INDY Committee Meeting

STANDING COMMITTEE ON INDUSTRY

COMITÉ PERMANENT DE L'INDUSTRIE

EVIDENCE

[Recorded by Electronic Apparatus]

Tuesday, November 3, 1998

• 1544

[English]

The Chair (Ms. Susan Whelan (Essex, Lib.)): I'm going to call the meeting to order. Pursuant to an order of reference of the House dated Tuesday, October 6, 1998, we are here to consider Bill C-53, an act to increase the availability of financing for the establishment, expansion, modernization, and improvement of small businesses.

I want to welcome our witnesses here today from the Canadian Restaurant and Foodservices Association. I want to apologize for our delay in commencing the meeting, but we do have a number of members here now. Considering that it is going to be a verbal presentation, I thought we should wait until we had a sufficient number of members.

That being said, I'll turn it over to Mr. Ferrabee to begin the presentation, and we'll let you decide what will be the speaking order.

Mr. Michael Ferrabee (Vice-President of Government Affairs, Canadian Restaurant and Foodservices Association): Thank you very much, Madam Chair. I want to thank you for inviting us as a group to appear in front of your committee. It seems that my appearance and that of others piqued your interest in the issues we raised last week, and I'm very grateful for that. I also want to personally thank each of you as members of Parliament for your continued interest and concern about a program that you all know by now matters a great deal to the restaurant and food service industry in Canada. You probably know that the restaurant and food service business in this country is one of Canada's most labour-intensive industries. Fully 30¢ of every dollar you spend in a restaurant makes its way in one form or another back into the pockets of employees. We employ 876,000 Canadians in this country and we are one of the largest sectors in the country.

• 1545

I have with me today the senior financial or operating officers from a cross-section of companies from across the country in the food service business. I also have with me operators who wear two hats, as food service people but also as activists in the Canadian and Quebec franchise associations, and they'll introduce themselves.

We've come here today to specifically raise with this committee the importance of the existing Small Business Loans Act to our industry and also to address the two biggest provisions of the draft regulations that cause us concern. I will be introducing, and we'll work our way down the table, the people who have joined me today who have come in from across the country. At the end of their presentations, I would like to propose a solution to this committee. It was hammered out last evening by CRFA, the Canadian Bankers Association, and the Canadian Franchise Association, with the help of officials of Industry Canada who came down to Toronto and made themselves available.

First, I'd like to introduce the witnesses who are with me today: Stefan Rishikof is the director of real estate and franchise development of Cultures Restaurants Inc., Toronto; Alain Villeneuve is the vice-président exécutif de Chez Cora déjeuners and Breakfast People of America, from Montreal; Axel Rehkatsch is the senior vice-president and chief financial officer of A & W Food Services of Canada, Inc., and he has come here from Vancouver; Peter Ruscio is vice-president, finance and administration at M-Corp inc., from Montreal; Pierre Filion is a senior district sales manager for Pizza Pizza Limited here in Ottawa, Ontario; and Michael Whittaker is the president of Grinner's Food Systems Limited of Truro, Nova Scotia.

I will turn it over to them for their comments. As I said, I have some concluding remarks following their interventions. We will start with Stefan Rishikof.

Mr. Stefan Rishikof (Director of Real Estate and Franchise Development, Cultures Restaurants Inc.): Good afternoon. Before starting, I'd like to introduce myself.

My name is Stefan Rishikof and I'm the director of real estate and franchise development with Cultures Restaurants Inc. Cultures Restaurants is a regional chain comprising 41 restaurants, of which 39 are in Ontario and two are in Quebec. Let me add that we have three restaurants here in the Ottawa region.

Cultures' annual sales are approximately $18 million and we employ close to 400 people. The majority of these employees are young people and newcomers to Canada. As a franchise system, our strategic goal is to expand through franchising. As I will detail during my brief time before the committee, the proposed changes to the SBLA contemplated by the House of Commons industry committee will have serious negative implications on our ability to expand and consequently to create employment.

Prior to my current position with Cultures, I was an account manager for four and a half years with both the Hongkong Bank of Canada and the Bank of Montreal, both in Montreal.

At this time I would like to share with you experiences I have had working in the trenches of both careers. During my career in banking I had the opportunity to utilize the business improvement loan under the SBLA to grant loans to several small businesses. As you know, or maybe you don't know, applying, complying, and finally disbursing an SBLA loan is at times an arduous process. However, the joy and relief on the part of the borrower when it comes together is truly satisfying.

• 1550

During my career with Cultures Restaurants, the same experience was true. When the franchisee is finally behind the counter serving customers, they are beaming with pride. In both cases, the SBLA formed an integral part in helping them to realize their dreams. Thus, my experience with the SBLA, as both a lender and a vicarious recipient, has been favourable. It has served its purpose to finance small business people who have acquired a Cultures franchise.

When qualifying a franchise candidate, in addition to considering their previous work experience, we screen each candidate via a rigorous financial and credit evaluation system. Briefly, this entails a background reference check and ensuring that they have a minimum of 40% of the purchase price in cash. This equity requirement reduces the financial pressures and helps to focus the franchisee on restaurant operations. Also, we ensure that the candidate has the attitude, work ethic, and sweat capital required to run a restaurant.

While each of these skills can contribute to the success of their business, without the financial resources offered under the SBLA, there would be no opportunity for them to implement their skills. Unfortunately, desire on the part of the franchisee/borrower is not enough. Thus, the proposed changes to the SBLA would make it impossible for these candidates to open their businesses.

During 1998, five of our existing franchisees sold their restaurants. Each sale was motivated by different reasons. There were health issues and other business opportunities.

Whatever the case, if the proposed changes were introduced, it would effectively shut out these resales and unfairly punish these small business owners. In addition, during 1998, two new Cultures restaurants opened, both of which were financed with the SBLA. Without the SBLA, the ambitions of each franchise would not have been fulfilled.

