing their existing clients before new ones.

Conversely, it is very difficult for emerging brands to get financing and it could take several years for a lender to get comfortable with a brand which is why it is so important to develop relationships with multiple lenders early on.

In any case, non-bank/private lenders (including our sponsor MidCap Financial) are generally active because they have more flexibility with underwriting ratios and loan covenants, although this comes at a cost in the form of higher borrowing rates.

2. How active has the 2023 M&A market been and what is the 2024 outlook?

M&A deal flow slowed significantly in 2023 because of the large gap between buyer & seller going forward profitability expectations – reflecting extreme COGS & labor cost variability, a sharp increase in borrowing rates, and a higher level of lender scrutiny. Also, deal size is smaller than what was seen during 2021.

Fortunately, there is more optimism for an increase in 2024 M&A activity (although it might be skewed toward 2H24) as some long-term franchisees are fatigued and are now looking to exit (even at a lower multiple).

3. Are the operators looking for financing? How far would rates have to decline to get them interested again in M&A?

Some lenders are encouraging their borrowers to hold off on taking on new debt until rates come down – that is unless it’s absolutely necessary or represents a great opportunity. Further, new unit development could be adversely impacted over the next year because of current lending tightness and an elevated construction cost environment which is prompting some operators to push back on their existing development requirements.

Lenders expect rates will hold at the current level for the next 6 to 12 months before easing. In any case, the current high-cost operating environment means scale is more important than ever for franchisees.

4. How are the banks doing?

Many of our clients have indicated that the last 2 – 3 years have been the most challenging in their entire careers. This is partially attributable to a sharp increase in bank regulator scrutiny since the Signature & Silicon Valley Bank failures in March, including an increased focus on bank ratios and higher reserve requirements.

While several banks currently have their lending program “on pause”, they are actively working with other banks who are open for business to help get their clients financing.

In any case, the syndication market is challenged by a significant decline in the pool of participating banks which has led to higher spreads needed to incentivize participation.

Lenders are now looking at the entire borrower relationship to increase their overall return, including ancillary services such as deposits, payroll, treasury services, corporate cards, and 401k plans.

5. Are their restaurant loan portfolios performing well?

While bankers have been closely monitoring their portfolios over the last 18 to 24 months, QSR franchise loans have been holding up well. In any case, bankers are watching consumers closely to assess the impact of higher interest rates on their discretionary spending. Fortunately, restaurant spending has proven itself to be more resilient than other discretionary categories, which reflects that many consumers who are not adept at home cooking have grown dependent on eating out (which also represents an affordable luxury).

Thanks Wally!

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