Your relationship with your lender doesn't stop when you sign on the dotted line. For many reasons, having an understanding of the lender's process and learning how to continue the dialogue could be grossly undervalued in the industry.
Join Rick as he discusses the following topics and more with Michael Eagen, a Managing Director in the Franchise Finance Group of BMO Harris Bank:
1. A Lender's Internal Process of Issuing a Loan
2. Acquiring More Stores
3. Syndicated Deals - What is That?
4. Covenants and Compliance
5. Dangers of Overleverage
6. Life-cycle of a Banking Relationship
Welcome to the Restaurant Boiler Room, season two, episode 11. I'm your host, Rick Ormsby, managing director at Unbridled Capital. Today in the boiler room, we have a great discussion from a recent webinar with Mike Egan, managing director at BMO Harris Bank. The topic of discussion is entitled, Managing Lender Relationships. And we discuss among other topics a lender's process of issuing a loan, syndicated loans, the dangers of over-leverage, compliance and forbearance agreements, and a general view of the lending market right now.
The Restaurant Boiler Room is a one-stop shop for multi-million dollar merger and acquisition activity and financial complexities affecting the franchise restaurant industry. We talk money, deals, valuations and risk. Delivered to the front door of franchisees, private equity firms, family offices, large investors and franchisors on a monthly basis. Feel free to see out content and sign up for our email list at Unbridled Capitol's website at www.unbridledcapital.com. Now, let's enter the boiler room.
The reason why I set this webinar up with Mike is I just thought it'd be a good idea to just get his perspective on what happens behind the scenes when a franchisee, whether it's a family office, a private equity firm, big franchisee, small franchisee, medium-size franchisee goes to acquire a business or wants to make a loan. So we're going to have him talk a little bit about that. The next life cycle of a business is if you want to acquire more stores, you [inaudible 00:01:29], you want to up-size your facility. What actually technically happens there? You know what I mean? What does syndicated deals look like? A syndicated deal is like you have a lot ... Now, you've got a business that needs more than 25 to 35 million in financing. And one bank won't do the deal.
What does it look like to have four or five banks involved? Who's in charge of that? How do you manage the accounting and accountability and administration of it? And how do you put the right relationships in place to grow when you've got six banks working for you? The dangers of over-leverage, Mike made me talk about this, but I think it's an important one. Compliance and forbearance agreements, so that's something that we're seeing a little bit in this space right now, right? The forbearance agreements of either delays on your loans or on your landlord payments. Maybe even royalty and advertising payments with your franchisor. Or if you're in a casual dining brand particularly.
I wanted to talk a little bit about the life cycle of the banking relationship. And then finally, Mike has an opinion on the current lending market. We do too, and so maybe we could just kind of bounce that back and forth once we get cooking. So with that being said Mike, let's see if you can be heard now. Go for it.
So I'll let you take it from here. Where do you want me to go? And you want to learn more about the lending process.
You want me to just kind of go through the list quickly?
Yeah, go through the list. And what's behind it? Answer these questions on the board, and then the black box of what happens behind the black box of getting a loan approved from the time they see Mike Egan, they get a phone call from Mike Egan, until the day that the money ends up in the bank. Just all of that stuff. But yeah, please do.
Got it. So the typical package that I'm looking for is three years of financials, a year over year analysis, the interim periods. I would tell you that the more granularity that's required today is sort of imperative because we are looking kind of period to period, store by store what happened during COVID-19? So we're looking at March, April, May, June, July. And for many concepts, they had a really tough April, May, but by the middle of May things seemed to turn. And the fast food guys kind of figured out how to manage through this and actually drive sales and EBITDA to better levels, staffing levels and those sorts of things. PPP was a huge distraction but a benefit at the end of the day. And so that, why we're looking for that granularity.
So not only same store sales, but transaction counts and basically tell the story of what happened over the past year. I would expect lots more questions today when applying for a loan. So just be mindful of that. And in terms of ...
Mike, how do you think about EBITDA in that case? For example, let's just take EBITDA, right? So you know what 2019 EBITDA was. 2020 EBITDA depending on the rand, you either had it was starting off normal, maybe a year over year flat. And then all of a sudden it goes whoom down, and then goes whoom up. And then now you look backwards and for many QSR concepts at least, EBITDA is probably up a little bit over last year, or maybe a lot over year, over a year over year basis. Some concepts went down and are just migrating to get back up. How do your risk guys look at normalizing EBITDA right now? How do you think about it?
Yeah, I think that, that's a good point. If there's been a big drop in those first few periods, March, April, May, and it rebounded let's say June, July, August kind of moderating the two, offsetting [inaudible 00:05:00]. I think the crosscheck ... The short answer is we're going to look at 2019 as sort of a normalized EBITDA number, right? Under normal conditions. You're going to compare that to where they're trailing 12 EBITDA has been. And you're going to have to make some assumptions. For the folks that have experienced 30%, 40% sales increases, whether it's pizza or chicken in some cases, you're going to have to edge that down as to at some point in the next year, we're going to reach the point of normalization where you're not going to be able to enjoy those same kind of sales lifts permanently.
The biggest problem you have right now is we're sort of believe it or not entering a phase of restaurant shortages with 100000 restaurants closing so far in the industry. So there's an out of whack situation happening with demand that's probably not permanent.
Okay. All right, so that's important for those who are listening, right? A little bit of normalization of some of the increases if you're in the QSR business in kind of a looking forward run rate. So there's a lot of modeling, more scrutiny. Tell us about the process of term sheets and commitment letters. How do those work for you guys, and then also broadly across the lending industry?
