QSR operators: Are you getting a good deal on your financing?
By Cory Damm, LeaseQ vice president
Consumer mortgage and auto loan rates have held steady at 2 or 3 percent for the past 10 years. Car manufacturers can even offer zero percent financing by subsidizing rates. It's the cheapest money in the world — and it's warping how we understand the cost of capital.
Leasing and financing are critical tools for QSR brands as they open locations, expand existing ones or even refresh equipment for new menu items or better efficiency. But when single-digit rates are the norm, it's tough for QSR operators to know if they're getting a good deal on financing.
But operators have a right to know the fiscal products available to them and why different options are priced the way they are. That's the purpose of this deeper dive into the pros and cons of Small Business Administration (SBA) financing and loans, working capital, and equipment financing and leasing.
SBA loans and financing
The Small Business Administration does not provide small business loans themselves, rather they guarantee business loans through SBA-preferred banks. With the SBA guarantee, lenders can offer financing to QSRs at the lowest interest rates because the government has promised to pay back 85 percent of the loan in the event of a default.
The primary advantage of an SBA loan is this government guarantee. Because this typically covers 75 to 85 percent of the loan, it eliminates much of the risk for the lender and creates more favorable terms for the borrower. The primary disadvantage is more paperwork and a longer wait for approval, compared to conventional loans.
"The newly implemented U.S. tax law has benefits for QSRs buying new or used equipment. Section 179 of the law doubles the write-off for equipment — including front-of-house and back-of-house essentials — from $500,000 to $1,000,000 for 2018 and beyond. It also allows QSRs to depreciate up to 100 percent of new and used equipment in the first year. This includes payments for equipment being financed or leased."
"The SBA guarantee lets lenders offer financing to entrepreneurs and business concepts that conventional lenders would otherwise decline," DCV Franchise Group Director of Business Development Anthony Byrd said in an interview. "This is especially relevant for QSRs, because banks typically view new restaurants as risky ventures."
Byrd added that SBA loans tend to have lower down payment requirements and longer terms, compared to conventional loans. April 2018 maximum interest rates on SBA 7A loans over $50,000 for a period off less than seven years were 7 percent (4.75 percent base rate plus 2.25 percent markup), according to fitsmallbusiness.com. That jumps to 7.50 percent (4.75 percent base rate plus 2.75 percent markup) for periods longer than seven years.
Working capital exists naturally when a business is properly capitalized for start-up or expansion and has cash in reserve to use as needed. But, most QSRs — and small businesses in general — are not so fortunate. The alternative is to create working capital with short term loans and deploy it in projects that have a rapid return on investment to help with payback.
The wrong way to do this is with a revolving credit line. Like a credit card, a credit line is meant for daily operations and short-term expenses. Using it to buy or finance a long-term asset or project can wipe out quick cash for payroll, supplies and unexpected fluctuations.
The right way to create working capital is with a letter of credit — a basic agreement that allows a business to purchase something for a certain amount of money, within a certain time. The typical window is six months, and entrepreneurs can re-up these agreements for longer. A letter of credit is ideal for QSRs buying or replacing equipment for their locations with better rates than a credit line.
"Many QSRs look at working capital loans like they look at mortgages: They expect a single digit interest rate, but don't have the collateral to back it up," ARF Financial CEO Steve Green said in an interview. "As a general rule in short-term unsecured lending, the shorter the term of the loan, the lower the interest rate, and the higher the monthly payment. The best way to reduce the loan payment is to extend the term.
"For example, a 6-month term will offer the lowest rate. But in most cases, the payments will put too much stress on the restaurant. A 24-month term will have a higher interest rate, but the payments will be much lower, increasing cash flow for the operator," he added.
Equipment financing and leasing ... and the new tax law
Equipment financing is a loan or lease secured by using a piece of equipment as collateral. Financed equipment generates revenue to service the debt and pays for itself over time, improving cash flow and working capital for the QSR. Monthly equipment lease or loan payments are also considered a pre-tax business expense.
Speaking of tax, the newly implemented U.S. tax law has benefits for QSRs buying new or used equipment. Section 179 of the law doubles the write-off for equipment — including front-of-house (FOH) and back-of-house (BOH) essentials — from $500,000 to $1,000,000 for 2018 and beyond. It also allows QSRs to depreciate up to 100 percent of new and used equipment in the first year. This includes payments for equipment being financed or leased.
Along this vein, we like to tell the story of a chef who recently financed $820,000 in equipment for her kitchen and bar, including TVs and audio, signage, point-of-sale (POS) systems, furniture and artwork. Under the old Section 179, she could only write off the cost of her BOH equipment, which was just under $500,000. Now, she can write off 100 percent of the equipment for her restaurant, better manage her cash flow and begin serving customers at her refreshed location sooner.
Consumer understanding of the cost of capital can become easily disjointed. As a finance industry, it's our duty to educate QSRs and businesses across industries about the types of financing available, and ensure they have access to the right options to grow their business while increasing their earnings.
Cory Damm is vice president of client services at the online marketplace for equipment financing, LeaseQ.
Topics: Back Office, Business Strategy and Profitability, Equipment & Supplies, Financial News, Financing and capital improvements, Food Cost Management, Food Trucks, Franchising & Growth, Furniture and Fixtures, Industry Services, Interior Décor, Operations Management, Ovens, POS, Restaurant Design / Layout, Self-Ordering Kiosks, Systems / Technology