Season 2 Episode 8: Liquidity and the Lending Market: Post-COVID-19



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Welcome to The Restaurant Boiler Room, season two, episode eight. I'm your host, Rick Ormsby, Managing Director at Unbridled Capital. Today in The Boiler Room, we will be infusing a recent webinar with John Hamburger, President of Franchise Times. And we'll talk about recent updates to the franchise industry, and particularly what is going on in the lending market for M&A acquisitions and franchising right now.

The Restaurant Boiler Room is a one-stop shop for multimillion-dollar merger and acquisition activity, and financial complexities affecting the franchise restaurant industry. We talk money, deals, valuations, and risk, delivered to the front door of franchisees, private equity firms, family offices, large investors, and franchisors on a monthly basis. Feel free to find out content at Unbridled Capital's website at

Now, let's enter The Boiler Room.

Well, hey, everybody, this is Rick Ormsby. How are you? It's a great day today. Thanks for joining. One of the things I'm really excited about today is we went out into the marketplace and reached out to probably somewhere around 30, no, 25 national lenders and really put together a nice little survey, and got their thoughts on the lending market right now and what they see the future will be, both kind of a qualitative view of the market and also a quantitative view, kind of what rates should look like and what lease suggested leverage will look like, and how it will all change. And so, I'm hopeful that that'll be a nice takeaway for you from listening to this. I haven't seen anywhere where there's been kind of a wide-scale survey of franchise lenders yet. So hopefully that'll be valuable to you, and that'll be kind of the meat and potatoes of what we talk about. We'll make that most or a lot of our discussion today.

A couple things I'll say. Number one, really super pumped to hear a lot of my friends and clients, a lot of you who may be on this webinar talking about a return to health of your business and really some really exciting sales in P5, and for those other of you who are on a monthly system, through the end of May. So the month of May was really a good month. I heard a lot of our QSR clients, the large QSR clients, are telling me their sales are up somewhere between 15% and almost 40% year-over-year for P5 or the month of May. And this is spanning across most types of brands, not just pizza, or chicken, or tacos, or burgers, but across really lots of the brands. So I'm really excited for you guys.

And for those of you who aren't participating in it yet because you're mostly a dine-in concept, or you're a fast casual concept, just hang in there. I don't know what life is like in your area of the country, but we're seeing a lot of people, a lot of foot traffic around in our retail centers now. So, keep hoping and praying for a great recovery. And for those of you who are doing well, man, bank that cash flow while you can, and congratulations for it.

The next thing I wanted to do is, I wanted to mention quickly, those of you who know me, Rick Ormsby. Unbridled Capital helps people buy and sell companies and raise money for their companies. And so, if you have any interest in joining our database, go to, and there's a little yellow box up at the top right, and you can click and join our database. I'll tell you, with the positivity kind of sort of returning to the market in kind of a trickling format, it looks like we're going to be kind of announcing two or three, maybe four new M&A assignments in the next probably 30 days or less. A couple of 50 to 100-unit deals in the pizza space. A chicken brand deal that's probably going to be 10-ish units. And then also a fast casual brand in the Southeast that's kind of the largest franchisee in kind of a tier two, tier three brand, I think.

So, a couple of really interesting deals coming out now, so sellers are kind of returning to the marketplace. We're also doing two Taco Bell recapitalizations right now. We're helping people find new depth for their business, to either buy all partners or just to refinance an existing lender. So, that's coming back to the market a little bit too. We're excited about that. So, you guys probably, if you're doing really well, I got off the phone with a Wingstop franchisee yesterday. He was like, "Hey, man, the banks are calling me again, so I'm really pleased about that."

You can also go to our website too, before we start, Go to the top if you want to see our old webinars that we've done. So we just did one a couple weeks ago with MMB Law Firm and Derek Ball at Unbridled's office talking about PPP, the Loan Forgiveness Program, and it was really well-attended. We had over 200 questions asked in that webinar. And that one's going to be, just go to our Media section, and then the Webinar link, and you'll see our three prior webinars, and that's the most recent of the three. So please go there. I mean, I think it's just a wealth of information for your business.

I mean, all kinds of questions. Do cell phone bills count for PPP forgiveness? What happens to my retirement plan? What's full-time equivalent? All these kind of questions. I'm over the $2 million threshold. What happens? Am I going to be judged differently? How's that going to look? So, there's all kinds of technical answers to your questions. We also did one on business interruption insurance, and then one on the real estate market and the M&A market, and those are all up on the website.

And then the last thing I'll say before we start, and then I'll see if John's still with us. But we have three upcoming webinars. I'm pushing them out just a little bit because it's summertime. But one's going to be on bankruptcy. Another with Capital Spring on alternative financing methods, if you're running short and you're looking for equity for your business. And then the third is going to be, later this summer, we're going to have Mike Egan of BMO Harris Bank on the call to talk a little bit more about the Lending Market Act, middle or end of the summer, so we can kind of continue to take temperature checks every 60 to 90 days to see how the M&A market and the recapitalization market is performing and what's going on in the lending market.

So, John, are you still there?

Yeah, no, I'm still here, Rick. Can you hear me okay?

Yeah, totally can hear you. So we'll go with it then. Awesome. I'm glad you're-

I can see you, but I can't see myself on this. But go ahead.

Awesome! Okay. Well, you're a dashing young man, John, but I guess we're not going to be able to see that today. So, tell us a little bit about yourself. I'm honored that you're here. John is a founder and president oF Franchise Times. He's a name in the industry that everyone really knows and just a delightful man and a knowledgeable man. He's got a lot of experience in the industry. And John, could you maybe introduce yourself a little bit?

