Rob Hunziker with Advanced Restaurant Sales
Re-imaging has long been an intimidating word for franchisees of top tier franchise companies. The cost to re-image a single restaurant ranges from $50,000 to $800,000 or more in the case of a scrape and rebuild requirement. The franchisor would like the franchisees to believe that the “investment” in reimaging will result in a positive return on investment (ROI) going forward. Recently, franchisees and lenders have been questioning that “truism.” Below are several potential scenarios for franchisees faced with imminent re-imaging issues and possibly some solutions.
Scenario 1 – Strong franchisee, ample cash flow at the unit level
Re-imaging expense is not a major issue because the primary lender is usually happy to finance the cost in anticipation of improved sales and cash flows after the re-image is completed.The only gauge the lender will normally examine is the fixed cost coverage ratio (FCCR), which uses the restaurant’s projected EBITDA, after re-imaging and divides it by its anticipated fixed costs (including lease expense and note payment). As long as the FCCR is above the minimum acceptable level of the primary lender, financing should be approved
Scenario 2 – Franchisee in good standing, minimal cash flow at the unit level
Franchisee has to make a determination whether the continued good standing with the franchisor is more important than possibly going into a negative cash flow after debt position at the unit level (if the re-imaging is not completed by the franchisor mandated deadline, the franchisee is technically in default on the franchise agreement). The risk is that the additional financing costs may not be offset by improved cash flow as a result of the re-imaging. If the decision is made to go forward with the re-imaging, the lender may require additional collateral or a personal guarantee on the new loan. This could potentially lead to further problems if the cash flows go substantially negative. The positive side is that the re-imaging creates adequate cash flow to offset the additional note payment.
Scenario 3 – Franchisee hanging on with franchisor, negative cash flow at the unit level
Franchisee needs to assess the potential improvement in cash flow from the re-imaging to determine whether there is a reasonable probability to emerge with a positive cash flowing restaurant after debt payment. If not, the cost of selling or closing the unit should be explored. If it is decided to go forward with the re-imaging, financing can most easily be obtained from the primary lender because they will likely want to protect it investment. A loan from a new lender would be contingent upon the franchisee’s ability to present a positive pro-forma analysis of the unit after the re-imaging is completed. A track record of sales and cash flow improvements after re-imaging by other franchisees will present the best argument to the lender. These results should, hopefully, be available from the franchisor. If the decision is made not to go forward with the re-imaging, the risk is that the franchisee goes into default with the franchisor. At that point, the franchisee is at the franchisor’s mercy in terms of monetary penalties, being disenfranchised, and the ability to sell the unit.
Scenario 4 – Franchisee is examining the possible sale of unit(s) requiring re-imaging
Franchised units are sold in today’s market based mainly on a multiple of rolling 12-month EBITDA. At the time of sale, if the re-imaging is currently due and has not been completed, the buyer and seller need to come to agreement on who is responsible for those costs. The argument for the current franchisee (seller) is that the reimaging will “pay for itself ” and the buyer will receive the cash flow benefits of the re-imaging, so the Buyer should be responsible for the costs. The argument for the buyer is that the re-imaging needs to be completed before the franchise agreement can be transferred in good standing. Therefore it should be the seller’s responsibility. If the seller believes that cash flows will improve as a result of the re-imaging, seller should complete it and hold the unit(s) for several months to derive a higher price. A compromise of the above arguments can be arrived at if the seller can present hard evidence (franchisor compiled results, post re-imaging) of improved cash flows. A pro-forma analysis based on those results, acceptable to the buyer as well as the buyer’s lender, is the best method for determining who pays for re-imaging. If the pro-forma improvements in cash flow don’t increase the value of the unit enough to cover the re-imaging costs, then the seller should contribute part of those costs. There also should be some discount on projected cash flows for the risk taken by the buyer, in case those cash flows don’t improve. In summary, there should be some contribution by the seller for re-imaging unless the valuation resulting from the pro-forma analysis improves by substantially more than the re-imaging cost. If there is no proof of (or significant argument for) cash flow improvements as a result of the re-imaging, the seller should be responsible for those costs.
Rob Hunziker is principal with Advanced Restaurant Sales,
which is involved in the sale and leasing of franchise and chain restaurants
of all concepts nationwide that are available for acquisition and
merger. You can reach him at (678) 229-2384 ext. 2, or by e-mail
at rhunziker@arsales.biz.