Yeah. I'd say the term sheet process, we spend a lot more time up front. And sometimes it feels onerous for the borrower. But I do like to ask a lot more questions, eliminate surprises. And then we put together a pretty meaningful analysis, a thoughtful analysis and look at some downside risks as well. But what I'm trying to do there is really eliminate surprises. And we'll float that in front of the folks who do ultimately sign off on the commitment letter process. So I can give you a letter of intent, or a summary of terms that's going to be 99% where we're going to end up once the commitment letter is approved through a deeper due diligence.
And so once we have an agreement on terms, we're probably looking at about a two-week process to get to a commitment letter approval, assuming information's flowing. And everybody's happy with the answers that are coming along with that process. So all in all, it's probably about four weeks to five weeks to get to a commitment letter after a deeper due diligence phase. And then you're closing process depending on the collateral could be anywhere from the next two weeks to as much as the next four or five weeks if there's a lot of real estate due diligence involved.
Any comments on how credit decisions are made?
We've been pretty consistent through this phase where the key metrics that probably drive most credit decisions are lease-adjusted leverage and it's probably debts to EBITDA and fixed coverage ratios. But at least adjusted leverage is the driver. And what I would tell you that for solid concepts, kind of sort of tier one as we used to call them, in the QSR space you're probably looking at five and a half times to maybe 5.75 times lease adjusted leverage. That's sort of a hurdle for the term debt you can put on a company at closing. Now each brand's going to be a little bit different. Some brands have higher EBITDA margins like Taco Bell, or perhaps Wing Stop versus others in the burger business that are going to be lower, kind of high single digit. That's going to influence how much debt you can put on the business.
Yeah, very good. You want to talk about how you calculate ... Do you want to talk about quickly how you calculate lease-adjusted leverage just so people know?
Yeah. So for some borrowers who are on their growth phase, right, 10, 20 restaurants, you may be working with lenders who don't look at lease-adjusted leverage. They look at debt to EBITDA or fixed charge coverage ratios. As you grow you will be required to look at lease-adjusted leverage fundamentally because your business is financed with leases. And you have to convert that lease payment into an imputed debt number. And the way we do it, which is just a rule of thumb, there's not a real good answer as to why we use it, but the rational is you're capitalizing the rent with a multiple of eight, which is about a 12 and a half cap. And you're multiplying eight times the rent, adding the debt that you're going to be borrowing. And that is in the numerator.
In the denominator, you're going to use EBITDA after corporate overhead and any adjustments plus the rent. And so when I talk about lease-adjusted leverage of five and a half to 5.75, some concepts are down at five and a quarter or five times, that's the number you're trying to solve for in order to get credit approved.
Yeah, that's good. That's good. Know that calculation, right? It's like, that drives ... That's a key driver to borrowing money and also staying compliant with the money too. So, there we go. Very good. Let's go to the next slide then. Acquiring more stores. So now I'm a franchisee. I've gotten in the business. Old Mike at BMO Harris has lent me some money. I'll give the example of I don't know, a 30 or 40 unit franchisee, or 20 unit, whatever. Someone you bank. And now they're an inquisitive buyer and they want to grow. What's next? They call Mike and say, I want to [inaudible 00:10:04] or I want to build more stores.
I want to grow out my trade area. How do you think about it? What technically do you do?
Yeah. So think of your business as managing the level of debt across new and older stores, existing stores, right? And so when I'm going to do a term loan for acquisition financing up front or recapping your existing debt, I'm also going to provide you with a development line of credit, your DLOC, D-L-O-C that's in your second tab there. Your development line of credit is typically 80 to 100% financing of the hard costs of a new store. So if you think about internal rate of return and leveraged internal rate of return, if I'm providing 100% financing of the hard costs, you're covering the soft cost to get that new store open. That's very powerful in terms of return on investment for the equity owners because my debt is typically a lot cheaper than the cost of the equity required to build new stores.
We do want you to grow, and it does make sense. And in markets where it makes sense, we are supporting the franchisees to get to that level with organic new growth. If you find an acquisition in an adjacent market, or even in an adjacent state we don't like you to stretch too far and wide unless you've got a really strong infrastructure and/or some history of managing multiple markets. But we will look at embedded equity that builds up in the business over time, as you're advertising debt or as you're growing EBITDA, that could be used as a contribution towards new acquisitions, in addition to any cash equity you might put into a new deal.
So that's one way to think about growing. Using again the bank financing, which is a much lower cost of capital to grow, as a bigger component to your capital stack if you will. Kind of jump right into your return economics down below, and your cash on cash returns, most operators are familiar with that. How much cash am I taking home at the end of the day versus my equity investment? That's simple enough to answer. But historically, you could probably be looking at 20, 30, 40% returns on new stores for sure. But for acquisitions because the purchase prices are higher, right? Six, seven, eight times EBITDA, maybe more if Rick is selling your company.
And your ability to get a high return on that investment becomes more challenging. What I would say to buyers today who say multiples are completely out of whack, they make no sense at all, I go back to the saying, I've been saying it for a few months now, is that we used to say fast food restaurants were recession-resistant, it's pretty safe to say that they are apocalypse resistant now. Their ability to survive and perform at a higher level in this pandemic, as dining rooms are closing, most operators today almost welcome that in some respect because it's a much more simple five model to run a restaurant with a drive through.