Yeah. Thanks, Rick, and good afternoon, everybody. As Rick mentioned, I'm John Hamburger. I'm the founder of Franchise Times Corp. And we publish Franchise Times Magazine. I'm sure you've seen it. We also publish the Restaurant Finance Monitor. That's where I spend most of my time, is on the Monitor. And then we have another publication called Food Service News and Food on Demand News. And we produce a couple of conferences. I'm sure some of you have been to our Restaurant Finance and Development Conference, which is in November in Las Vegas every fall. So that's me. Thanks, Rick.

Yeah, totally, John. And thoughts go out to you, brother. Prayers, too. I know you're in Minneapolis, and I know the situation there has been alarming all the way around.

It's definitely not good for business, I would say that, Rick.

Yeah, yeah. Yeah, I know it. I know it. We just live in a sad world at times, my friend, you know? But yeah, so thank you for being here. And this is going to be an interchange back and forth, and I'm excited to kind of unfold this survey for you guys. But first, we're just going to just chat, John and I are, about the temperature out there, and then talk a little bit from a broad perspective about lending in a post-COVID-19 world. And then we'll unveil this 10-question survey from the Lending Community and talk a little about that. Then we'll talk about how to get a deal done right now in this marketplace. And again, like I was talking about at the beginning of kind of the webinar here, I think things are returning to a little bit of positivity, right? I think we can all feel it, hopefully, in the market. And then we'll do a little Q&A with John, and we'll wrap up.

So, just to get a start here, I'll start off and just say, look, what I was saying earlier is, it seems in the QSR segment at least that sales are pretty substantially, I mean almost incredibly, in a lot of the QSR brands. If you're not a QSR brand, you're a casual dining brand. If you're an independent or if you're maybe a fine dining brand, or even a fast casual brand, you're not probably experiencing this level of sales. Although I hope that you're trending back in a more positive direction. But sales are up big in many brands right now, especially for May or P5. I think we see some optimism returning. I hear a lot of great stories from franchisees who've just gotten gritty and have taken this time to really kind of really strengthen their business by making good management decisions, by getting more involved in the daily P&Ls, and all the things that have to happen from an operational perspective, tackling speed of service with greater fortitude.

So, some of the things I've been hearing from the franchise community are really encouraging. Folks are really buckling down to succeed. And then I kind of just say that we have this kind of quiet, a lot of people have been on deferred loyalties, deferred landlord payments, deferred bank payments, and some of those restructuring are starting to happen, talking to some of the third parties and some of the lenders and landlords out there who are gearing up to get paid and get paid in full again. And that'll be an interesting discussion as we move that through the industry.

Now John, what do you say about all this stuff? Any comments here from you? What are you seeing?

Yeah. I'd echo that, Rick. QSR has been really strong. Drive-through windows are worth their weight in gold. It's amazing some of the chicken concepts, how well they're doing. Popeyes, Saxby's, Raising Cane's, KFC. A lot of the regional pizza concepts are really doing well. Marco's Pizza, Toppers Pizza. The question you're going to have to ask is, are these concepts just being discovered, or is this pickup in business that they're seeing here during the COVID period, is that going to continue? And then also, what happens with the dining rooms when they open?

But it does seem to me that optimism is returning. Now that the casual diners are opening up, a lot of the restaurant analysts are kind of excited. They're seeing a lift to their overall same store sales, even as their off-premise slows down. So I would say that things are looking better than they have in a couple of weeks in our industry.

Yeah, no doubt about it. Coupled with the PPP money and sales that are, in some cases, significantly above where they were, a lot of franchisees are going to have a good summer, I think.

You think about all the stimulus that's gone out into the markets. The $600 a week supplemental unemployment. The $1,200 stimulus check that went out. The PPP money that went out to businesses. The Federal Reserve has pumped a lot of money into the consumer economy, and that's why you're seeing it so much in QSR and pizza. And even some of the casual dining, I look at Outback Steakhouse Texas Roadhouse, Olive Garden, how strong their their to-go business has been. You've got to look at that and say there's a lot of money being pumped into the economy right now, and it's benefiting some of these restaurants.

Yeah. Yeah. Actually, I did to-go service at Texas Roadhouse recently. I was amazed at well-heeled it was, goodness gracious. They had, I mean, a system that was really strong and a ton of business. You mentioned that brand particularly, so, yeah, that's been-

Rick, you mentioned you went to Texas Roadhouse. To me, it's absolutely amazing, when you think about it, that Texas Roadhouse and Olive Garden, those were the two concepts that both of their CEOs, Gene Lee at Garden and Kent Taylor at Texas Roadhouse, those were the ones that had really early on dismissed delivery. Now, they were still doing a fair amount of to-go business, but dismissed that delivery aspect and really didn't promote it. It was more of an in-store dining promotion. And how well they've done and how well they've been able to pivot to that, I think, is really a testament to how energetic both their management styles are.

That's a good point, really good point. Yeah. As we just kind of keep going here, we threw down a couple points to just kind of talk about, as we talk about lending and M&A particularly in a post-COVID-19 world. Interesting times, John. First point says historic diversions in QSR especially, sales are way up, but lending is somewhat difficult. I mean, I've never seen that in almost 20 years in this business. I mean, what do you say about that? It's strange, isn't it?

It is strange, but I think what's happened is the lenders aren't sure whether this is a COVID effect, and they're kind of concerned about what happens post-COVID. So, there's this uncertainty on the part of the lenders. And if you think about this whole process, these sales in QSR, Rick, didn't start out strong right away. I mean, the first week, two weeks, three weeks, there was a lot of concern out there because there wasn't much action in anything, even pizza. You talk to the Domino's operators in the early days, there wasn't much going on. Well then now all of a sudden, it takes off with all this stimulus that's out there. And this has really kind of thrown the lenders, I think, for a loop. They're not quite sure what to think about. What are valuations going to be? What are these businesses going to look like as we get into the summer and the fall? I can understand why it's a concern on their part and why it's difficult.

