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Debt Ratios for Restaurant Franchisees

Posted by David Katz | Nov 25, 2019 | 0 Comments

Buying into a franchise can be financially rewarding for a business owner. However, there are always risks with any business enterprise, including franchises. A franchise circular makes it clear that the franchisor is not providing any guarantees of success with the opening of any franchise and potential investors also need to understand the long-term risks of investing in any business operation, including historically successful restaurant franchises. 

Rising Restaurant Franchisee Debt

According to an opinion article on the trade website Restaurant Business, franchisee debt levels can be a big problem. “Operators' rate of leverage has soared in recent years, which may become a burden in an economic downturn.” This is due, in part, to restaurant chains relying on franchisees, putting more responsibility and financial risk in the hands of the restaurant operators. 

The article notes the leverage ratio for McDonald's franchisees times earnings before interest, taxes, depreciation, and amortization (EBITDA), rose to 3.1 in 2018, up from 1.3 in 2008. For Wendy's, the leverage ratio is 7 times EBITDA in 2018, up from 5.7 in 2008. 

Another article in Barrons, claims that restaurant stocks could have a debt problem if the franchises do. While these articles are aimed at investors, the greatest risk may be borne by the franchisees. As debt ratios increase, an economic downturn will hit individual franchisees hardest. 

Restaurant refranchising strategies have changed a number of previously company operated locations into franchises, leaving franchisees with more responsibility in remodels, new development, and as a result, more debt and risk for the operators. Additionally, increases in wages in a number of states and cities will leave restaurant operators bearing a lot of the increased costs of running the company while still being restricted by their franchise operator agreements. 

McDonald's Versus Domino's Pizza

Bernstein Research analyst Sara Senatore looked at 13 restaurant chains and found McDonald's has some of the highest sales volume (averaging $3 million per store in 2018) and requires the greatest amount of liquidity from franchisees for new store openings. This combination of high sales and high liquidity may offer more protection to the company and to franchise operators. 

Alternatively, Domino's Pizza has a much lower rate of revenue per store (less than half the average sales volume of McDonald's) and a much lower amount of liquidity for franchisees. This may leave franchise owners much more exposed to a market downturn, especially in light of increased operating costs. 

What Franchisees in Massachusetts Need to Look For 

Franchisees and potential franchise operators need to understand the risk and obligations of operating a franchise, including their debt exposure in the long-term. If you are thinking about starting a franchise, you need an in-depth inquiry of the professional and financial track record of the franchisor. Additionally, a franchisee should always consider the larger economic picture in deciding whether the industry, such as the restaurant business, is a good one for such an investment.

Experienced Franchise Business Lawyer 

The Katz Law Group, P.C. has more than 35 years experience representing businesses in Massachusetts and New England in franchise transactions and disputes. If you are thinking of buying a franchise or getting into a franchise business, contact an experienced Massachusetts franchise business attorney. Contact the Katz Law Group today.

About the Author

David Katz

Attorney David S.Katz is the founder and managing partner of the Katz Law Group, P.C., located in Marlborough, Massachusetts...

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