In the retail business, a retailer only has 10 seconds to capture the attention of the consumer. Therefore, it's important that our restaurants are able to capture and attract the eye of the consumer. Cultures obligates the renovation of the restaurant as a condition of each resale. In this manner, we ensure that each restaurant stands out among the clutter of the competition. Generally, a renovation consists entirely of leasehold improvements.

The proposed changes contemplated to the SBLA would make this virtually impossible. Therefore, to summarize, 90% of new franchisees utilize the SBLA and 90% of our resales of our existing system use provisions under the SBLA.

Regarding the 50% buyback provision, Cultures Restaurants Inc. will not provide a guarantee for the SBLA. While we are confident in our concept, we will not provide a guarantee that has no upside potential for us.

As can be seen, the SBLA provides a vital role in the hospitality industry. It's an indispensable system that provides liquidity for franchisees to pursue their own aspirations.

The proposed changes will, without question, impair and impede both the expansion of us as a franchisor and our franchisees via the resale market. As such, I believe the proposed changes, as outlined in subsections 5(4) and 12(7), must be eliminated.

Thank you for your attention.

The Chair: Mr. Villeneuve.

Mr. Alain P. Villeneuve (Executive Vice-President, Breakfast People of America): I'm one of those who Mr. Ferrabee introduced as wearing two hats. That's because I sit on the board of the Quebec Franchise Association and I'm also involved in the Quebec Restaurant Association.

I would like to introduce myself a little bit more. I am the executive vice-president of Breakfast People of America, which is a corporation based in Montreal. We have actually 30 franchisees, so there are 30 locations. There's the

[Translation]

Chez Cora Déjeuners.

[English]

Unfortunately, there isn't one in Ottawa. Our annual sales reach an average of $25 million, and we support approximately 600 jobs in Quebec. Actually, we developed our network with the great help of the SBLA, and I would say that none of those restaurants would have been opened without that support.

• 1555

As my friend said before, we also ask for 40% cash down from each franchisee. It's quite a lot of money. Those people are operators, not investors. Without that support they wouldn't be able to open new restaurants, and there wouldn't be the creation of new jobs.

I feel that the problem we have to face eventually with the modification of the regulations won't affect just the restaurant industry; it will affect the whole franchising industry, which is actually growing at a pace far above that of the retail industry.

You may know that more than 40% of the retail industry is covered or run under the franchise system, and those modifications would be an intrusion into the relationship between the franchisor and the franchisee. To my knowledge, this doesn't exist even in those countries where there is strong regulation on franchising. I'm talking about the States and about France, where la loi Doubin, which is one of the most recent regulations, does not cover such relationships. I feel it would affect completely the essence of the franchising by asking the franchisor to act as an investor or a guarantor to the franchisee.

I feel that our own development in our corporation, which is planned to cover the whole country, won't be possible if the modifications that are on the table are adopted.

I thank you for your attention.

The Chair: Thank you very much, Mr. Villeneuve.

Mr. Rehkatsch.

Mr. Axel F. Rehkatsch (Senior Vice President and Chief Financial Officer, A & W Food Services of Canada Inc.): Good afternoon, Madam Chair. Thank you very much for the opportunity to visit with you this afternoon.

My name is Axel Rehkatsch. I am the chief financial officer of A & W Food Services of Canada. Our headquarters is in North Vancouver. I flew out today to share with you our deep concerns about the changes that are proposed under the Small Business Loans Act.

A & W started in Winnipeg in 1956. It was the first Canadian hamburger fast-food chain. Today we operate and franchise 507 restaurants across the country. We have sales of $335 million. There are 265 independent business people who employ approximately 15,000 people across Canada.

This year we have opened and plan to open 45 new restaurant locations, and as many next year. Each of these creates further employment opportunities. To achieve this, what we have done is we have developed financing programs with four of the major banks in Canada in which we put together a pre-approved program of approving franchise operators who invest 40% cash and who borrow 60% debt. We've done that around the core of the existing small business development loan. The majority of the new operators we're now putting into business will seek and avail themselves of these loan opportunities.

Leasehold improvements represent almost 50% of the assets that are acquired by the business. These are integral parts of operating a restaurant. These are major components that are inseparable from the business inasmuch as they represent the heat, lighting, and air conditioning of the restaurants, together with the tiling and most of the built-in equipment. Therefore, they are an indispensable part, and excluding any portion of those would make the existing financing of the business unviable.

• 1600

In the case of existing leaseholds, restricting the ability to finance the buyout of one operator to another is a disadvantage for us in expanding jobs inasmuch as currently, as often happens in other businesses, some operators sell out and thus allow new operators to enter the business. Those who sell and exit the business in turn buy another business, which in turn generates further employment. Therefore, all these particular programs help build the total economic growth of the country and employment.

In reflecting on the proposal to change the regulation regarding whether or not the franchise, or A & W, would guarantee 50% of the leasehold, we thought long and hard about it, but in the end we rejected it. The reason we rejected doing so is that this in effect would be a charge against the balance sheet of our company, and we therefore would not have that money available for further expansion and for our own growth. Therefore, it in turn would restrict the ability to foster and develop more jobs.

We believe, as every responsible franchisor does, the business must be on a sound footing. We do a considerable amount of due diligence to try to ensure that happens. We believe the current program meets the needs of the current new people coming into the business. It meets the needs of people who exit the business and then therefore grow the business for someone else. It's a program well suited to our industry, and I request the support of this committee in making sure these proposed changes are not put into effect.

On the downside of being a responsible franchisor, I'd like to share with you that I've been with A & W for 23 years, always in key financial roles throughout the company. During that time I'm aware of only one case where a SB loan had to be worked out, and we did that with very minimal cost to the program.

Thank you for your time.

The Chair: Thank you very much, Mr. Rehkatsch.

Mr. Ruscio.