Yeah. And for those of you listening, John's perspectives are really important here for a number of reasons. With the RFDC, for those of you who go every year like we do, and it's a great conference. I'll tell you, he talks to lenders almost every day, right? That's number one. Number two, lenders are notoriously squeamish about getting on a call and doing things like this. I think it's because a lot of them work for big companies that have big compliance departments. So when John and I are kind of spitballing and talking about this, we kind of are summarizing our viewpoints from talking with multiple folks. John's got a better perspective than most.

Well, tell me, I put this point up too, brand reordering, drive-through and delivery concepts are clear winners. What are you seeing there, and which brands are you really excited about?

Rick, first of all, I mentioned early on the Raising Kane's. I mean, I just can't believe the amount of business that Raising Kane's are doing through their drive-through window. My daughter lives in a suburb of Minneapolis, and I was down to see her two weeks ago, and there must have been 40 cars, 40 cars out onto the main drag going through the drive-through window at Raising Kane's. So I mean, there's a brand that I think has really taken off and is really going to take off.

When you talk about brand reordering, I think what's really interesting here is how efficient the QSRs have had to become. And I talked to a number of different operators. A KFC operator told me a couple weeks ago, he was up 8%, but his labor was down 4%. So, tremendous efficiency. And that's going to make it interesting to see what happens here. Are some of these operators even going to want to open the dining rooms? That's going to be, I think, a big question coming up in the next couple of weeks. But clearly, drive-through and delivery have been very successful here.

Yeah. I think it's a really good point, because we've seen the same thing in some of our transactions, that labor and food costs, but particularly labor costs have been significantly down with dining rooms largely closed. And the question is, how long will this amount of demand continue through the drive-through to push sales so much higher, right? We got to think that it's not going to stay that way forever. When that happens and sales drop, then maybe operators will be forced with a different decision to reopen their dining rooms. But it's easy to keep your dining room closed now because your sales are high and your labor savings are amazing. So, you're getting kind of a double effect.

I was just on the phone with one of the country's largest operators here a few minutes ago, and I think he made double the profit in May that he made last year at the same time. Wow.

Isn't that amazing? Isn't that amazing? The interesting thing, I think, Rick, is what are the brands going to do? Does the brand want diners inside the restaurants or not? Are they going to mandate that for some of the franchisees? I don't know. It's going to be interesting to see how that plays out.

When you and I were talking a little while ago, you brought up a good point that's not on here, but I'll just ask it of you again. Without naming brands specifically, you brought up this idea that certain brands that were heavily penetrated with large kind of financial disinterested buyers seemed to maybe have worse speed of service, and through the drive-through just kind of anecdotally, than maybe the ones that hadn't done that as much. Do you have any more thoughts about that? Maybe those who are on this webinar might find that interesting.

Well, that's been one of my big complaints of this whole asset light, where the franchisors were selling off stores. And it was very easy for them, Rick, to sell these stores to large multi-unit operators. And I think a number of them have gotten to the size where I don't think they run the stores as well as maybe a 30-unit operator, a 40-unit operator. Maybe an operator who's in two markets. Well, these guys happen to be in 20 markets, 10 markets. And my experience is that those stores are not run that well. And I'm not saying that everybody in that category is that way. But I'm just seeing generally, that's what I run into. And so, I think it was a financial decision. These franchisors decided, hey, this was an easy deal. I can sell off these company stores to these big franchisees. They can get financing. I don't have to carry back any paper. We can do these deals.

And I think some of them are starting to really question the size of some of these franchisees, and are they really doing the brand a favor when they don't operate them as good as some of the smaller operators? It might be easier to deal with a big operator. You got a big operator with 400 stores, it's easier than dealing with 10 operators with 40 stores. But not if that operator is not doing a very good job running the stores. And I think that's something that they're going to have to take a look at once this is all over.

It's interesting. On a prior webinar, I said this, but I said that, point number three here, the buyers are reemerging, some of them forcefully. And I really believe that. I mean, in the last couple of weeks, we've had quite a few buyers coming back to us saying, "We're ready to buy. We want to buy something. We want to buy a business." I had two calls yesterday with guys, one of them was a family office med group, and the other a bigger operator looking to get into another brand. And so, those kind of phone calls are coming back somewhat forcefully now, and people calling all the time. So, it's interesting.

And so, at Unbridled, we probably had, I don't know, 15 deals that we were working on pre-COVID. And a lot of them have come back now. And in the last three or four weeks, we've had six or seven of those deals really push forward towards buyer and seller signing a purchase agreement, or buyer and seller agreeing again to a price that might have been slightly lower or had some changes in the terms in order to combat... or a slight reduction in what the banks were now willing to lend because of the crisis. And those deals are back on, and they're all moving pretty well.

So, I'm seeing right now that valuations haven't changed substantially in the QSR businesses that we're largely representing. Now, some of the ones that don't fit the profile of heavy drive-through, quick service food, aren't doing as well.

Rick, why wouldn't somebody want to buy a QSR chain? Think about this. 2008, 2009 recession, they were stress tested. They came through fine. And now you have the ultimate stress test, being shut down for a couple weeks, forced to shut down your dining rooms. You shift to drive-through, and you're doing more sales than you were doing a year ago. Why wouldn't you want to buy that business?

Yeah. Yeah. No doubt, no doubt. The only comment you might say is, "Well, I don't want to buy it on a too high, the EBITDA numbers are too high." But everyone wants to buy something cheaper for cheaper than what people want to sell it for, so that's an age-old problem. But yeah, that's a great point. It really is a recession-resistant business. As long as gas prices don't sneak up into the $3 and $4 a gallon, it really does well.