Obviously it's a huge challenge for folks who have dining rooms, and rely on that. Now you're relegated back to relying on delivery, which is not very profitable, or takeout or curbside delivery as an alternative. And then of course patio dining or parking lot dining, which unfortunately as winter is coming will be more challenging for those operators. But back to the ... Are 15 to 20% returns acceptable today? Think about these investments on a risk-adjusted basis. If they perform this well during a pandemic, and they perform well during good times as well, your ability to take a lower return rate, it's the old risk and return paradigm.
You can assume that you can take a little bit less risk. And especially if you look at a 10-year treasury, which is down below, well below a point. And that's the risk free rate. And if your premium above the risk free rate is up in the 15, 20% range, that might be a fair return today.
I think it's a wonderful point. And it's a wonderful point for a lot of people who are listening to this podcast webinar and podcast too. A lot of these folks are sitting in New York City looking at a portfolio of investments that may include all kinds of things, investing in beer companies in Belgium and buying Amazon stock and buying real estate in California, whatever you're doing. You talk about being apocalypse resistant, of course you and I have seen when E-coli and genetic corn and all these things hit brands and do damaging things. Rats in restaurants and bad social media publicity. So they're not totally risk-free, but I agree with you. And of course I'm not objective either, right?
I'm more subjective. I'm part of this industry. But I look at what's happened post-COVID for the QSR companies particularly and I say, my goodness, the inherent risk of operating these businesses is probably less than even I realized. And so I think you bring up a lot of good points when you think about someone's broad investment portfolio. What do you think about multiples? Of course I talk about this all the time, but what do you see about ...
Is it a Rick Ormsby deal? Is it a Rick Ormsby deal?
It's a big multiple. Historically, so this is my 21st year of doing this. And historically, you could say that typical multiples for restaurant franchisees were somewhere in the four and a half to six and a half range. And I do remember the days of when a very large Taco Bell franchisee in say 2009 I think it might've been traded for six and a half times. And everybody was like, whoa, that's out of line. That's so crazy. I would safely say today, the marketplace for Taco Bell, which is sort of the gold standard in the fast food space because of their EBITDA margins, their dominance in that Mexican QSR, their ability to add new products and adding fryers over the past year or two, those multiples are drifting up.
I know buyers are not going to want to hear it, but it's eight to nine times. And in some cases, maybe a little bit higher than that. Back in June when we did our thing with John Hamburger on another webinar, I was kind of predicting that real estate values as well as multiples would probably hold up for anything with a drive through. And I think that's probably true. You could probably add a little bit more insight into that as well as to what you're hearing from buyers, what they're willing to pay. And certainly what sellers are probably demanding now.
Yeah, that's a good question. And heck, I can do another webinar on this. But I guess my quick reaction would be generally speaking, if you're kind of a middle America QSR operator and you're listening to this conversation, and your business is doing well, you can expect that your valuations are probably ... Two things affect valuations, right? If you're just selling an operation, not the real estate, you have your EBITDA multiple over here. And then you have your EBITDA over here, right? So both of them affected, I would say the EBITDA multiples in many cases are flat holding up well. In some they might slightly be coming up slightly, right?
In some of these brands that have just taken off, like [inaudible 00:17:15] might be a Sonic or something like this where sales ... Or Popeyes where sales are up 30 and 40% month over month, year over year, just shocking amounts. But your EBITDA is up in many cases too. And I know there's this normalization of EBITDA that has to happen when you're between buyers and sellers. And there's a negotiation obviously and the lenders are involved too. But EBITDA in many cases is up too. So I think what you're saying is absolutely right.
Yeah, I'll give you some empirical data on real estate as well. Initially I was caught in the middle of a transaction, we were doing some appraisals in April. And the appraiser came back and attached a 10% discount not knowing what the future was going to be, and how it was going to occur. But it was a fast food deal. And I think that was a mistake, but at the time who would know what was going to occur? The empirical data has come out for the second quarter on triple net lease, sale lease back properties. There's still a 60 basis point premium for triple net lease restaurants, fast food restaurants. And it's only drifted up about 15 basis points from a year-over-year basis, which is not bad at all.
And I think that really was all ... And maybe most of the larger brands that we would finance or you think Wendy's, Taco Bell, KFC, so there has been very little movement in that. And that range for those cap rates is still between call it 5.40 and maybe 6% on the high side. And depending on lease term and those sorts ...
So would it be driven by tax? Some of it being driven by tax uncertainties, you know what I mean? Sellers wanting to sell quickly potentially, but there seem to be a really ... And people obviously who are selling out of things to buy other things, right? And to do it, and to defer taxes and 1031 exchanges. I see the same thing. I think what you're saying is right, that the market's really fluid. It looks a lot like the residential housing market in Texas where you are or Florida where I am, where things are falling off the shelf quickly, aren't they?
Well that's what happens when [inaudible 00:19:28] dumps money out of helicopters, and you've got a couple trillion of stimulus coming from the federal government, there's a lot of cash. The savings rate spiked to 19%.
I saw that.
After the stimulus checks went out. That's a huge number that people have. There's a lot of distress out there. There's a lot of people suffering. There's no question. But there's a lot of cash out there too right now.
Yeah. Yeah. A lot of ... A couple of brands, I won't name in particular, a lot of the franchisees are good friends of mine, they call me and they say, PPP was a blessing to us. And so whatever [inaudible 00:19:59] the way that was administered, it provided a lot of helping hands to a lot of franchisees. And good dear friends of mine who have really good large businesses that were able to advance because of it. Tell us a little bit about syndicated deals. First of all, what the heck is a syndicated deal?