Mr. Peter Ruscio (Vice-President, Finances, M-Corp inc.): Good afternoon. My name is Peter Ruscio. I'm the vice-president of finances with M-Corp inc. in Montreal. We're the franchisor of Mikes Restaurants. Currently, we have 113 units, one in Moncton and the balance in Quebec, which generate sales of about $100 million a year and which support approximately 4,000 jobs network wide.

I'm here today basically to support the small business loans program and to explain a little bit about its key role in our development over the last 30 years. Our trade has been around since 1967. It has been instrumental in our development to 113 units and in developing opportunities for small businessmen in Quebec.

In recent history and currently it is probably the single most important program available for financing investment in new restaurants and to promote our development into the maritimes and other geographic regions of the country.

It has also been instrumental in our current renovation program. After 30 years of our being a chain in Quebec, the renovation of our network is essential in order to survive in the competitive world of the restaurant industry. Therefore, this program has been instrumental in our renovation efforts as well.

I'd also like to comment on the guarantee, which we have also thought about considerably. Essentially, it would impact our balance sheet and financial statements as franchisors and therefore limit our resources to invest in other programs, such as research and development and training of employees, which are also key issues in the franchising and restaurant business. In addition to that, I think it would give a competitive advantage to larger multinational companies coming into the country.

Thank you.

The Chair: Thank you very much, Mr. Ruscio.

Mr. Filion.

Mr. Pierre Filion (Senior District Sales Manager, Pizza Pizza Limited): Good afternoon. My name is Pierre Filion. I'm the senior district sales manager for Pizza Pizza.

Pizza Pizza has been in operation since 1967. It currently has 317 locations across Ontario and in parts of Quebec, with annual sales of approximately $175 million. At this time we employ approximately 4,000 people in what we believe are very important jobs. They are jobs that often lead to careers, so they are good starting points but they also develop into careers. A lot of our senior people, including myself, have been in the business for over twenty years and started anywhere from being delivery drivers to pizza cooks. It's well worth noting that these jobs do in fact lead somewhere.

• 1605

I would also like to mention that approximately 90% of our franchisees have benefited from the small business loan. They have in fact provided them with the opportunity. They had the energy, they had the want, but did not have the ability to seek other forms of financing, and this has given them the opportunity to get into business and with a very good success rate. It is also worth mentioning that at this time we're in the process of renovating a large number of stores, well in excess of approximately 150 locations, to better suit the changes that have taken place in the industry, be it through the expansion of our menu, our product line or seating, which is currently the case. These leasehold improvements can amount to well over $100,000 and would not be available to the franchisees if it weren't for the Small Business Loans Act. Again, it's very critical. We have already renovated several stores. I myself have done ten just in the Ottawa area alone this year, and with great success. We know that it is proven and we also know that it's imperative for us to support our franchisees, so that they too obtain these funds to renovate so they can compete more effectively in their marketplace.

The franchisees who are in these locations we're talking about go through a very lengthy training process to assure us that they are competent and able to run these operations, that they are not high-risk operators. We have a lengthy relationship with them. We want to make sure that if they are in fact buying a business they are likely to succeed. We're not interested in turnover. We rely on their energy. Our whole support staff is there so that they will succeed. I myself have been around long enough to be able to see some of these operators pay off their loans, reinvest into the business, either relocate it, increase its size or bring it to today's standards, with great success. It's really pleasant to be able to see the growth that is taking place within the chain, and the volume, and of course the jobs that this creates throughout the industry.

With regard to the guarantee of the 50%, we are very concerned about this because we feel it would in effect tie our hands in regard to the moneys that we currently put aside for the support and/or the growth, the research development or the growth opportunities, that we feel we need to hang on to.

On a personal note, I will bring a little bit of importance to the fact that we keep talking about jobs and we keep talking about the restaurant sector, and as mentioned, I can't stress enough the importance that twenty years ago I was probably somebody who benefited. I was employed as a driver in a location and I have been able to create a twenty-year career that I'm very proud of. I enjoy the business and I enjoy the opportunity to be able to compete in the food sector, and I cannot stress enough the importance this Small Business Loans Act plays in that role. Without it I could not have renovated and opened the locations that we have in Ottawa or any other parts of Ontario, because we're dependent on it. We're dependent in order to be able to compete and to continue.

Thank you very much.

The Chair: Thank you very much, Mr. Filion. Now, we'll turn it over to Mr. Whittaker.

Mr. Michael Whittaker (President, Grinner's Food Systems Limited): Thank you, Madam Chair. I'm the president of Greco Pizza Restaurants in Atlantic Canada. We are a 91-unit pizza chain—yesterday we were at 90 units, today we're at 91 units, I'm pleased to say—in the Atlantic provinces. We employ about 1,200 employees, two-thirds of those being youths. We have $24 million in annual sales and we are throughout the Atlantic provinces. I'm also one of those people who are wearing two hats here today because I also sit on the board of directors of the Canadian Franchise Association.

• 1610

First, I want to talk a little bit about the importance of SBLs to our company. I was quite surprised when I did some research over the past few days and realized what percentage of our stores are using SBLs. Of the stores we have in our system, 73% have been financed with SBLs. They have been critical to our growth in Atlantic Canada. Our franchisees are small business owners, so SBLs provide critical access to capital that banks just won't provide. SBLs have been extremely important to us and are one of the key elements of our success.

I flew in today from New Brunswick because I'm very concerned about the proposed legislation on the SBLA. First, on existing leaseholds, our experience is that almost every time a restaurant is resold or reopened it improves. New owners provide renewed energy and new ideas, making the business more successful and contributing more to the local economy, particularly in creating more jobs or, at the very least, making existing jobs more secure. Without existing leasehold financing on SBLs, my company would experience many fewer units and a higher percentage of poorly operating units that could eventually be susceptible to closure. Also, an independent restaurant that may have closed is a perfect candidate to be reopened under our successful franchise concept, creating new jobs in the community. Removing existing leaseholds would virtually kill any new growth we may experience in this area.