Well, what do you think about, just before we get into the Lenders survey, any comments on loans? I mean, look, residential loans are a little bit harder to find than they were, I'm hearing. I actually know a little bit about this because I'm selling my house right now. But interest rates are really low. And we had four offers on our house in one day. PPP markets appear fluid, right, you know what I mean? But commercial loans are harder to find for sure, and selling bulk real estate is largely still probably somewhat illiquid. I mean, what are you hearing, anything different than that?

Yeah. I would say that there are still groups, though, that are interested in buying real estate. I think it is going to be, for the next six to 12 months, a little tougher to finance it, just given all the things that the commercial lenders have had to deal with over the last three or four months. It's going to take a while for that to shake out. But there's still an appetite out there for commercial real estate.

Yeah, good. Yeah, good deal. Just a little harder to find. And let's hope that it recovers so that they stay healthy and it becomes fluid again. So this is a 10-survey question. I always for some reason overestimate or underestimate the amount of work that our company does, John, because we're almost always working on somewhere between 15 and 20 deals, right? So I'm like, oh man, everybody else is too. So my first question, which obviously is not happening that way, but the first question is, how many franchise M&A deals are you personally trying to fund right now? And I think we had 17 or 18 responses. I think we had a little bit more than 25 banks that we queried and reached out to. We got about 17, 18 responses. All the big major ones that you would know, and of course I'm not going to divulge who they are or how they answered particularly. But you can see directionally here.

Kind of interesting. Look like almost 40% of them had non. They're not even working on an assignment right now. And very few of them are working on a lot of assignments. Most are just working on a handful. So I think this may be a little bit because of the tepidness of the market. But it may also be because there's not a lot of supply on the market too. I think anyone at Unbridled would tell you that we were loaded with business up to COVID. But since COVID, it's kind of gotten quiet, right? So there's not a lot of supply of businesses that are on the market right now. And maybe that's a reason why we're at that place.

And I'll go through number two, John, and I'll let you comment on both of these, and what you see and what you make of them. But the second question is, how is your bank looking at new franchise M&A loans going forward? And this is pretty interesting. It looks to me that not lending right now is probably somewhere around 20%, right? Maybe a little bit less. 15%. Looking but unlikely to lend, maybe another 15%. So maybe you've got about a little less than a third of the people, basically the lenders are not lending on this survey. You have a little sliver that are saying open and looking to take market share. Now of course, my plug for Unbridled is, I know who's looking to take market share. So if you're looking to recap your company, you should call us.

But cautiously lending for the right circumstance is clearly a majority of what we're seeing here. What do you see through this, John? Any comments?

Yeah. Yeah, Rick. That's consistent with what I'm hearing. Again, with the lenders, the two big issues are the cash flows. Are these cash flows that QSR restaurants having right now, are they sustainable post-COVID? And how do you value these companies? And I think one of the things, you think about the lending community. I mean, so many of these banks had to rally to produce these PPP loans. And there's still this uncertainty, although I think when the House passed this bill the other day, it's going to be good for restaurants. But there's still this uncertainty of this PPP loan forgiveness. That's entering into a lot of this. Cautiously lending for the right circumstance. That means the biggest part of your chart, your pie chart there, that's lenders working with their clients, their existing customers, ones they understand. And I think that there's going to be some lending that's going on there.

But when a new one comes in, you're going to get these questions about valuation, cash flows. What's the status of the PPP loan? Have you paid all your landlords? Are those up to date? It begins the underwriting process, which I think is going to take a little bit longer right now, until we get past all this COVID stuff.

Yeah. Yeah, certainly, wouldn't you say, John, and I certainly would, that whatever process you're going through, whether it's refinancing your company, or you're looking to buy out a partner, or you're looking to sell your company, or you're buying franchises, whatever it is, expect at the current time that it's going to be a little slower than it otherwise would be, because underwriting's just going to be a little bit more difficult.

Yeah, I agree.

Yeah. As we go through this survey and as we go through this webinar, if you have any questions, feel free to type them out. We'll keep our eyes peeled over here on the right and try to answer them as we go along. There's a little chat function there. And then the other thing I'd tell you, too, is at the end of this presentation, we have it recorded, and we'll send out the recording and this presentation to everyone who signed up. So don't worry about that. That'll come out probably within three or four days after the presentation.

So, here we go. Question number three. How soon will franchise lending get back to pre-COVID-19 levels? Now, it's one man's opinion, right? But since they're lenders, I suppose they have a pretty important opinion to give. So, its kind of an interesting graph. And you all on the webinar know me as an optimistic person generally. Realistic, but optimistic. And I probably would have put this, if I was voting here, I probably would have put this in the six to nine-month, maybe nine to 12-month kind of range, right? But it looks like we're pretty heavily leaning into the one to two years from now, which may be a little surprising to me. I don't know, what do you think about that, John? Does that surprise you?

Well, Rick, if I look back to 2008 and 2009 recession, that's fairly consistent with what happened there. 2007 was a big year in franchise lending, but then it shut down in '08. And it really didn't come back until around 2010. It took a full two years, I think, for lenders to get their hands around some of the workouts. They were doing the workouts on the banks themselves. And so, I think this is consistent with '08 and the '09 recession. It could change to the positive if, for instance, we didn't see a second wave of this virus that everybody is predicting here in the fall and next year. It could come back a little bit quicker. But it's consistent with what happened in '08, '09.

Well said. Just while we're on the topic of '08, '09, any other kind of things jump out in your head about things you saw then that you'd tell all of us to be aware of now? I mean, I was doing deals back then and was sitting in bankruptcy courts in Delaware, and it was a tough time towards the end of it for franchisees.