Are you in Hollywood or something? What is that?
Think of it more of a club deal in what we do. It's a club of banks, a group of banks that you pull together to do larger deals. And the idea is that the banks want to spread their risk for larger transactions, right? And so for a franchisee, why would I want to do this? The fees are a little bit higher, but you have one bank putting together a deal, bringing in multiple lenders. And it's very common in the private equity space, and of course all the large corporates out there, they'll use a club of investors, a group of investors. In our case, banks, buying the debt as most don't really want to be more than 25 or 35 million in exposure to a single borrower just from a diversification strategy.
If there's an event of failure. And some lenders will go higher than that, some prefer to be lower than that. But that's sort of the sweet spot for most lenders. And why would you do this? There are some additional fees. You pay that administrative agent. Let's say it's BMO putting together a deal. And we've done at least a couple deals here where we were a co-lead arranger for a chicken concept recently at about 33 million. We took a ticket in somebody else's deal. So then we were the lead arranger on a 51 million dollar deal on a Mexican concept where we were the lead arranger brought in another bank. And so there's some annual fees that you'll pay in that 15 to 35 thousand dollar a year range.
Where most of the deals are at our size. That's to pay say BMO Harris bank to administer the loan. The check the compliance certificates, to deal with the different banks, to negotiate with them if there's waivers or covenant issues or just to get on the phone and work with them. It is much more convenient instead of having four different banks ... And most lenders do not like disparate collateral. They don't want to have one lender with the good stores and then one lender with a group of bad stores, and you're fighting over where the cash flow's going.
Lenders prefer to have one credit agreement with a set of covenants that are mutually agreed upon up front by the borrower and the banks involved. And we have a lean on all assets of the business. It's a lot cleaner, it's a lot more organized. There are certain borrowers that don't like that. They prefer to have a little chaos in the bank group, and have folks competing against each other, which is fine. That's a good strategy from a borrower's perspective if you can achieve it. But generally, the market prefers these cleaner, larger transactions. And sellers do as well because they have certainty of close.
And that's probably the most important thing. That's where these things come into play is during M&A activity where you're buying a larger group of stores.
So yeah, yeah, great explanation. Let me ask this question. I'm a 40-unit franchisee. I live in, oh, who knows? I live in Iowa, okay? I started the business. I drive a pick up truck. I see all my stores in the course of a week. I've done it for 40 years. And I have a business now 40 years later that's worth something, for 60, 70 million dollars. And I've got this fancy shmancy buyer from New York City who is going to come in and buy it. And he's going to borrow $60 million let's say whatever. Make me feel comfortable that this isn't the craziest structure with risk and 100 different lenders in a bucket that will never close.
If it's a larger bank that's got a track record of actually closing deals and leading deals, which we do. Any many of the larger ones do as well. You can take some comfort as a seller that it's going to get across the finish line.
Our marketplace ...
Yeah, reputation goes a long way. For a bank that's never done a syndication before in the franchise finance space, I'd probably have some questions about that. But at the end of the day it's on your buyer to make sure they fulfill the requirements of their purchase agreement, which includes getting the financing done. That's honestly probably the only way to get a deal size that large financed, larger financing done is to go that route of a syndicated deal.
Yeah, for sure. And I know we're going to talk a little bit more about how to manage those relationships going forward. So let's keep that in mind everybody about how to manage this structure once you have it in place if you've borrowed money under a syndicated deal, whether it's your first or second. And I wanted you to have the opportunity to talk a little bit about over leverage. Clearly the way we see that from time to time, it wears its ugly head at certain times in the life cycle of a franchise business when the economy or the brand doesn't perform well. But go right ahead. I know you have some things on your heart.
Yeah. This idea of a bifurcated loan structure that some are pushing. Prior to COVID-19, and having done this for 21 years, I've been through two or three or these down cycles. What I have seen historically is that when you push the envelope on leverage, you're going to get caught. And this is not a very high margin business. Most restaurant operators today are talking about single digit EBITDA of the six percent to maybe 10% range. A few are the outliers at 12, 13, 15%. But you don't have a lot of room to make mistakes. And the old rule of thumb was that if your sales fall let's say five percent, you might erase two and a half percentage points from your EBITDA margin.
So if you had a 10% EBITDA margin, you're talking about a 25% decline in EBITDA. You're likely to trip a covenant if you're running your leverage very high. And obviously tripping covenants, you're going to spend more time on the phone with the banks than you will with your GN's trying to drive sales and EBITDA. So we're probably the last folks you want to talk to unless you're buying something or rolling over some debt. The idea of a bifurcated structure is another way that kind of plays a little bit of an arbitrage between using that formula of eight times the rent you charge your operating company, versus 100% of the debt you might have on your real estate company. So you've got a real estate company and you've got your op-co company, your operating company.
You have debt perhaps in two different lending groups on each one. On an individual basis, your operating company might have a 5.50 or 5.75 lease adjusted leverage, and it looks fine for the lenders on that business who don't have the real estate as collateral. If you were to collapse the debt structure that evolved, that exists with the real estate company, so you add 100% of the debt that's at the real estate holding company and you're charging rent to the op-co, if you put the two together, instead of 5.75, you may actually be at six and a half or seven times EBITDA, EBITDAR rather in a lease-adjusted leverage global analysis. Now some broker types out there will tell you that, hey, that's totally acceptable. You should be willing to do that. You should not look at it.