A second major concern about the proposed regulations is the buyback agreement from franchisors. The franchise industry is as diverse as the restaurant industry. Small regional franchisors like me cannot possible be treated the same way as a large franchisor. This will create an unfair imbalance between large and small franchising companies. I can guarantee you right now that we would never agree to a buyback provision in stores. Franchisors are not in the position of guaranteeing loans; it would simply represent a contingent liability on our balance sheets.

I am also a board member of the Canadian Franchise Association, and last Tuesday at our board meeting in Mississauga we distributed these regulations. The response was clear and overwhelming. Franchisors were quite upset. This is an unfair and unwarranted intrusion into the franchisee-franchisor relationship. The franchise industry is a major player in the Canadian economy. Why penalize or discriminate against an industry that is exploding in economic growth?

This regulation discriminates against the industry that most successfully uses SBLs. It would be punitive to mature systems, and I should add that mature systems often have fewer defaults due to the fact that they have an established track record. I should also mention that Ron Greenwood, the chair of the Canadian Franchise Association, was involved in these discussions, which I think took place last night, and supports the concerns we're discussing here today.

These new regulations would eliminate the benefit of small business loans, so I urge you to understand and study the significant implications to small business growth that these three onerous regulations would pose, particularly to growth in the restaurant and franchise industries. The SBL program is a very good program as it sits now, and we urge you to please not tamper with it.

Thank you.

The Chair: Thank you very much, Mr. Whittaker.

Mr. Ferrabee, you had some closing comments?

Mr. Michael Ferrabee: Yes, I did. Thank you very much, Madam Chair.

I think you have a good cross-sample of the industry from across the country and I think what they did is raise a couple of key points. One of them is that obviously the Small Business Loans Act as it exists today is enormously important to the operation of their business. I think they also gave you some very important evidence from their own business with respect to the impact of existing leasehold improvements as well as the 50% buyback. What I wanted to do was fill in the committee on a meeting we had last night with Industry Canada officials at the CRFA offices with respect to the draft regulations and the legislation.

• 1615

We spent some time talking about the draft regulations. I also had the good fortune of talking to other groups, and I am now convinced that there may well be a solution on the horizon to the issues we've raised today and that I've raised previously.

You've heard from operators in our industry representing the Canadian Franchise Association as well as the province of Quebec. In all cases you heard of the importance of the existing SBLA to their operations. It's a government program that in its present form works, as Michael said.

As we said repeatedly both here and in front of another parliamentary committee, it's a good program that should not be tampered with. It's fulfilling its mandate, and it appears to be well on its way to operating on a cost recovery basis. If you need any assurances as to its importance, I think the eloquent testimony of operators here today provided that context.

You've also heard about our concerns with existing leasehold improvements and the 50% buyback provision for franchisors. If I could just clarify, the existing leasehold improvements category was explicitly excluded in the draft regulations, and that will have an impact on existing businesses and the available pool of capital. The 50% rule in the regulations, as I understand it, applied only to franchisor-franchisee relationships, and other leasehold improvements could in fact go ahead.

Discussions with the department last night and the proposals made by the CBA in its most recent letter, which I think you've been given a copy of, satisfy our concerns. We had a very useful meeting. Industry Canada officials were in the room and on the telephone, and, as Mike mentioned, the head of the Canadian Franchise Association was also involved.

I think you'll find the language in the Canadian Bankers Association letter to be very compelling. I will provide my own spin on it. I think what their letter says quite clearly is that it is recommended that the legislation as presented be passed by this committee on the condition that Industry Canada at its appearance on Thursday agrees to the following: that the regulatory provisions that exist today with regard to existing leaseholds and the security provisions be kept in place until such time as there can be a consensus reached by all stakeholders on how to address the concerns of abuse raised by the department with regard to these areas.

In practice, as I understand it, this means that the status quo of the existing SBLA would remain until we all can agree. We would have to agree on wording that keeps the program accessible to users in our industry and others while dealing effectively with the concerns raised by the administrators of the program.

We support not only the existing SBLA but also the cost recovery nature of the program. As such we have a direct stake in ensuring that the program is being run efficiently and effectively. If there is abuse in the system, we all end up paying for it because it's being run on a cost recovery basis.

I do have every confidence that working with Industry Canada and all stakeholders, we will be able to arrive at a consensus on the draft regulations that satisfies everybody involved.

Finally, further to my comments in front of your committee last week, I wanted to mention to you that all of my dealings with officials in the industry department have been solidly both professional and collegial. It was, in fact, the industry department itself that walked me through the regulatory changes, directed me to the sections that would likely impact our industry, and helped me to formulate appropriate questions for my members who are engaged in discussions about the impact of the draft regulations.

I have no reason to believe that the kerfuffle created by the draft regulations was anything but a well-meaning attempt by officials to address what they perceived as potential problems with the existing program. I also have every confidence that they now fully understand our concerns, based on our conversation last night, and that they will go the extra mile to ensure that our concerns are addressed.

Finally, in conclusion, I wanted to thank again each and every one of you on the committee for allowing our industry to have a platform in which to raise our serious concerns. I believe you've done a real service to this Parliament and also to your constituents, and I wanted to personally thank you all.

The Chair: Thank you very much, Mr. Ferrabee.

I want to go to questions now, and I will turn it over to Mr. Jaffer to begin.

Mr. Rahim Jaffer (Edmonton—Strathcona, Ref.): Thank you, Madam Chair.

I'd like to thank all our witnesses today for travelling from all around the country to be here. I think it's a very important issue.

• 1620

It's interesting that we're dealing with franchise organizations in particular, because that's my background. Before I was a parliamentarian, I ran a coffee shop franchise from Edmonton. Actually, it was financed by the SBLA, so our family benefited from that.

I want to play devil's advocate for a moment. The SBLA was created to provide financing for small businesses, but it usually targeted the high-risk areas where people wouldn't necessarily get financing from other sources, and the government would step in to allow for that to take place.

