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Topics: Franchisors

What your FDD says about your brand to a lender

Franchise Disclosure Documents are essential to helping franchisees determine whether they should invest in a specific franchise system. However, your FDD also says a lot about your brand to a lender as well. This is a significant factor in determining the eligibility of your franchisees, a crucial element to the growth of your brand.

Important items

While lenders will certainly inspect a franchisor's FDD in full, certain items stick out more than others.

"Item 20 is the most important thing for lenders to look at because units that stay open generally repay their loans," says Ron Feldman, Chief Development Officer at ApplePie Capital. "If you have a high rate of closures, it's going to raise a red flag for a lender."

Nearly as important to lenders is Item 19, the FDD section detailing financial performance.

"Lenders will examine cash flow against administrative expenses."

"Having transparency in Item 19 all the way down to EBITDA and cash flow gives the lender confidence there's an ability to repay the debt," Ron says. "Having no Item 19, or only an Item 19 that is focused on sales, doesn't give a lender enough information to make an informed decision."

Lenders will also look into franchisor financials, examining cash flow versus general administrative expenses. In short, lenders want to ensure you're not dependent on selling new franchises to stay afloat.

"Recurring revenue self-sufficiency is important," Ron says. "If a franchisor needs an initial  franchise fee  to make payroll, the franchisor's ability to support franchisees becomes suspect, and may convince the lender that this loan is not a good risk to take.

Total transparency

Beyond proof of concept that your franchise system works and is in good financial health, lenders are looking for transparency on your FDD. That said, it can be a major mistake to provide information without context.

For instance, FDDs feature a section to detail ceased operations.

"If a unit is moving from one spot to another, for whatever reason, and it happened to be closed on December 31 of that year, the franchisor is required to put it into that category," Ron says. "However, the lender won't be able to see why it was closed without adding more information. Footnoting that info could be very important to lenders."

Another example is providing transparency regarding the operation of company stores.

"Company stores should be in there as part of Item 19, but you should also footnote that they are company stores for transparency reasons," Ron continues.  Treat your company stores for Item 19 reporting purposes as if they were franchisee operated, paying royalties, marketing, and technology fees.

"Banks have less franchising experience than specialized lending partners."

Also keep in mind who is analyzing your FDD. A bank will inherently have fewer insights into how franchising works than a lending partner that specializes in franchise brands.

"There are those who will take the time to understand your brand and those who will not," Ron says. "It's transactional lending versus program lending. ApplePie Capital is focused on program lending; we're looking to build a relationship. Banks are more transactional, focusing only on the specific loan they're working on."

While your FDD will tell lenders much about your franchise system's financial profile, it will also say a lot about your trustworthiness. Ensure your FDD is open, honest and comprehensive to help support your franchisees who are seeking franchise loans. This strategy will ensure financing for your franchisees and predictable growth of your system.

Topics: Franchisors

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