Is bank accreditation yesterday’s hero?
Several recent developments have cast doubt on the future of the current methods for bank accreditation of franchise systems.
It seems inevitable that at some point Australia will move away from the current processes where banks “accredit” franchise systems to a more user pays model.
However even more serious doubt has been cast on the future of traditional bank accreditation by efforts to link bank accreditation of franchise systems to some sort of implied bank endorsement of the model.
Probing questions as to whether bank accreditation is an endorsement, or is misleading, were addressed to the Franchise Council of Australia and others by the Parliamentary Inquiry into Franchising, and have raised concern amongst some experienced franchise bankers.
Although there seems little basis for any genuine claim, in the current climate banks could easily decide not to take the risk. Smart franchise systems are moving to take control of their own destiny by having their own transportable bank credit material. Like the demise of the Berlin Wall, if change happens, it could happen very quickly.
Let’s take a look at what has happened, and more importantly, where to from here?
What is impacting bank accreditations?
There are a number of franchise related issues confronting banks today including:
Reduced growth prospects
Banks are in the business of lending money and the franchise sector has provided a solid pipeline of new transactions for decades with a seemingly sound risk profile.
Although franchising continues to punch well above its weight, in both GDP contribution and employment, the short term growth prospects are no longer strong. It is little surprise that enquiry levels from prospective new franchisees have fallen sharply with the adverse and sustained media coverage that has engulfed the sector over recent times.
Asset quality concerns
A natural bi-product of reduced confidence and enquiry levels is a weaker secondary market for existing business resales which in turn creates higher risk for both business owners and lenders.
The broader retail sector is also far from buoyant and with such a large proportion of the franchise sector in retail this creates its own concerns. In particular, the current challenging environment in retail shopping malls, which has been largely ignored in the Inquiry and related media coverage, is likely to be of significant concern to lenders across many small businesses not just franchises.
Highlighting the focus on asset quality vigilance, was the remarkable increase in major bank risk personnel attending the recent Annual Franchise Lending Summit.
The cost of maintaining accreditations
Most major banks estimate a minimum cost of $20,000 to assess an accreditation and a similar amount to complete an annual renewal. With less transactions to assess, and weaker growth prospects, the logical reaction is to cut personnel which in turn reduces the ability to maintain marginal accreditations. This has played out in reality with staff reductions and the number of accreditations also under pressure.
Over recent years we have seen Australian lenders following US trends where the reliance on independent information far outweighs individual accreditations with banks. For example, more than 8,000 US lending officers subscribe to the US Franchise Registry where they can access various types of information to input into their assessment of individual transactions negating the need or value of completing their own accreditation process.
In addition to the adverse publicity from the Banking Royal Commission, the Committee of the current Parliamentary Inquiry into the Operation and Effectiveness of the Franchising Code of Conduct has also suggested that banks have played a part in the failure of some individual franchised units through their lending programs.
This is likely to trigger a round of accreditation reviews and may discourage the provision of new accreditations in the short term.
Where to from here for franchise finance?
Understand that some things don’t change
Even during the current adverse climate many brands continue to enjoy lending programs through the strong performance of their franchisees and the invaluable support a strong franchise system can provide to both the individual franchisee and their lender.
Others have taken simple but key steps to highlight their transparency and commitment to working in partnership with their lenders.
Banks remain in the business of lending money and will continue to do so when the risk profile of a transaction is solid. Franchising is only one part of their massive lending portfolios and when their existing loan book is sound and future opportunities are apparent the lending wheels will turn.
Fortunately for the sector over recent years we have also seen the emergence and strengthening of alternative funders, particularly in the area of equipment finance.
Recognise that better information unlocks improved finance
The greatest risk for a lender is uncertainty. The greatest uncertainty comes from no information, which in reality is what most banks feel they are being asked to make an assessment on.
One of the worst mistakes a franchise system can make is to point to the number of outlets as a yardstick pf achievement.
Lenders supplement their own industry knowledge, with the quality of their loan book, the support they see being extended to underperforming franchisees and any additional information they can access. It is critical the information they receive is in a language they understand and trust.
Getting to yes
With less bank accreditation apparent, at least for now, the majority of transactions will be assessed on a case by case basis. Accordingly, it is almost pointless for franchisors to ask banks about what is required to get an accreditation. The question needs to be: “What more can we do to make it easier for you to lend to our franchisees”?
Transparency (highlighted on The Australian Franchise Registry™) and the availability of independent and objective information for lenders will go a long way to getting the right answer to that question by focusing on tomorrow’s opportunities rather than yesterday’s events.