It's ironic, because in the case of franchises, they have a track record. They've actually been proven in the market. They grow because of people's interest in the names and franchises, and they actually are successful in their operations. I know that even in the case of my particular franchise, there was an agreement made with particular financing organizations because of their track record. I heard some of our witnesses talk about certain portions of capital that investors would bring to the table and that then the bank would step in and finance the rest.

My concern is—and I would like to hear the opinions of the witnesses—that because you come from the restaurant industry, which in most cases tends to be successful and continues to build, instead of looking at ways to try to improve a program that could at times almost work against you because of the fact that it restricts to some extent banks' flexibility in loaning in many cases, wouldn't it be to your advantage, given your place in the market, to look at the option of trying to fix the Bank Act or trying to create more competition in banking that could in turn, I think, provide more success for your industry and actually provide lower rates, more competition, and so on and so forth? I'm simply throwing this out, and I would like to hear your opinions on it.

The Chair: Mr. Ferrabee.

Mr. Michael Ferrabee: Maybe I could react to that initially and then see if there are some people here who have some things they would like to add.

I think greater competition in the banking sector and all kinds of big picture policy ideas are a really good idea. I think that if we take apart all the pieces of the financing arrangement and everything else, we may find a better way of doing this than through the SBLA.

But I want to make it very clear so that people understand. We think the program works. We support it. I think you've heard testimony here today about the importance it has played in the economy and in the development of a sector that traditionally had an enormously difficult time getting financing. Maybe some of the people around the table can add to this, but I've talked to a lot of restaurateurs who have said that prior to the SBLA, if you walked into the office of a banker and said, “I have this great idea for a restaurant,” there was a secret passageway out back that you found yourself in pretty quickly. It was virtually impossible in a lot of places to get financing in this industry prior to this program. It has worked exceptionally well.

Is it the best possible configuration if we had the best of all worlds? Maybe not, but our sense is that it works very well and that it's one that should be supported and one we feel we have a real stake in. We think it has done very well. It has helped an industry that I think provides an enormous number of jobs in this country and one that we think is really important.

The Chair: Mr. Rehkatsch.

Mr. Axel Rehkatsch: Let me add a couple of comments. I can give you a tangible example. In 1991 the Canadian Imperial Bank of Commerce had a prohibition of lending any money to restaurants in the province of Saskatchewan. They had sufficient invested in that sector, and they were not prepared to lend any more money to it. If you recall, that was the year there was a recession, and consequently they were risk employers. So without the SBLA program, restaurants would not have opened in Saskatchewan because most banks were not prepared to lend money. Restaurants are considered to be high risk even though franchisors have a very strong proven track record. That's one comment.

The second comment is that over the years we have developed a very strong relationship with four financial institutions to put into place programs that pre-approve certain locations and certain concepts based on certain criteria. Each of those programs, however, has as a cornerstone the small business loan. Without that the banks would not do that. They would not put forward those types of programs.

• 1625

We have, however, recognized that we cannot rely on the small business development loan in all cases, and there are a number of cases where today we have franchisees who do not use that facility. And we've worked extensively with the banks to understand cashflow lending. It's something they do not like to do for small businesses. We keep working towards encouraging them to do that. However, that is on an exception basis and it's not something they're comfortable doing.

The current program works well. It creates jobs. That's the most important thing. It allows people to get into business and to build the economy, and they do that successfully. I encourage us to continue with it.

The Chair: Thank you.

Are there any other comments? Mr. Jaffer, did you have another question?

Mr. Rahim Jaffer: Yes. I have one last question and I think I'll direct it to Mr. Ferrabee, if possible.

One of the amendments that this committee is looking at pertaining to this particular legislation is to allow for provision that in future, if there are any more changes regarding regulations to Bill C-53, it should come back to committee, which would allow organizations like yours or others that have concerns with potential changes to the legislation, about how it would impact their particular area of industry, to address those concerns and obviously have input so that we don't have any flawed decisions made by government. I'm curious about how you would respond to that and if you think it would be a useful tool for your organization.

Mr. Michael Ferrabee: I've very much enjoyed the opportunity and appreciated your interest in dealing with the draft regulations at the committee stage. I think it's allowed us to bring to the attention of officials as well as this committee some problems with the draft regulations.

I think it would be a process we'd love the opportunity to participate in. I don't know enough about how that works in practice to be able to feel confident in providing an assurance...maybe a change to a regulation is a comma and a period at the end of something. If what you're looking at is major, that every five years they change the regulations or make substantive changes, I think it would be a wonderful opportunity. I think it would be a great opportunity to hear directly from the industry and I certainly would support you in proposing an amendment.

Mr. Rahim Jaffer: Thank you.

The Chair: Thank you very much.

Madam Jennings, please.

Ms. Marlene Jennings (Notre-Dame-de-Grâce—Lachine, Lib.): Thank you very much.

First of all, I'd like to apologize for having to leave the room several times. I have another file that created a couple of emergencies. I wasn't here, Mr. Ferrabee, but you were just at the point of explaining what the suggestion or the proposed solution is. Could you very briefly recapitulate, because I do have some questions.

Mr. Michael Ferrabee: That's the advantage of having written notes to work from. I'll just quickly read the section, hopefully trimmed down from the rest of the stuff.

What I'd suggested was that discussions with the Department of Industry last night, and the proposal made by the CBA, the Canadian Bankers Association, in their most recent letter, satisfy our concerns. I understand the committee has a copy of that letter.

To summarize my understanding of it, it's that the legislation as presented be passed by this committee on the condition that Industry Canada, at its appearance on Thursday, agree to the following: the regulatory provisions that exist today with respect to existing leaseholds and the security provisions within the regulations be kept in place. So the SBLA we've been operating under for the last three or four years would essentially just stay where it is until such a time as there can be a consensus reached by all stakeholders on how to address the concerns of abuse raised by the department with respect to these areas. In practice, this means that the status quo of the existing SBLA would remain until we can all agree.

Ms. Marlene Jennings: That's what I thought a solution was going to be. As the draft regulations now stand, the policy change is in the draft regulations and not in the legislation.