But the reality is, it's debt. Any way you cut it. And there's an arbitrage between the two because eight times the rent is you'll oftentimes lessen the debt that's on the real estate holding company. So this bifurcated structure, I would tell you the sweet spot's probably six times. And I've tried to message that too to the franchisors as well. I think they're on the same page. They're starting to look at that more meaningfully. Especially if an operator is using some expensive sale leaseback. You think about sale leaseback as a third party rent. And that's expensive too, but even separating with two lending groups, it's just going to get messy if operations slip. And so we're not big fans of it. We'll do it. We'll finance both sides of that transaction. We'll sometimes hold even just the op-co side of it if we look at the global and it still makes sense.
But I would just be mindful of that. Don't push the envelope. You'll end up paying for it later.
Yeah. Yeah, that's well said. That's well said. Thank you for that. Thank you for sharing that. How about obviously sale leasebacks. Method of financing and method of growing. Sometimes when we sell businesses we separate the business and real estate and sell them separately. People always ask me, what do I do with the real estate? And I say, you usually see three different things happening when someone calls us and wants to sell their business. You can either sell the business and the real estate to the operator in one transaction. You can sell the business to an operator and keep the real estate. Or you can sell the business to an operator and sell the real estate to a separate party whether it's in one transaction to a [inaudible 00:29:03], or in many transactions at a better cap rate, but more hassle and more fees typically to on the 1031 market. But either way, sale leasebacks can be a part of the business.
But they come with a risk. And in the big rent increases that we used to see back Mike, I would say I saw them getting signed up in '08, '09, 2010. And then we got whacked with the great recession. And you saw these operators who all of a sudden had 10% sales drops or 15% sales drops. And then their first five year kind of kick up in rent happened and they signed 15% rent increases over five years. And by the time they hit that, most of those guys were in solvent if they had done it across their whole portfolio. So I've seen the works and the hickeys from that. But go ahead and tell us your thoughts.
Yeah. Look, I've been on both sides of it. I've sold both sides of it. I will convince you that you should finance the real estate, and I can convince you that you should sell the real estate.
Are you in the restaurant business or are you in the real estate business? The fundamental returns you're going to get restaurant operations are going to be upwards of 20, 30, 40% if you're great, right? If you're investing in real estate, you're going to get that cap rate. That's your return of and return on capital. So for a smaller operator, it makes sense to keep the dirt longer because it is your rainy day fund. It is a retirement strategy for many. But if you really want to get larger, you really have to make that decision, I want to invest in operations because I'm going to get my highest levered rate of return, my internal rate of return off of that side of the business.
What I would probably ... The right answer is, you're going to do some of both. You're going to prune your portfolio, you're going to sell the stores that you don't want to own longterm. You're going to do sale leasebacks on those. You're going to try and negotiate one and a half, two percent rent increases per year so you're not slammed every five years. That'd probably be my recommendation. And you're going to keep the really great sites for longterm retirement or to flip at another time. I will tell you this though, cap rates, I don't think they've really been much lower than where they are now. I know they were low in 2006, 2007 or so, and they shifted back up a bit.
But people have a complete aversion to paying capital gain to the point where they want to invest in triple net lease properties. And so they will buy it, and they think of it as a bond investment where you own a piece of real estate at the end of it all once the debt is paid off and whatnot. Or the end of the 20-year lease let's say. And there's renewals. It's attractive. I think it's a mix of both strategies.
I would just say this too, I'm an entrepreneur, right? And so I understand the life cycle that happens and the psyche that happens in many people's minds. If you're an operator out there, I feel you, right? You first start this company and you don't know whether it's going to make it. And you're up at night three in the morning staring at the ceiling and wondering if it'll all hold together, right? And then you meet some success. And once you meet some success, your immediate reaction is in many cases, okay, I want to de-lever, de-risk myself and pay it down. And have as little debt as possible, and have as much security and collateral as possible because I remembered how bad it was when I got started and how scared I was.
Okay? That's phase two. And then phase three is you come out of it and you're like, maybe I was too conservative. I've been running this business, it's been successful now for seven or eight or 10 years. And I kind of want to grow it a little bit. Maybe I need to take on some responsible debt. And then if you get to the next stage which is where you want to really grow it because you're confident that it's going to succeed, then you tend to move along the real estate life cycle that way. And then you sell the real estate to fund acquisitions of higher returning operations. Whatever that's worth, I think that's really wise. Last thing about ... I'll just say this. If brands aren't performing well, over-leverage, it can be a problem, right? If you're in a brand where you're projecting sales are going to be down five percent year over year, the sales de-leveraging make over-leverage a massively worrisome thing for a lender I'm sure.
So let's move on. We'll move on to the next. And I saw one question from someone who's a friend of mine actually. And let me answer it. Does it matter if ... Do EBITDA multiple matter depending on state? And I would say EBITDA multiple in what we do matter in a couple different ways. Number one is going to be brand. Number two is going to be the performance of the stores themselves. The third is going to be very clearly the number of units. And number four is going to be location of the units. And then you're going to have other things, like are they remodeled or do they need remodels? What do the leases look like? What are the margins?
But those first four are going to be some of the areas that are most important. And yes it does matter by state for sure. So all things equal, there's a lot of variability here. But all things equal, a Wendy's location in Tennessee is going to be worth more than a Wendy's location in New York. Sure. It is going ... All things equal, a KFC location in California will be worth a little bit less than a KFC location in Las Vegas or Phoenix maybe. That's just because of some of the regulatory issues involved there. But if you have a larger transaction of great stores, sometimes people will I think rightly look past the state. There you go. It's more complicated than just a singular question, but it's a good question.