Yeah. I think what's going to be interesting here, and I think your operator audience is smart enough to figure this out, is you'll know fairly early in the process what your bank is going to be like. You could take their temperature pretty easily, I think. I remember back in '08, '09, there were a few banks that decided that this was the time they were going to take market share. And so, if you recall at the time, GE Capital was redoing a lot of loans, but they weren't making any loans. And it was a good time at that time to refinance out of GE Capital. And so, there were a number of banks at that time that saw that as an opportunity and took advantage of it. And I think operators are going to need to have that discussion with their current bank and find out what is their temperature of this industry going forward.

Yeah. And a little bit of this, John, was happening before COVID-19. I mean, we had two or three fairly decent-sized names in the space leave, or leave the space, fire everybody, one or two got bought out. And then clearly, we had whispers of a couple of the big franchise lenders saying that they weren't making any loans, any new loans, pre-COVID-19. These were just whispers, of course. But some of this was happening beforehand. And so, I'm not surprised that you have people that were looking and will look to ramp down. But the point is a good point, because several of the lenders in '09, 2010, 2011, some of them stepped in early. And the ones that stepped in early built a fantastic practice with great franchise clients. And I think that's what you're referring to.

In number four here, you've got post-COVID-19, who will you be the most likely to make loans to? And this is an interesting kind of result here. So I'm going to just kind of let you guys think on this a little bit. But the box that was checked by whatever, 65% of the people, was all of the above. So, we'll loan to everybody, which is one to 10-unit operator, 10 to 50-unit operator, and family office private equity, okay? So, in and of itself, that doesn't really necessarily mean too much. I mean, it means something. But what I think is telling in this slide is if you take that one kind of graph away, you're left with, will you lend to these three parties, but not all of them? You only have the 10 to 50-unit operator as the answer. You see what I mean? No one says, "I'm just going to lend to the one to 10-unit operator." And no one says, "I'm going to lend to the family office private equity guy." Maybe there are some learnings there.

And I would just say this. Having been in this industry for a long time since I left since I left Yum! Brands in '05, I've been watching the consolidation of the one to 10-unit operator, and frankly, been a part of it. If I went back and counted, I had 100 different one to 10-unit operators whose business I've sold. I don't know what the number is. But the consolidation has been unbelievable over the last 10 to 15 years in that smaller operator space. And I got to think that will continue, especially if there's something to be said here that a lot of lenders aren't going to be focusing on the one to 10-unit operators anymore.

So, any comments that you see there?

Well, the one thing I would say is the banks have always liked those 10 to 50-unit operators because generally, they've got a growth mindset. And the bank can grow with the 10 to 50-unit operator. The family office, the private equity, they tend to be a little more transactional. But that 10 to 50-unit operator, they really like. I mean, look, they're in the business of lending money. They're going to look at all these different business types that own and operate these restaurants, so.

You think there's a case to be made for a little bit of a breakup of some of the large groups that are out there? We're going to see it in certain brands and certain groups, 100% for sure. But the 10 to 50-unit operator, you and I have both always loved, because they're the guy that hopped in his pickup truck and started store number one, and then built store number two and store number three. And he may have 28 units in Omaha, Nebraska and still knows the local band and the local football team and those sort of things, and is involved in the community. People like that type of an operator. You think that will go away going forward, or do you think that will, in terms of the 10 to 50-unit operator, you think there'll be more of those types of folks as maybe the larger deals may unravel a little bit?

I think it's ultimately going to be up to the Wall Street investors in the big brands. There was a sense early on in this crisis that some of the big brands were in trouble in terms of the financial wherewithal of some of their franchisees. I'll use an example, Pizza Hut and NPC International. NPC is the largest Wendy's franchisee. It's the largest Pizza Hut franchisee. The questions coming out of Wall Street a day after COVID and the day after the shutdowns is not so much, is NPC going to survive, but how's this going to impact the franchisors collecting their royalties? I got a lot of calls from people wanting to know, what's the financial condition of these large franchisees? And if that were to turn into a situation where there were some large royalty defaults, I'll bet you money the franchisors are going to go back to saying, "Hey, we'd rather have the 10 to 50-unit operator and split it up a little bit and diversify our risk a bit."

You look at some of the big brands, look at Wendy's. I mean, they've got a lot of big, giant franchisees. And I'm sure that they're looking at that right now. They're taking a look and saying, "Do we want that kind of risk with the big operators?"

Yeah, no doubt. And it's the old M&A thing. I used to liken almost every analogy back to basketball because I love basketball. But remember, John, if you're a basketball fan, back in the day, you'd look at Bill Russell or Bob Cousy, and those guys had short shorts and tall socks, right? And then we get into the early 2000s, and you have short socks and baggy shorts, right? And then now, we have short shorts again and medium-length socks on the basketball court, right? So, things just go back. They just constantly change. And you see things getting broken up and putting back together, and the M&A market's kind of the same way. You see the five to 10-unit operator going away, and then maybe you see the 10-unit operator coming back, I'm not sure.

But I do think the financial complexities are just going to continue to overrun the smaller operators. And while the marketplace is strong, they've just taken advantage, frankly, of crazy high prices on their businesses in a good way.


And that's what been part of this M&A boom over the last four or five years.

To your point about how things change, I can remember back in the '80s and early '90s when the franchisors were buying back franchisees.

Yeah, right.

They could buy them back, and they wanted to have as many company stores as they could. Well, then that changed, and you saw what happened here in the last 10 years with them selling the company stores to franchisees. So there could be something that would make them want to buy them back. I don't know what this today, but you never know.

Necessity, maybe. Who knows? Yeah. [crosstalk 00:35:50] Who knows? But let's go on here. So number five is, what segment of franchise lending will your bank most favor going forward? I thought this was kind of interesting. So the first one, the little green one here, is a really low number. These are highly leveraged top-tier QSR brands. Tacos and a few burgers chains as examples. So, I mean, these are the eight-and-a-half times Taco Bell deals, right, and the seven times Wendy's deals. These larger, highly leveraged, high valued deals is what I was trying to ask from lenders, which frankly have been the ones dominating the stage over the last couple years. Look at how low that number is.