Mr. Michael Ferrabee: The area we're concerned about is in the regulations, not in the legislation, absolutely.

Ms. Marlene Jennings: Do you, as a sector of this industry, feel comfortable with a policy change that is found in regulations and not in the legislation?

While you're thinking about that, I'll go on to the second question.

[Translation]

All of the representatives who have testified here mentioned that an amendment or a change in policy as reflected in the regulations could favour large franchisers.

• 1630

However, in the case of medium-sized franchisers... A & W with its 350,000 franchises, is a rather large...

Mr. Michael Ferrabee: These are all small companies.

Ms. Marlene Jennings: I understand.

How would franchisers benefit if they found themselves in the position of having to guarantee a loan? Likely it would be because they own many franchises.

Mr. Michael Ferrabee: They would benefit two ways. First of all, the large well-known international restaurant chains already have arrangements with the big banks to finance their franchises.

Ms. Marlene Jennings: They have their own programs.

Mr. Michael Ferrabee: Exactly. They operate their own programs to assist franchise operators. Often, under these programs, the loans are awarded at below prime, which is much more attractive proposition than the Small Business Loans Act program.

[English]

The SBLA, as we all understand it, exists with a number of cost provisions built in. This is not—and I want to make sure this committee understands this—a government handout. It's a cost recovery system where the fees, the costs, the amounts you pay above prime rate, are dictated by the cost of the program, which creates a very delicate balancing act. It creates a very delicate problem.

In our submissions to the other parliamentary committee we talked extensively about this. If you change one of those elements, if all of a sudden there are a greater number of bankruptcies, the cost goes up, and all of a sudden accessibility is going to be affected because the individual small business person says, “Hang on a minute, you want twice the prime rate for this loan? I can arrange it with a bunch of friends or something. It's something I can't afford to invest in.” So accessibility is very important to our industry, and it's enormously important that this balance be kept. But we are paying significantly more under the SBLA to access financing in an area that the banks traditionally do not finance.

[Translation]

Ms. Marlene Jennings: With your permission, Madame Chair, I'd like to ask one final question.

You are under no obligation to answer if you feel that this might cause problems for departmental officials. What is your opinion of officials who decide to make radical changes to a government policy without consulting the parties directly concerned?

[English]

Mr. Michael Ferrabee: I would like to respond a little because I think it's important. There is a process, and I was trying to get my own head around the process. I spent some time in Ottawa and I understand a little bit about it, and I've had some time to get a further explanation not only from officials here but also people I have talked to in Ottawa.

There's something called legislation, there's something called regulation. Every piece of legislation that makes its way through Parliament—almost every piece, I think—has attached to it a whole series of regulations. In many circumstances, for right or wrong, and I'm not arguing that point, those regulations actually appear after the legislation is passed. In many cases they appear long after the legislation is passed.

What they normally do is go through a process that involves consulting with stakeholders. You'll notice that the copy of the regulations I got, and I assume it was the same one as yours, had a cover memo on it from people in the department. It had a distribution list of key stakeholders. The normal manner in which this is done is that the draft regulations go out to stakeholders, and they're given an opportunity to comment in a particular time period; and there are meetings, there are discussions. What that really is is an attempt to do in its best scenario is to take.... I've been there before. You're sitting there drafting regulations and you're trying to capture a problem. You write it down this way, and you don't really know what kind of effect it's going to have out there—in fairness.

When this stuff came up—I deal with government, I don't run a restaurant—I had to rely on these people to tell me what's involved, and why it matters and why it's important, and that's why I spent two days on the phone talking to them about these areas. That's the opportunity in some cases for feedback. I'm not sure I feel hugely comfortable about commenting on the process with respect to the committee, because I haven't been here throughout in terms of the industry committee. But that's the process as I normally understand it. I'm thrilled that the committee took the opportunity to look at the draft regs, that it asked for them and we had the opportunity for input.

• 1635

Based on my discussion with Industry Canada last night, I am reassured that there was no intention to deliberately in any way exclude an industry. With the assurances I've received from them that they are willing to go the extra mile to make sure our concerns are addressed, it gave me a great deal of comfort last night. And I like the suggestion, frankly, of the CBA; that essentially, if we can't agree, it stays the way it was, which seems to be the fallback of the status quo.

There's also, frankly, an added incentive on our part to make this work—if there are perceived abuses in the system, to get at them. We pay for it. We don't want interest rates that are 5% above prime. We want to get the bad apples, if there are any, out of the system. If we have ways of improving it, let's improve it. I think we can come up with better regulations to satisfy everybody's concern. It may take us a little while, but in the meantime I think your work has been well rewarded in that you have listened to the people here and figured out that the existing SBLA is a pretty good program.

I went on at great length, my apologies.

Ms. Marlene Jennings: Thank you.

The Chair: Thank you very much.

Just to clarify for our witnesses and committee members, as Mr. Ferrabee outlined, that's one of the possible processes for our regulations. There is another process involved as well. There are many pieces of legislation that require the regulations to come before the different committees—for example, the Official Languages Act and the gun legislation. There are other processes out there to ensure that stakeholders have further input aside from previous consultation.

There seems to be some confusion out here as to the delay and length. To clarify again, my understanding was that consultation was taking place for months and months on the Canada Small Business Financing Act, which is now before the committee. I would not have anticipated any surprises in the regulations, which is what we appear to be finding and what you seem to have found last weekend. That really shouldn't happen after many months of consultation, regardless of whether they are drafted or not. Consultation is consultation.

That being said, we appreciate your bringing this to our attention and being here.

We'll proceed to Madame Lalonde.

[Translation]

Mrs. Francine Lalonde (Mercier, BQ): I wasn't here when the witnesses were introduced to the committee. Unless I'm mistaken, they are all franchisers. There are no franchisees among you. Is that right?

Mr. Michael Ferrabee: That's right, we are all franchisers.