Yeah. I'll make a point about EBITDA multiples. The buyer has one on the deal he just closed. The seller has one, and Rick Ormsby's got one.
And none of them match.
None of them match, yeah. Yeah. Yeah.
So it's a matter of what you think you can do with the assets. Why you would pay more, right? Or is there low-hanging fruit there or not? I think that's a ... Was it a good operator or not, right? It depends on the brand. Where's the brand headed? It's a number of different variables. But you make your money when you buy an asset. So it is kind of critical to think about that long and hard. But again, we're in a different paradigm right now where if you're thinking about risk adjusted returns, being in the QSR business has suddenly become much more viable.
Yeah. Or what is your thesis.
Having a drive through.
Having a drive through. The thesis even before COVID-19 when I meet with family offices and private equity guys I would say that your number one investment criteria should be the drive through. You say, why, right? Because it's easier to get the food. People want convenience, they want fast. Dennis Lombardy who's an old mentor of mine and he used to say that if the drive through folks could manage to actually throw the food out the window at 10 miles an hour through your window, that's what customers are really looking for, right? Just incredible speed of service, get the food right, make it hot. And now it's got this new paradigm of it's conceivably safer to stay in your car when you get your hot food.
Isn't that funny? It's so true. Well then let's keep going. We got about maybe six or seven minutes maybe to keep going on these slides.
I'd like to get this one because this one's a good one. So what the heck is quarterly compliance? What does that mean to me? And then go through some of these questions and ...
Yeah sure. A quarterly compliance certificates you're going to attest and sign off that you have met your ratios that we agreed upon in the credit agreement up front. That you're going to meet every year and oftentimes they do step down every year after 12 months. So gradually you're de-levering the company. Now obviously if you're looking at another acquisition or you want to do a dividend recap, which are less probable today on the dividend side of things, but you're going to reset covenants when you do a new acquisition. So those numbers move around. Think of covenants as nothing more than the ability of the lender to hit the pause button if your plan is not working. If you're not hitting the EBITDA margins you thought you were. Or your sales are in decline. It's not designed to be a gotcha. And it's not designed for the bank to try and shut you down. It's really to just get you back to the table to think about that.
Yeah. So what does it mean?
If you're out of compliance ...
Am I going to jail? What's happening if I'm out of compliance?
You're going to get back to the table and you're going to negotiate with a lender. Probably a new reset of covenants. So maybe over a shorter term like show me the plan to get back to where we were and where we thought we were going to be on the backside of it. Now obviously in COVID-19, a lot of that goes out the window because governments, local governments are shutting you down with 24 hours notice. If you're a full service operator and dining rooms are getting shuttered. So your ability to come up with a longterm plan is a lot more challenging. Banks understand that. They're going to have to kind of think about that and when it comes to term.
And I would tell you that in certain situations today, it's going to be really hard to measure a trailing 12 EBITDA that you'd use for a measurement on a compliance certificate. You're probably going to go to a liquidity measure. Make sure that there's enough liquidity in the business if it's burning cash over the next six or 12 months. And that's going to be a more important trigger to get folks back to the table if things are not going well. But look, if you're out of compliance, the bank has the right to call the loan and ask for it to be paid off. So at the end of the day, that's what it's really all about. Banks are not in the business of chasing borrowers out the door. And if you're working with a lender who's done this for a really long time, guys who have been restaurant operators, I feel your pain. I understand the business better than some who are kind of new to the space.
They're going to be a little bit more understanding and hopefully a little bit more compromising when it comes to coming up with a solution to kind of get you through what could be a forbearance agreement. We're not going to default you. We're going to sign an agreement. You're going to hit these mile posts to work your way out of a trouble spot. And as long as you do that, we're going to forbear on any kind of default. And so if you don't hit those metrics, then obviously we go back to the rights that the bank has in order to try and get repaid. But in these times right now, bankers have been very flexible. You've had to be.
And the regulators told us to be back in March. Now at some point that's going to flip, and the regulators are going to force us to write things down and qualify things as troubled debt restructurings and whatnot that will require bigger reserves. But for right now, I think we're still in this phase of let's just work together to try to get through this.
There are comments I would make. The first comment is I think you go into a relationship with anybody, whether it's a ... You got to look at the lender as a partner, right? They're invested in your business. You really, really do need to whatever visibility you can, whether it's through references or friends of yours who have been ... If you're a franchisee who have taken loans from some of these banks like ... You really want to find out who is in the trenches with you when problems happen, right? It's one thing when we're all skipping down the road like Pollyanna. But if we're sitting in the trenches in World War one back to back shooting, I need to know who's in the trenches with me. And someone who will fight for my business if I come into a problem. And I think that's where one of the real value adds that Mike and his team provide. And I think across the space you find varying levels of that type of loyalty and stick to it-ness.
I had a second point that I ... Oh, the second point is a comment Mike. And you made the comment that you guys are easy right now, but there's a time that will come. What do you expect will happen when the time comes? And when it's time to pay back some of the ... To restructure these loans, when it's time for all the deferrals or some of the interest or whatever it is that you and other lenders have oftentimes or sometimes been involved with on behalf of franchisees. When does the come up-ance come here?
Yeah, I think it depends is probably the answer. If an owner is willing to step up and put equity in or find another source of capital, the senior lender is going to be more accommodative with interest only phase, maybe capitalizing some interest in rare situations. Especially if there's risk of default. The idea is that we're going to get through this by maybe next summer when we have a vaccine and it may be distributed. Or we have a better sense of therapy treatments, so the risk of death is not so high. But that's all speculation for right now. So I think it depends. It really does. And if you have a borrower who's like, hey, you're on your own. This is a non-recourse loan. You figure out, here's the keys. You run the restaurants. I don't want to work the grill again.
