The Coronavirus pandemic (COVID-19) has small businesses and franchises on life support. Cash is the lifeblood of any business and revenues are nearly non-existent due to the quarantine taking place throughout the country.
Franchise owners are struggling to figure out what to do as these shutdowns were unexpected and could create a possible recession.
8.4 million Americans are employed by franchises according to Statista.com and the top franchise industries are food, service, and travel, all of which require physical interaction among other humans. With the quarantine in place, franchises are having to lay off either all or a portion of their staff as some locations are still able to offer limited services while social distancing. For example, some fast-casual restaurants are offering only drive-through/curbside pickup and third party deliveries while others are completely shut down
On March 23rd, 2020, the Federal Reserve lowered the target range for its federal funds’ rate by 100 basis points to 0-0.25% as a way to boost the flow of credit to consumers and small businesses. Following the interest rate cut, the federal government, as well as local municipalities, are aggressively offering low to interest-free Economic Injury Disaster Loans to certain businesses that qualify (link provided at the end of the article for more information on these loans). This is great for small business owners as it is offering temporary cash infusion to assist with their day to day expenses. Within these expenses, the government is even offering small businesses the opportunity to have costs related to payroll, utilities, and rent forgiven.
With the recent news of the government running out of money and those who do not want to wait on the Federal Government for these loans, listed below are additional funding options that can delay repayment while giving the business a runway to build up cash flow. These options do require access to investors that are open to being flexible with their investment strategy.
Revenue-based financing is an option that allows equity-conscience franchises to raise funding without giving up equity or profits, and also bears no monthly debt payment. The business will repay the funding by sharing a percentage of its gross revenue with the investor. This is already common practice with the franchisee as per their franchise disclosure document, as every franchisee/operator has to pay a percentage off of their sales to their franchisor as a royalty. This option may not work for some franchisees as they are already paying a royalty on their gross sales, however, for an emerging franchisor, this could be an option for them if they don’t want to take on more debt but still want to sustain and grow the business. They would not be confined to any royalty agreement as they are the franchising system. Here is a template of a revenue share agreement courtesy of legal firm Cutting Edge Capital.
Shared Earnings Agreement
A Shared Earnings Agreement or “SEA” is an investment instrument that allows an entrepreneur to raise capital without giving up equity or having a percentage of your gross revenues taken away. It’s like raising equity capital without giving up ownership and control of the business, but the investors financially benefit when the owner financially benefits, that way they are more invested in the business. This might be a good option to some as it wouldn’t infringe on the royalty agreement between the franchisee and franchisor. The emerging franchisor is still able to use this option as well. Once the franchise business reaches profitability, the SEA calls the company to make payments to the investor(s) but only up to a predetermined amount, called an “earnings cap” which could amount to 2-4 times the original investment. Once the cap has been reached, franchise owners are free to continue on without any future payments. Here is an example of a Shared Earnings Agreement courtesy of Earnest Capital.
Convertible debt is an equity investment instrument with “debt-like” features. It’s an investment instrument that is common in the venture capital industry, typically serving as a bridge loan for early-stage startups when they are in between financing rounds. For example, a company may need capital to fund payroll or other necessary expenses prior to their next round of funding. Though convertible debt is mostly used in the venture capital industry, it can really be applied to any industry, such as franchises. Traditionally, convertible debt works as such:
The investor will invest X amount into a company along with interest for a period of time. At the maturity date, the note will convert into equity at the company’s next funding round. Franchises don’t have “funding rounds”, however, the instrument can still be used and made suitable for a franchise. Instead of converting to equity, the note may have a balloon payment at maturity date, or be converted into a term loan at the maturity date if the principal balance and interest is not paid in full. Here is a Convertible Note Agreement that can be updated to meet your standard.
For those who are considering applying to the SBA’s Economic Injury Disaster Loan Program, or the Payroll Protection Program we have highlighted them in this blog post that includes all of the basic information one would need to understand the terms of the loan. Any small business owner can apply for these loans on the SBA website.
Regarding the funding options above they are not the silver bullet, but are additional options to help satisfy a business’s short-term financial needs. Investors are still hard to obtain during these difficult times, but the above options may help build confidence in investors as they are more risk mitigated than equity. FundingFuel would still recommend seeking legal counsel prior to using any of these investment instruments.