Mrs. Francine Lalonde: I'm pleased to meet you, but I also like to hear from franchise operators and find out what problems they are experiencing because they are the ones who have to live with their loans. Your industry must be set up in such a way that franchisees can get loans, although those who do sometimes go bankrupt or must sell off their business at a loss.

I re-read the transcripts of our meeting with departmental officials. They noted that they had been gathering statistics on loan defaults since 1995. I think they were trying to get across the point that in the franchise industry, many people abuse the system.

I recall as an MP seeing cases, not in the food services industry, but in the dry cleaning industry where a franchise had been purchased for a ridiculous high price and the franchisee was unable to pay back the loan. He was forced to sell at quite a loss. The franchisee may get a loan, but he may also be forced into bankruptcy. The franchiser can then buy back the business for a song, only to turn around and sell it again for a substantial sum of money.

What would it take to close this legal loophole and to ensure that small businesses can continue to get loans?

• 1640

You are in favour of the status quo until some kind agreement can be worked out with the department. As you can understand, we are not comfortable with that option, even though you may see it as a good solution.

As parliamentarians, this poses a problem for us. You're as much as telling us that we should pass the same piece of legislation, unless the other parties can agree on amendments.

I have a problem with that. Would you care to comment?

Mr. Michael Ferrabee: Certainly. First of all, concerning abuse of the system...

I'm sorry, but I'd like to answer that question in English.

Mrs. Francine Lalonde: By all means.

[English]

Mr. Michael Ferrabee: We're as interested as you are. In talking to the industry department, they brought to our attention some potential abuses that the well-intentioned but obviously problematic drafting provisions of the draft regulations were intended to address.

We are equally concerned, as I mentioned before. With a program that operates on a cost recovery basis, we have the same interest as everybody else in getting people who abuse the system out of the system. Our problem, and I think you identified it as well, is in getting to the bottom of that.

We have some rough numbers from the testimony of Industry Canada about what percentage might have been involved in that. Let's collect that data. And I'm not suggesting a three-year study, I'm talking about getting immediately to the bottom of the problem. Let's make sure that we can address it in a tangible way so that it gets rid of the abuses. They shouldn't be there. The examples of abuse that Industry Canada gave us are ones that nobody at this table would support, because given the nature of our industry, we think it's important that those not happen, and also because we're paying for the program.

Second, with regard to your question about being somewhat—I don't want to put words in your mouth—offended at the fact that somehow we'd go off and cook a deal and leave you people out in the cold, in my case, and I can't speak for the CBA, the only reason my comments focused on a solution that involves key stakeholders and the industry is, pure and simple, that I would never presume to suggest to the committee its role in the process. I assumed the committee may well want to participate in that process, but I do not presume to suggest to the committee its role in however that works. I assumed members of Parliament would probably have some views on that, and I anticipated that a number of you would, and that subject would come up.

So I trust you accept my explanation.

[Translation]

Mrs. Francine Lalonde: Absolutely, sir. You explained the situation quite clearly.

I have another question for you. I was somewhat troubled by the comments of departmental officials—and I say that quite honestly—who referred to value added and who argued that value added was not a reason for refusing a loan. This notion is something new and is not found anywhere either in the regulations or in the legislation.

A restaurant owner who is not a franchise operator may do some renovations, go bankrupt and sell his business, or have that business taken back by the owner. That owner may turn around and sell the restaurant for the best price he can get. There may indeed in this case be no value added. If this were to become a standard consideration... perhaps I'm mistaken, because I don't have a copy of the rules or recommendations respecting lenders. I wouldn't mind, by the way, getting a copy of them. What are these called in English? Your letter mentions that it would be useful to have the guidelines for lenders for comparison purposes.

I don't think these guidelines suggest that loans should be awarded on the basis of some kind of value added. This is something new to me. Would you care to comment?

• 1645

Mr. Michael Ferrabee: I want to be certain that I understand your question clearly.

[English]

Your concern, as I understand it, is that the industry department raised the issue of value added with regard to the Small Business Loans Act.

Ms. Francine Lalonde: Yes.

Mr. Michael Ferrabee: That's not the first time I've heard that. I think in some of the consultation documents they issued with the legislation, and this is from memory, they spoke on a number of occasions about the importance of job creation and of providing extra value, because in part that's what small business is about. It's the driver of the economy. In our industry, where 30¢ of every $1 goes back into the pockets of employees, it's very labour intensive.

[Translation]

Mrs. Francine Lalonde: In that case, yes, but that's not the same thing.

Mr. Michael Ferrabee: In our case,

[English]

it's very important.

I've certainly seen reference to it before. I'm uncomfortable commenting on what Industry might have talked to the committee about or the context for that, if you don't mind.

[Translation]

The Chair: Thank you very much, Mrs. Lalonde.

[English]

Mr. Lastewka, please.

Mr. Walt Lastewka (St. Catharines, Lib.): Thank you, Madam Chair.

I really appreciate the fact that you've come here today.

As I heard your testimony, it reminded me of very strong corporations doing proper due diligence with strong management systems. Yet when it comes time for franchises to get a loan, they have to go through the SBLA. Why are they not getting a regular loan from the banks? Mr. Whittaker, I think you mentioned that 73% of your franchisees have to use SBLA loans. Why aren't we getting regular loans? Is the restaurant business that high a risk?

Mr. Michael Whittaker: Traditionally, the restaurant business has been known to be a very competitive business. Certainly, as Michael mentioned, the recession of 1981 and the introduction of the GST in 1991 set our industry back quite a bit. We've been spending the last several years basically climbing back and improving our market share to the point where I think that situation is changing. I think our industry is once again going into a period where we're as prosperous as we were before, not that we don't have our challenges.

It's a good question. It's a question that might be better posed to the banks than to us. Certainly, our interest is to get the best possible financing opportunity for our franchisees. Their profitability is paramount to ours as franchisors, so it generally tends to be the best method of raising capital for the franchisees.