So banks are going to try and figure out a way to get it done, but this is when true character is revealed. We used to say that we're the five C's of lending back in the day when I was coming up as a junior banker. And the first one is character. And if the character of the borrower is not strong, you're not going to be able to overcome that with the other four C's, which are collateral and capital and capacity to repay and those sorts of things. And so it really does depend on the relationship and what a borrower is willing to do to help get through this. And most franchisees, this is their livelihood. And they've personally guaranteed franchise agreements. So they have liability that's real. And they're going to do whatever they can to try and save their family, to protect the bankers. Most are very good folks that are in just a very tough spot right now.
I didn't want to ... When we get off this compliance agreement, there was a question that came in about how are we handling COVID-19 adjustments and PPP money? Whether that's a nonrecurring income if you've got forgiven debt. Banks are not doing that. They're being very, very, very selective in any kind of a COVID-19 adjustment because it's actually ... I think where we're all sort of headed is that it's really hard to figure out what is the right COVID-19 add-back? And instead let's figure out if there's a breach of a covenant, let's figure out a way to grant a waiver to help you do what you need to do right now, whether it's distributing a little bit of money or restructuring something, we're going to be more accommodative around that versus trying to figure out what's the right EBITDA adjustment.
For revenue that was lost and never occurred, that's not going to happen. That's not gap ... The SEC and the folks in the [inaudible 00:43:42] and whatnot have given guidance on what is non-recurring and recurring. And the bottom line is, something that recurs after two quarters is recurring. It's not a recurring event. And for right now, it appears a lot of this is going to continue to be recurring for the foreseeable future.
Yeah. Thank you. Mike, we've got about five or six more minutes total. Hey, we got one more slide to kind of go through. So let's go through it quickly, and then for those of you listening, please reach out with some questions if you want to. If I see any questions pop in, we'll answer them and kind of pivot from this last piece, which is just ... Well, we have two more slides, but let's do ... I think we've talked about the life cycle of the banking relationship. The value add of bankers. Do you have anything you want to talk about here just in a minute or less?
Relationship banking, somewhat of an anachronism, right? In today's world, bottom line is, things are very transactional, right? I am a great guy, I'm a wonderful, trusted advisor. I've worked hard to get to that level. But if somebody's offering you a deal at the quarter point [inaudible 00:44:46] spread, oftentimes I lose. And I get an at a boy. But I think there's a lot of value in relationship banking. I'm an old school guy when it comes to that. And I do think that having a really good trusted advisor, especially one that's been or tempted to be an entrepreneur, opening a restaurant has a little bit of perspective. Or have been through multiple cycles, that's going to be very valuable in times like this. There's going to be a lot of pressure from senior leadership at different banks.
There's already stories of banks exiting. And so that's one of the reasons I'm feeling a little bit bullish about next year because BMO is over 200 years old. We actually predate Canada believe it or not. And we plan on being here for the long haul. My boss, Rick Thompson's been doing it for over 30 years. I've been doing it for over 20 years. Many of the people on our team have been in this space for over 20 years. So it's a great business and we're a fabulous group of folks to work with. So that's our plug for BMO Harris bank. And we're getting deals closed right now.
And we are taking risk where others are not. And so I'm planning ... This was always our investment thesis. There's always going to be lenders that'll undercut me on price. And there will be borrowers that chase price. And those are probably not the borrowers I'm going to have longterm as a customer. It's those longterm relationships that you're willing to pay for a little bit of good advice. And you'll sleep better at night knowing that somebody's fighting hard for you internally. And will be there in the long haul.
Yeah. Thank you Mike. I appreciate that. I did a lender survey a couple of months ago now, and the question was basically, are you lending money right now? And if you divided it roughly evenly, a fourth, a fourth, a fourth, a fourth, a fourth said, no. A fourth said, not really. Another fourth said, yeah, cautiously for the right opportunity. And a fourth said, yeah we're looking to take market share and really grow. And so the market is there. There is liquidity, but there's maybe less of it. Still enough clearly. And Mike and BMO Harris are one of the ones I think in that fourth pie of 25%. I think it's important that we talk about having a club of lenders for your growth, right?
Because we talked about the syndication. We talked about how if you're going to be a big franchisee, and you're going to have a big portfolio, you're likely going to have to have relationships with multiple lenders in order to finance large amounts of money. And we did have a question that came in here. And the question was basically, do you treat private equity sponsor-like groups the same way that you do franchisees? I think if I could characterize that question.
My heart is with him, the guy in the pickup truck because I was the guy in the pickup. I am the guy in the pickup truck man. So come on Mike.
I hear you. I hear you. Look, private equity is different than family offices, are different than owner operators, right? Each one has strengths and challenges. The interesting aspect that I've seen, the interesting challenge I've seen lately is family offices are very interested in the space. And they're starting to understand that. And we've financed a few. When we finance the [inaudible 00:48:05] groups investment in [inaudible 00:48:07] restaurant group down in Houston 75 or so Taco Bells, they understood this. This was a great investment for the longterm. It had real estate attributes. It had powerful growth economics, and the ability to build an organization around a really strong, young management team.