And instead, you see a lot here in the middle, which is mid-leverage legacy QSR brands. I mean, I know that's kind of a vague comment. But I was trying to kind of approximate, I don't know, an Arby's type of chain. Have its good positive momentum, but a legacy brand with a lot of locations. And then you saw here a mid-leverage QSR brand with resurgence, like some of these pizza chains, like Pizza Hut or Papa John's, where sales are through the roof now, or some of the chicken chains, like maybe KFC of Popeyes, or maybe, to your point, Raising Kane's or some of the others. Interesting. What do you make of that?

I think the lenders are pretty smart. I mean, you look at some of these highly leveraged deals, they're not anxious to get involved in those. They have their underwriting standards that they've been following and pretty good about it. And the stress deals, that always comes with a lot of hair too. You've got to believe in the turnaround. And that's a big leap of faith for a lot of commercial bankers.

No doubt about it. Well, if you're in chicken, pizza, or a Sonic drive-in type of concept, I mean, I just think it's good news for you particularly. I just think you're going to get a lot more attention than you have in the past and more capital put towards you, which is ultimately going to be great for your brand and good for Unbridled and our clients, right, who are buying and selling these companies. The highly leveraged deals that the lenders don't appear to be wanting to favor going forward, they're just going to need more equity to transact at the same multiple as before. Good news is, for brands like Taco Bell, there's buyers willing to stand in a line for two years, right, to buy that type of a business because they want to get in the brand so much. And they'll just necessarily have to sacrifice a little bit on their returns and increase the amount of equity they put into these transactions, which, no surprise there, no surprise.

So, around post-COVID-19, how likely will it be for your bank to lend to a casual dining brand? This one surprised me, John. So, it's a pretty evenly broken out pie chart here, with a lot of people saying somewhat likely or likely.

I'm really surprised by that too, Rick. The banks have really spent the last five years, I think, kind of working their portfolios away from casual dining. To say likely if a good well-capitalized operator comes along, there are a lot of good well-capitalized operators in casual dining. It's not like everybody out there is over-leveraged and suffering. I know a number of operators who own their own real estate, very low amounts of debt. They're going to come through that. So that little green sliver on the pie chart looks like that would be an okay choice for them.

Somewhat likely, that's kind of like saying maybe. Okay, I don't want to offend you by saying somewhat unlikely, so I'll say somewhat likely. It depends on the deal. So there's not a lot of action here if you look at this for casual dining.

Yeah. Interesting. Interesting. All right. So, number seven. What part of the loan process will get the greatest increase in scrutiny from your risk department? I just threw four kind of random items out here. They weren't necessarily correlated. There's a million different things. But I just wanted to see what kind of feedback we got. So, in other words, if I, the borrower, am coming to the bank, what's the bank going to be most concerned about with making me a loan, of these four items? And it was a pretty even breakout, really. But personal guarantees took a bump up from what maybe I would have expected. I put it on there because I figured in the environment that we're in, bankers are going to want more collateral, and they're going to want more guarantees. And personal guarantees, in a frothy market, where largely things are going away for decent-sized loans, right? So it's interesting, a little bit, to see that.

The leases, I put that on there because obviously, lease scrutiny is going to be bigger going forward. Your relationship with your landlord and the security of the lease that you have, those are going to be important items to receiving a loan from a bank. Any comments there, John, that you see?

Yeah. The one, Rick, on personal guarantees always pops up in a downturn, when you're coming out of a downturn. And then it goes away as one or two banks decide they don't want the personal guarantees, and then it becomes less of a factor. So, I get that. I think leases is an interesting one. I think that's going to be something where I think operators are going to have to, as part of their pitch to the lender or their underwriting package, they're going to have to explain those leases that they have, and what are the bumps, and what are all the additional charges in there? I think that's an interesting one.

Yeah. I agree. Number eight's what's the primary metric you use to make franchise loans? So, all of the above. We put three metrics here. Straight leverage, which is just debt to EBITDA, basically. Fixed charge coverage ratios and lease-adjusted leverage. So, you hear a lot about lease-adjusted leverage in the marketplace, right? But if you look at the pie chart here, probably twice as many lenders were focused on fixed charge coverage ratios principally before lease-adjusted leverage. So that's a ratio. And for those of you who have to do government reporting with your banking or with your lenders, you're probably calculating your pre- and post- fixed charge coverage ratios. So those become important for not only getting a loan, but also servicing, having your loan serviced with a lender. Lease-adjusted leverage is obviously a big term we continue to hear in the M&A market a lot.

And then we see that most lenders look at all three. What do you hear? You hear about the same thing, I'm sure. Well, as you're talking about lease-adjusted leverage. But the fixed charge coverage ratio's a big ratio that lenders look at.

I've always, Rick, looked at the lease-adjusted leverage as a way to kind of stretch an M&A deal. The fact that they're looking at straight leverage, fixed charge coverage ratio, all of the above, means that they're underwriting and they're sticking to what they want here. That's what I would say.

Yeah. And I think lease-adjusted leverage has typically in the past several years has been somewhere between five-and-a-half and as high as six times. And someone might correct me if I'm wrong on the webinar, but I believe just off the memory, it's eight times rent plus total funded debt divided by post-G&A EBITDAR is how you calculate lease-adjusted leverage. And so, what you end up doing for M&A transactions is you would assume a lease-adjusted leverage of whatever the number is. Let's call it 5.75. And you know what the rent is, and you know what the post-G&A EBITDAR is. So you solve this little seventh grade equation for your total funded debt. And that becomes how a lender looks at how much money they're going to advance to a client in an M&A transaction.

