NNN Franchisee Credit Question

[Jay H.]

When evaluating the strength of a franchisee or a national QSR how much scrutiny it is placed on the franchisees financial statement more specifically the personal asset ownership?

Here's my scenario, the franchisee of a national QSR restaurant and myself are finalizing the terms of a lease for a build to suit. This particular franchise does not corporately guarantee their franchisee leases, so the strength of the lease rides on the experience and credit worthiness of the franchisee. When reviewing the financials of said franchisee how much weight is put on the actual ownership of the personal assets?Say for instance the personal financial statement reflected a net worth of 8 million dollars but when digging into the actual assets on the financial statement I find that the majority of those assets are jointly owned with spouse or layered in partnerships. 

Have any of the commercial brokers in the forum seen this scrutinized by potential NNN lease buyers?

Thanks in advance!

[Joel Owens]

I think Jay the question becomes if this franchisee and their concept is the highest and best use you could land for that parcel??

If it is then the next question is alternative site selection. How hard you can push the potential franchisee is how defensible your location is. If there are multiple other sites in the area they could build on that are just as good then you have a weaker position. If your location has multiple attributes that are key that other sites do not have the franchisee will be more forced to give in to your demands.

At the end of the day as a developer you are looking to eventually sell off the income stream so the lease and guarantee is very important for commanded cap rate. If you were holding for retirement and were a local investor you might could bend on a few items.

I think the corporate as another poster said being more flexible is about volume. They spread out the risk with multiple projects so it doesn't affect them as much. The mom and pop developer really has to protect their capital risk more so everything needs to be made where a successful outcome is high.

An example is when I tell individual clients not to purchase a Best Buy for example even though the cap is high because it presents a lot of risk if it goes dark. A large fund will buy them because they own 50 and if one goes dark the others are making them money so when averaged out they are still doing great overall.

Personally a new franchisee represents the most risk. You have to plan on if they go dark and you do a negotiated settlement to break the lease then what would go in there and at what rate??

For myself I can relay an experience. I have been looking at buying existing Papa John's as a franchisee. They can be run absentee owner and I have decades of experience in the pizza industry in all facets.

If you go to Papa John's franchisee site the remaining locations in my state are non-optimal meaning they are in low population, low median income, rural type towns. To do a new build in those areas is extremely risky unless you are local and just absorbing another business in the trade area.

I do not like brand new builds as they are costly to my capital, you have to train a manager and employees, and you do not know if that store will do 6,000 a week average or 15,000 a week as it is not established yet.

Conversely I can buy an existing building established for years and the management and employees are already trained up and I know what the profit has averaged being seasoned for years and years. So from that perspective my risk is reduced and I buy the cash flow business at a better multiple due to not risk to the business or start up of it but because ( seller is retiring, partner dispute, health reasons, traveling to another state, moving out of the country, other businesses with larger capital exposure needs attention, etc.) Of course Papa John's once they found out I was experienced and would not be opening or looking into opening high risk locations just so they could add another store I got the cold shoulder which is to be expected............ : )

I asked if they sell their corporate locations and they said generally they do not. I found out that 80% of Papa John's are franchisee owned and around 20% are corporate. Papa Johns when I asked for a list of franchisees or if they knew who was selling a location they said that the franchisee only has a requirement to tell them they are selling once under contract with a new owner ( buyer ). Right now I am calling the Papa John's within my area in a 20 mile radius to see if they are corporate or franchisee owned. If so I might have interest in buying one.

My research so far shows profit is about 250,000 and up after expenses per location and you only need a small amount of employees compared to other models. I saw some for sales but in other states for about 1.5 to 2 times net earnings multiple which is good value.

I looked into Steak and Shake before but their margins are thin and you have to get 100 employees per the offering circular. I do not like businesses where I have a capital exposure of 1 million plus for the low performing stores only throwing off 10% return. The restaurants have  to throw off way more cash flow to make it worth it versus doing real estate.

So far it seems the cherry stores are all corporate owned from Papa John's and they do not want to give up. If I can't get what I want I will just stick to real estate only for my investments. Just like anything else you can't buy an inferior product, location  and you can't overpay. Most parent companies does not care if they franchisee makes money as they care about driving sales at all costs and living fat off the royalties. I am not saying that about Papa John's I have just seen that with other corporations before.

Jay your franchisee you need to make them put skin in the game with attachable assets. You are taking a risk on them so it has to be fair and balanced for both.