Once Seen as Risky, Banks Rethink Franchise Loans

One year ago, the International Franchise Association held a conference to discuss ways for franchisees to obtain the financing they needed to get their businesses up and running.

One outcome of that meeting between bankers and franchise owners will be announced today, at the second annual IFA Lending Summit, when the Consumer Bankers Association will announce a standardized lending “template” for working with franchisees that should speed up the lending process and strengthen the relationship between banks and franchise owners.

“This is something that needed to be done, and we got it done,” Mark Luppi, chairman of the small business committee of the CBA told CNBC.com.

“The IFA was feeling neglected by banks. And banks tend to shy away from franchises,” he said, explaining that a few “fly-by-night” operations had made banks wary of lending to companies for which they had no history.

What the banks needed, said Luppi, who oversees small business banking for HSBC in the U.S., was a way to connect with franchisors and franchisees, to build that history, and a structure that would eliminate the “worse-case scenarios” before they started.

This new lending template will have a significant impact on potential franchisees and hiring, said Steve Caldeira, CEO of the IFA.

“For every $1 million in lending, 34 direct jobs are created in the franchising industry,” he said. “There is a direct relation between access to lending and job creation.”

Caldeira said that tighter lending standards by banks and increased scrutiny by regulators because of Dodd-Frank rules have slowed lending to small business owners, franchisees among them. While he projects 2.1 percent growth in franchise jobs in 2012, research done for the IFA shows that a shortfall in lending to franchisees will result in 94,000 jobs that will not be created.

It’s not that banks don’t want to lend that money, said Luppi. “We, as bankers, need to make loans. Margin on deposits is low, and we need to push forward to make money,” he said.

Research done for both the CBA and the IFA shows that demand for loans is down, as business owners pulled back on investments in an uncertain economic climate, and worked to rein in debt. The CBA determined that bankers could work to develop demand.

“What bankers learned about franchises is that, rather than being riskier than traditional businesses, these businesses have a structure of support around them, a marketing team, and people to step in if a business is in trouble,” said Luppi.

Part of the information-gathering process are “discovery days,” where bankers visit the franchise, to walk through the operation, learn about the organization, and how new franchisees are set up. All of this — the discovery day, the written information — creates a shorthand history, and a place for lenders and borrowers to connect.

Jon Luther, non-executive chairman for Dunkin' Brands and Arby's, said franchisees will benefit from this stronger connection between banks and franchise owners.

"Banks during the recession were holding back on lending and the small business community got hurt the most," he told “Squawk Box” during an appearance on Monday. "There is a lot of demand for franchising because the formula for franchising is … very workable, it’s been proven, it’s been tested. We have a very high success rate."

Luther said that banks are now beginning to understand the "formula entrepreneurism" that makes franchise owners a good risk. "The education is working," he said.

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