So it's really pretty simple. There's just a couple of formulas. Of course, guys like me and companies like ours will then attack the EBITDAR number to try to get the EBITDAR number, justify a pro forma EBIDTAR number as strong as possible to get the total funded debt as high as possible. And then we go to the marketplace and talk with various lenders to try to get the highest amount of lease-adjusted leverage. So instead of a 5.5, we might be looking for a 5.85 from a lender. And all these little numbers come together to help an M&A transaction get funded with less equity. And less equity obviously means more of a return for the buyer, the family office, the private equity group. And that's what drives the investment in the franchise.

So, number nine. Compared to pre-COVID, what's your expectation of lease-adjusted leverage reduction? And I've been kind of talking about, in a prior webinar, I thought it was going to land somewhere in the 35 basis points to 50 basis points range. That was kind of my guess three or four weeks into COVID-19, actually. And if you look at this, if I was going to average this pie chart, it's going to probably look like it's somewhere in the 45, 50 basis points range, is what most lenders are saying. So that's pretty consistent with what I'm been saying too. It's pretty substantial.

If you look at a lender, going from a five-and-a-half lease-adjusted leverage to a five lease-adjusted leverage, that's essentially a 10% reduction in the amount of money they're going to lend you. So it's like if you're buying a car, and the lender says, "Hey, put down $5,000 and I'll finance you $25,000 for a $30,000 purchase price," well now they're essentially saying, "Give me $8,000, and I'll finance you $22,000, you see?" Maybe those numbers aren't exactly right. But the idea is that is just becomes a little bit more equity to get the deal done.

Any comments on that or number 10, John?

Yeah. Just on number nine, Rick, there's nothing wrong with a little more equity in some of these restaurant deals. I think we're always late in the cycle stretching everything. As a lender told me, it's okay to pay your loans down. And you don't always have to stretch to get exactly the last penny that the lender's going to borrow you.

Where do I see rates setting in in the next one to six months? One of the things that's happened during COVID is that rates have gone from, the 10-year Treasury has just collapsed. The Fed funds rates are near zero. So I think what we're talking about here are the spreads are going to be a little higher, just for risk purposes, until the lenders come to grips with what's going on, and the valuation, and COVID cash flows.

Yeah. Yeah, absolutely. Absolutely right. I probably should have clarified that, whether I thought the increase was going to be because of the economy or because of the premium, the risk that the lender is going to take. My guess is you're right, it's the second. And basically they're saying, "Okay, interest rates are low. But even though they're low, I'm going to charge you a point higher because I'm scared" kind of thing.

Exactly. Exactly. Yeah.

Well, I'm going to take it off of the screen share for a minute, because I did see we had a question, so let me see what that question is, and then we'll jump into it. The banks will do a terrible job at managing portfolio risk. The better route of diluting systemic risk might be a portfolio of more smaller deals rather than few big deals. Same for franchisors. Look at the Domino's portfolio. Interesting. Interesting. But the pushback to that would be, if you're too big to fail, you know? But yeah, right, right. Risk is a lot lower when you have a well-diversified portfolio versus investing your dollars, your loan dollars, into just one or two investments, right? Yeah.

The only thing I would throw in there, Rick, is that it costs the bank just as much to make a $50 million loan as it does a $5 million loan. And that's why you see them pushing towards the larger amount.

The same reason why you see franchisors wanting consolidation in their system, right?


It's a lot easier to administer a franchise when you have five franchisees owning 200 units each than it is with 100 one-unit franchisees, right?


Yeah. Absolutely. Absolutely. Maybe now I have to take it off of screen share to see a question. That's another question here. No, no second question. Okay. Back to the screen.

So, just a real quick one. I'll run through this real quickly, John, and then I want to spend the last 10 minutes or so with kind of asking you questions. So, how do you get a deal down right now? I think lenders are backing up buyers with strong balance sheets, right? I mean, that's going to be clear. A good buyer is going to have lots of options. But maybe the questionable ones will be harder to finance. More equity is probably needed. We're seeing that on several of our assignments, where our buyers are having to come back probably with maybe 5% to 10% more equity than they were before, even if the purchase price is squeezed a little bit. Pricing, in our deals, at least. I mean, we're probably going to try to do $750 million of restaurant sales this year across maybe 20 transactions. Now, that may not be that high after post-COVID. But just to give you a view of the scale of the deals that we're seeing, we're just seeing minimal price drops, except for in brands that have really, really struggling sales that haven't been able to come back. And largely, those deals are still on hold.

We see some seller financing in our deals. The seller in another deal, the seller was selling a lot of real estate, and now they're going to keep it. We're working through a couple of conversations where buyers are proposing earn-outs to try to meet a gap between what the price was and what the price is now. And there's going to be alternate financing structures. And you'll see groups like our friends at Capital Spring. They become really pertinent when the lending market becomes less fluid, and they do a great job in what they do. But you'll see other kind of alternative methods of financing deals kind of step in. And we'll talk a little bit about more of that with Capital Spring in a couple of weeks.

And then I just think you need patience and perseverance. It's not going to be as easy as it was. It's just not going to be as easy to find the money or find the buyers or find the sellers because there're not going to be quite as many of them as maybe there were before.

But all in all, I say all that, and I tell you, I hope my temperature here is pretty warm, because I'm pretty positive about where we are in the industry. And maybe you all who are on this webinar don't agree with me. But from our standpoint, in terms of the momentum that's come back to the industry, the M&A, the QSR especially, M&A space, I'm mildly bullish at this point that we're going to have a pretty strong fall and a pretty health fall, too.

Any comments there, John?