And so why would you do that? That makes great sense. I tell a lot of the private equity guys as we said earlier about the internal rate of return. And you're not going to get four and five times your investment like you might in something a little bit more speculative. But these are solid base hits in doubles that you'll get over time with high teens, low 20s kind of levered internal rates of return. And that's a great piece of any portfolio strategy. Certainly one that performs during a pandemic. So, but then at the end of the day, it goes back to the owner operator. This is his family, this is his legacy. Sometimes it's his children's investment, and their children. And they'll want something that lasts for the longterm. And having a really good group of trusted advisors whether it's CPA's and lawyers or bankers around that investment, that's very, very important.
So those are probably some of the important considerations. I think the franchisors are really going to be drivers of who's allowed to own these fast food restaurants in the future because if you think about it, right, there's a lot of cash out there. I've been quoted before saying there's over a trillion dollars of dry powder of private equity looking to find a home. It's probably even higher now, right? And if you're going to invest in the consumer, which is 70% of the economy, right, and the consumer spending, are you going to invest in sticks and bricks, brick and mortar retail clothing stores? Or are you going to go after restaurants that have drive throughs that are incredibly resilient and people wake up hungry every day looking for food, probably half their food dollars getting spent at a restaurant.
So I think the number of buyers will increase over time in the space that we work in. And obviously it will be much, much more challenging for full service restaurant operators, buffet operators, even some fast casual operators until they kind of figure out the drive through aspect of it. It's going to be very challenging. And I won't spend a lot of time on it. The damage or the wreckage is evident, but full service independent restaurant operators ... It broke my heart reading the letter from an independent restaurant operator in New York City that was just posted at restaurantbusiness.com.
Restaurantbusinessonline.come. And just talking about the millions of dollars in taxes that they had paid, or paid out in wages over 15 years in creating a path for people to let themselves out of a really tough situation. Myself included, right? It just gave me a career in ultimately something I'm very passionate about, but I didn't have much to work with. I got a job as a dishwasher, worked up to the bus boy. Worked in the back of the house, in the front of the house. And it was a wonderful experience and built a lot of character in me. And I think about how somebody with a high school education can make six figures as a general manager in the restaurant business at some higher volume stores, restaurants.
That's incredibly powerful. Think of new immigrants who have come to this country and are looking for a place to build families. And this is a great industry to do that. So it breaks my heart when I hear there's still two and a half million people unemployed in the restaurant business. And that number's probably going to grow as more restaurants close and winter comes. I am worried about October, November, December, January for a lot of those full-service operators. But their ability to attract capital is going to be a challenge. The purchase price multiples will come down. There will be more distress sales. It will come back over time. It's not the end of the world.
But investors will be much more guarded around that. And I live in Austin, so it's a fabulous restaurant city with a lot of creativity. And again, it's just crushing to see so many wonderful restaurants go out of business because they can't make it. They can't make it on 20% or 30% down, or 80% down.
Yeah. The industry's going to change. We talk a lot on all the things you hear from me across all of our platforms about the positivity of QSR, and there is the dark side of what's happened through COVID. And we're acknowledging that and certainly we know that a lot of the QSR businesses a little bit is taking from those folks who are unable to now make it. And no one's [inaudible 00:52:52] circumstance. But suffice it to say, I think better times are ahead. And maybe I'm an optimist here, and in a way I shouldn't be, but I think better times are ahead. There'll be some pain and challenges, but [inaudible 00:53:04], we're going to get through it all together. And for those of you who are listening, I'm just thankful that you're consuming our content. Thank you so much for your time, Mike.
It's a blessing to spend the time with you. Here's a way you can get in touch with both Mike and me if you have any questions that weren't answered, or you want to reach out to him directly regarding a finance matter or a lending question. You can ask me too. I'll just say again in closing, please go to our website if you want to get our content hanging on. And we'll send you a copy of the recording of this webinar. And listen to the podcast too on Restaurant Boiler Room, and it's a blessing again. Thank you so much Mike for being here. Great insights brother. I really appreciated our time today.
I love it. No, we make a good team together. You're incredibly optimistic. I bring my sickle to the table with a black hood sometimes and I will end on a positive note. That this will be a great restaurant reset. There will be incredible opportunity coming out of the other side of this. Think of all the pent up demand. And the shortage of supply of restaurants. And for the operators who can survive this test, to find your character to stand on the edge of the abyss and not fall in, this will be an incredible revival. And I'm often reminded of the Spanish flu occurred in 1918, 1919. What came next?
The go-go times of the stock market ...
The roaring '20s.
The roaring '20s. Right. So we might be looking at the roaring '20s in another phase of our lives here. And I feel good about that. Call me anytime. We have a wonderful team of really seasoned people. And I'll get you with the right folks. If you're looking in acquisitions, we'll be happy to help no matter the size. And I look at relationships as a longterm planting of seeds. Eventually they grow into trees. And it may take years, but I'm more than happy to help anybody who asks for it. So thank you.
That's awesome. Awesome. Thanks again for attending. Appreciate it Mike. You guys, hang in there. Be safe. Thanks so much for entering the boiler room today. You can find our podcast on iTunes, Google Play, Stitcher, TuneIn and Spotify. If you like these podcasts, please listen, rate and review. I also encourage you to visit our website at www.unbridledcapital.com for the best franchise M&A and financial resources in the industry. Our website includes podcasts, videos, white papers, webinars and a list of our M&A transactions. Please note that neither Rick Ormsby nor Unbridled Capital LLC give legal, financial or tax advice. These podcasts represent opinions that have been prepared for informational purposes only. We expressly disclaim any and all liabilities that may be based on such information, errors therein, or emissions there from.