The beat goes on

When my business partner and I started on this road to buying a struggling restaurant chain, we attended a search fund panel featuring the best of them: Joel Peterson, Chairman of JetBlue, head of Peterson Partners, and much-beloved lecturer at Stanford GSB; Jim Southern, legendary search funder and now Boston-based search fund investor; and others listed here. The forecast was not good. Not only was the average searcher taking one to two years to identify and buy a target, the financing was becoming more difficult as banks (i.e. "senior debt") became more risk averse in the wake of the country's financial crisis.

We've confirmed how difficult financing is. Longtime industry consultant Mark Saltzgaber puts it succinctly in a Chain Leader interview: "Generally speaking," the types of financing available range from: "traditional bank financing, SBA (Small Business Association, or Federal Government) loans, equipment financing, sale leasebacks (given owned properties), and subordinated debt and private equity (friends and family, 'angel' investors and institutions)."

Right now, banks want a lot of evidence that a business will do well before financing it, either in the form of consistent, growing sales, or saleable assets (in the case of foreclosure). SBA loans, which are administered by traditional banks, remain difficult as well, given banks' attitudes towards business financing. Equipment financing is generally available through shops like GE Capital, but they're usually not integral issues for people like my b-partner and me, who need a lot more money than what it takes to buy a new oven or walk-in refrigerator. Sale leasebacks, or the practice of selling the land underneath a business only to lease it right back, are only an option if the business comes with land -- but smaller chains don't tend to have this option available.

What's available is subordinated debt, or so-called "junior" debt. This debt comes from parties like the seller, or from other debtholders who are lower down on the pecking order than traditional banks, and therefore carry more risk for the debtholder. If the business collapses, "senior" debtholders have first dibs on what's left. Then the junior debtholders. And then the equity holders. In exchange for taking on a subordinated position in the pecking order, junior debtholders charge more interest. So if banks are taking 5% for their first-in-line right to take back what they're owed, a seller who is financing a portion of the sale might charge 10%. Equity holders, like family and friends, might expect back 20% return on their investment. And so on.

We've accepted that we have the best shot at financing if we have more to put in. As everyone says, there's nothing like putting some of our own "skin in the game" that indicates that everyone's interests will be aligned. So while we're searching, we're trying to cobble together some money of our own, by taking odd jobs (MBA style), and living as sparsely as we can. We're also keeping a tight loop with our favorite banker (a fellow at Wells Fargo), making sure we're aware of what's going on in that world in case senior debt becomes available again. There are some angels we're ready to tap once a good investment opportunity becomes clear.

The beat goes on! We don't know what we'll end up with, but we're sure gunning for something good. Next post: an update on the search itself.