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Weekly UpdatesFranchisors face a dual challenge in these uncertain economic times--ensuring their organizations are financially viable and providing support to struggling franchisees. It would be wonderful to have a standard formula for addressing financial issues within franchisees, one that field support could be trained to roll out broadly. Unfortunately, as much as you'd like to have a "one size fits all" approach, it just won't work. To be effective and efficient, you'll need to tailor your approach to each specific situation.
Context
The current global banking crisis has made financial stress a hot topic. The reality is that it is always an issue; franchisors will always have under-performing operators. The difference is that, in these economic times, the number of problems to address will increase.
The economic environment creates a number of additional challenges. First, many franchisors have access to limited resources. Under any circumstances, workouts can consume tremendous resources: time, money and attention. As franchisors wrestle with their financial challenges, their resources are even more constrained. Because of this, franchisors should consider engaging outside help. There are plenty of firms that specialize in the financial and legal aspects of workouts and restructurings. If that's not an option, then at least establish a separate process and committee to handle workouts.
A second challenge is the pressure on the net-unit count. The more difficult it is to open stores, the more pressure there is to maintain existing units and royalties. This pressure may tempt franchisors to negotiate terms that would never have been considered in a "normal" environment. Finally, many lenders and vendors are quicker to pull the trigger when rent or accounts receivable start to age. If a unit loses the cash flow benefit of 30 terms, the financial impact can be disastrous. As a result, the franchisor needs to pay close attention and react with more urgency at the first sign of financial distress.
Mindset
It's important that franchisors approach distressed situations with the right frame of mind. Often there are strong emotions all around, and the right attitude is the first step to a successful resolution:
* Look forward, not backward. Its tempting to debate the cause(s) of the financial distress and to place blame. While it is instructive to conduct a full autopsy when the situation is resolved, franchisors should avoid the temptation to spend too much time looking backward. You can do this later. The early stages call for swift action and a forward-looking perspective.
* Build a bridge to dry land. Think in terms of building a bridge from today's dilemma to a future state where the problems are resolved. If a situation requires deferring royalties or delaying a re-imaging, then be sure that the time and cash are sufficient to resolve the situation. A franchisor can immediately improve cash flow by deferring royalties, ad funds or capital projects. However, there must be a clear, credible path to a more permanent solution. It's often helpful to think in terms of an investment. What do you expect to receive in return for the investment you are making now? If there's not a compelling answer, then you may just be buying time (instead of resolving the issues).
* Remember that you're in this together. In most distressed situations, all key parties are required to cooperate to reach a permanent solution. The franchisor, franchisee, lender, property owner and vendors each play a distinct role. Despite the natural self-interest that each party has, it will be critical to realize that all parties are necessary and past differences must be set aside.
* It is their entire world. Many franchisees have the majority of their wealth or savings invested in the unit(s). A franchisor has a portfolio of locations and franchisees, and for the franchisee, this may be all they have. Franchisors should expect a high level of emotion and approach the situation tactfully, but firmly. Franchisors should also realize that due to the level of personal stress created for franchisees in these situations, they make what appear to be irrational decisions. These decisions could be purely emotionally based or they could be rational from the franchisees viewpoint. If the franchisee knows he risks losing everything, he may be willing to make decisions that a franchisor would not make.
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Approach
At the first sign of financial distress, the franchisor should engage with the franchisee and consider the following three-phased approach:
Phase I: Determine the root cause. Multiple symptoms can raise the concern of financial distress. Sometimes the franchisee will raise an issue. However, many times, they will not. The symptoms include delayed royalty, rent or ad fund payments. Franchisors should not stop with the initial symptoms, but instead need to dig beneath the surface:
* Is there a unit level cash flow gap?
* Is there a system problem due to new accounting firm?
* Is there a balloon loan payment?
Also, realize that the issue may not be with your concept. Franchisees often have multiple concepts and diverse investments.
At Church's, we've seen otherwise healthy restaurants get into distress because of problems with a separate brand with a shared franchisee. It will be important to get a full financial picture of the situations. This includes an integrated balance sheet and consolidated P&L for the entirety of your franchisees' businesses.
Phase II: Conduct triage. As quickly as possible, sort the unit(s) and the franchisee into one of three categories: wounded, straggler, terminal:
* Wounded: These units are experiencing distress, but have a reasonable chance of being cured. For wounded units or franchisees, you should act quickly to stabilize the patient and begin treatment of the root cause.
* Stragglers: Sometimes there are franchisees who just don't want to run your concept or to receive assistance. For a workout process to have a chance, the franchisee must be ready, willing and able to improve. If not, then a franchisor should swiftly and professionally assist the franchisee to exit the system via sale, transfer or re-acquisition.
* Terminal: Unfortunately, there are situations that are beyond help. As hard as it is to admit defeat, there are times when a franchisor should help the franchisee face the brutal facts. At this point, there are still things a franchisor can do. If it's the unit that is terminal, the unit might be relocated. If it's the balance sheet that's terminal, the franchisor can facilitate a sale or transfer or even re-acquire the location. The key here is to know when to say when and take appropriate action.
Phase III: Follow a consistent, but flexible process. The process should be consistent enough to avoid accusations of favoritism or discrimination, but flexible enough to deal with the variety of situations a franchisor is likely to face. At Church's, we've established a simple "decision tree" process:
What is the cash flow potential? Is the location living up to the revenue potential? Great analytical tools are available to assess site potential. Even if fancy analytical tools are not available, franchisors can use comparable locations as a guide.
What are the opportunities to build sales? Is it operations, pricing or competition? Adding revenue may not a cure all, but it sure helps many issues and creates breathing room.
What are the margin opportunities in the unit? Benchmarking can be extremely useful. If average margins will fix the situation, then there's a good chance of success. If only the highest margins in the system work, then other actions will also be required. Franchisors should look beyond gross margins and labor costs. We've found significant cost savings opportunity in areas that receive less attention like pest control, cleaning supplies and landscaping services. In addition, a property owner who knows the seriousness of the situation is often willing to negotiate. Some rent is better than none.
Are there other sources of cash beyond the unit-level? Will a lender allow interest-only payments for a period? Will a vendor extend terms? Are there personal or business assets that can be liquidated?
Is the infrastructure sufficient to return to health? Making change is hard. Does the current team have the skill and motivation required? Do the current systems provide timely, accurate data to track progress? Are the cash management processes adequate? Building sales or improving margins will not build cash if there are leaks in the business.
How will you know that things are on track? All parties must agree up front on milestones in the process, trigger points that signal a need for a change in course. Franchisors should consider creating a 100-day-plan that highlights key milestones and clarifies who is responsible for what.
Specific suggestions
Here are some tactical suggestions to consider as you make your way through the process:
* When possible, have a Plan B. In financially distressful situations, it can be difficult to predict what you will find as you peel back layers of the onion, and you can't control the behavior of all parties involved. Consider more than one option to solve the problem if possible.
* Get a waiver and release from everyone as your standard process.
* Consider deferring rather than waiving royalties. Once they are gone, they are gone for good. If the business improves, having an opportunity to recapture even some of the royalties will increase your return on investment.
* Bankruptcy has its place, but it is not a silver bullet. Make sure you understand the issues bankruptcy will raise when you consider it as a solution.
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