The only thing that I would add in there, Rick, is that if this continues, if the QSRs and the pizza and this continues through the summer, and we start to see the casual dining, some of the family dining opening back up again, and if that doesn't impact the QSR space, then I agree with you. I think that a month worth of activity with some of the casual and family and fine opening up. And if that QSR remains strong, I could see quite a bit of deal-making being done this fall.

Hm. And the other side of what you're saying is it may not stay that way. QSR may go back down to where it was, right, and [crosstalk 00:51:25].

Yeah, that's going to be the big question post-shutdown. What happens to those volumes? They go back to pre-COVID? That doesn't mean that you're not going to have deals in the fall. It just means the valuations and the lenders are going to come to grips a little bit differently with those valuations, so.

Yeah, sure. We have time for probably a couple of these questions. Any of them are favorites of yours or ones you want to address, maybe, before we wrap up here?

Yeah. Let's see. Let's look at this here. Will private equity family offices thrive or go away? Rick, when you and I were talking last week, you were talking about partnering with a good operator. And is private equity and family offices going to thrive or go away? I think they could thrive if they partner with a really good operator. And they need to make a change, though, I think, from what they did pre-COVID. And that's, they need to put enough equity into these deals to run them for the long-term. And I think there are a lot of PE companies, mainly brands, not so much franchisees, they like the leverage. And they levered them up like some of the PE firms have done in the past 10 years. I'm not so sure. I'm not so optimistic about them thriving. But if they partner with a good operator-

Hm. Interesting comment, yeah.

... they put enough equity in to run these [crosstalk 00:52:48].

Do you want to tackle one other question here? What else do you see? Any brands that you see emerging as big winners from this?

Yeah. It's interesting, on the brands. I'm thinking of a couple of regional pizza concepts that have sort of emerged. One is Marco's Pizza, that's based in Toledo, Ohio. I was talking to their CEO a couple weeks ago, Jack Butorac. The last four or five weeks, they've been up 20% to 25% in sales. These are kind of regional pizza brands. Toppers Pizza, which is based in Wisconsin. These are some brands that I think, through the crisis, were able to really hone what they're all about. I'm thinking of a concept like Huey Magoos. A small little brand down in Florida turned compositive a couple of weeks ago. Salsarita's, a small chain owned by a friend of mine, Phil Friedman.

A lot of companies have found their way during this COVID crisis, where you take a look at family dining, fine dining, casual dining. They've been hobbled. They've had to work to try to do to-go, but there's not that many success stores in there, where some of these fast casual and some of these regional pizza, regional QSR have been able to find themselves during this COVID crisis. And I think those are the ones that we want to keep an eye on going forward.

Really nice. I've been heavily focused on QSR. Those are really good examples of different types of concepts that are succeeding, and it's a really thoughtful comment, so thank you very much. John, I just appreciate your time. I always love the Restaurant Finance and Development Conference and all the material you put out through the Monitor, which we love and read every year, or every month, I mean, and also the Franchise Times publication that you do. You guys do a great job. And I'm honored to have you on the call. For everyone who's on the webinar here, this is our information. If you have any questions, please feel free to let us know. Here's a little disclosure.

Before I go, I'll just take it off of the stop share, and I'm going to if we have any more questions or comments. We did have one more. What will franchisors do differently now? Do you see more franchisors active in taking back stores or developing operating capability if equity light? And that's a really interesting comment, so thank you for that comment. Yeah, I've seen this before. And basically, the model went like this. Back in the recession, back in the great recession, you saw people coming back, and franchisors were buying out of necessity, right? And the person who asked this question knows the brands that did this. And one of them particularly, they came in out of bankruptcy when buyers did not emerge to buy these businesses, and they took them over. They remodeled them. They shut down the bad stores. They changed the asset type. And then they refranchised the stores when they came out of bankruptcy and when the market got better, and there was now a fluid M&A market.

So, that was the playbook for a lot of the struggling brands. A lot of the good brands, of course, held on to their stores. And then they waited until 2014 when things started to heat up, and then they were the ones who sold their stores in high quantities and in a rapid fashion to these young family offices in New York with the Harvard MBA types, right? So, that's kind of the playbook that happened to make it asset light. I think the playbook is probably the same for struggling franchisors. If they have a bunch of stores in the hands of franchisees who aren't doing well and they ultimately work them out, work them out, work them out, and there's not any buyers that emerge from them, then I think you'll probably see a franchisor step in as a last resort. No one wants to reduce their footprint. Although COVID-19's given people the firepower to go to the street and explain why that would happen.

But I don't know that I necessarily see some franchisor taking advantage and buying back stores. I mean, there are a couple of brands that do have decent company ops. Arby's comes to mind, right? Over half their stores, I believe, are company-owned. I mean, they come to mind as someone who might continue to build and to grow and maybe buy some franchisees out. And there are several other examples as well. I don't know if you have an answer to that, John.

Well, I think, Rick, in the first three weeks of the COVID shutdowns, I think they were probably thinking, how many of these stores we're going to have to take over. But as sales have picked up strongly through April and through May, I think it's probably less of an issue. And you are right. I mean, Arby's, you take a look at Arby's, Wendy's, they have the capability of picking up these stores.

I think what the real asset light operators would say is, look, we've got the ability to put these stores into a large franchisee. We can move them around. And we don't have to actually take them over ourselves. So, that's going to be the argument of the real asset light franchisors. Fortunately, the sales have picked up strong here in April and May, and there'll be a number of workout situations that they're going to have to deal with. But I don't think it's going to be as bad as it looked like the first couple weeks.

Yeah. Clearly so. Well, I really appreciate your time, John. It's an honor talking with you. Thank you, everyone, for attending today. Reach out to us any time again. In closing, we'll send out this webinar and the presentation in the next few days. And reach out to either John or I if you want to chat any time. We'd be honored to chat with you. So, John, thanks a bunch, and see you guys.

Thanks for inviting me.