Mr. Walt Lastewka: My follow-up question is to Mr. Ferrabee. Has the CRFA met with the CBA to deal with that type of question?

Mr. Michael Ferrabee: In the four years I've been here I've talked to them about the provisions of the SBLA. I haven't talked to the CBA specifically about access to capital outside of the context of this program. Maybe I should. Maybe it would feel like I was pushing a rock in terms of access.

In my remarks when I was here last week I talked specifically about the financing problem, as the banks would see it, created by an industry that serves the public and is at the front line of consumer demand. When you build a restaurant, it's not like a manufacturing business, where you go and get the machinery and you appraise it and you have the box you put it in and all the rest of it. It's not as straightforward as that. Existing leasehold improvements and leasehold improvements themselves are key components of that. In the past the banks have not looked favourably upon financing those two key parts of our business, and frankly that's the reason the SBLA has been so successful in our industry.

Mr. Michael Whittaker: Perhaps I could just add to that.

Mr. Walt Lastewka: Yes, please.

Mr. Michael Whittaker: Another important point is that the typical investor who gets into the restaurant industry is not always your multi-millionaire. A lot of times it's your average guy on the street. It's somebody who maybe has a regular job but who wants to take a shot at opening his own business. So they tend not to have very deep pockets. And I think that is probably one of the reasons why this is an avenue for an investor, access to capital. The banks would normally say he doesn't have as deep pockets as maybe somebody opening a larger business, or a manufacturing business or something. They're small business people.

• 1650

Mr. Axel Rehkatsch: There's another facet to this, and it's something we may not look at when we confront the issue because we look at them as businesses. But really businesses are about people, and in the restaurant business it's far more related to the quality of the owner, and the amount of effort the owner brings to it and the amount of leadership the owner brings to it, as opposed to a technical skill of how to machine a particular product.

Consequently, it's viewed to be of high risk because it's so management and leadership intensive. It's a different perspective on the business.

[Translation]

Mr. Alain Villeneuve: As a relatively small operation with 30 locations, speaking from experience, we have encountered on several occasions requests for financing from individuals who had gone to the banks first with their proposals. Their business proposals had systematically been rejected, without any possibility of being reconsidered, despite the principle contained in the SBLA.

Obviously, when these individuals turned to a network like ours, with our added credibility, some banks, but not all by any means, were prepared to consider granting them a loan. Admittedly, not all requests are approved. The SBLA is not a cure-all or a magic bullet that allows anyone to become an entrepreneur. Nothing could be further from the truth. I think the banks are doing their job and merely being paternalistic when they review a project's viability.

The fact remains that the value added of any improvements made or of the equipment needed to operate a restaurant matters little once the restaurant is closed and the equipment is sold off. Clearly, these guarantees aren't worth much to bankers. Therefore, we need some help if our industry is to continue to expand and if the banks are to feel more secure about lending money.

[English]

Mr. Walt Lastewka: Mr. Ferrabee, you had some opportunity to meet with the department and have discussions with the CBA, and my concern is the abuse portion. When the CBA was here, their comment was very clear to us, that they understood there's abuse and something has to be fixed.

Although you've expressed a number of times that it's of interest as much to you to fix that abuse as to anybody else, my concern is that over the next number of months there be some mechanism to face the abuse problem, such that we don't have the Auditor General coming back and saying, “You folks in the restaurant business, the franchise business, and you people in the committee, didn't fix the problem of abuse. You talked a lot about it but you never did anything about it.” I want to be assured from your testimony that in working with all the stakeholders we must make some progress in fixing the abuse.

Mr. Michael Ferrabee: Absolutely. I think I've said a number of times here, and I'm happy to reiterate it, that if it's happening out there, let's get to the bottom of it right away. Let's write regulations that stop it, because it isn't serving anyone's interest. Some of the examples I've heard...and our problem is frankly they're anecdotal. I'm not suggesting they don't exist, I'm sure they do exist; people have told me they exist and I take their word for it. I have every reason to believe they're out there. We have no idea of the extent to which it's happening. We don't have an idea of what necessarily the problem is, of what potentially some of the other problems are; but let's put our heads together and get to the bottom of it and fix it and stop it. Absolutely.

Mr. Walt Lastewka: I'd be interested in our at least making a step in that direction, with the understanding that over the next five years we're also going to measure and watch certain things. Then when we have the review five years from now, we can take whatever step we took on eliminating the abuse and then take the other step with the proper data, as you have mentioned.

• 1655

Mr. Michael Ferrabee: From talking to Industry Canada officials, I know they've already begun to think about how we might be able to do that. I'm not sure about it in any sort of hard way, but they started to noodle around how we may be able to get some of that. I wouldn't speak for them and suggest that they have stuff written down that we're all going to be able to agree to tomorrow, but that's my sense.

Mr. Walt Lastewka: Thank you, Madam Chair.

The Chair: Thank you.

Mr. Jones, please.

Mr. Jim Jones (Markham, PC): Thank you, Madam Chair.

I was expecting a totally different audience from the restaurant association. I was expecting the small restaurants, the one or two restaurants, but here I have really large or decent-sized corporations that have established track records and procedures in terms of how they do franchising and all that.

Somebody mentioned that from a franchisee standpoint, you recommend that a person first starting out has 40% cash and 60% debt. Out of that percentage, how much is his franchise fee, and does he pay that right up front to you folks?

Mr. Axel Rehkatsch: I can answer for A & W. The franchise fee is $42,000. Depending on how much they are putting into it, it will represent between 15% and 20% of the cash equity. In addition to that, they have to have their time that they spend and invest in training. They have out-of-pocket expenses.

Mr. Jim Jones: So that franchise fee is given right up front.

Mr. Axel Rehkatsch: That is given up front, that's right.

Mr. Jim Jones: That's not part of the financing.

Mr. Axel Rehkatsch: That is not covered by the financing.

Mr. Jim Jones: There's another thing I don't understand. Somebody said over here that they have a whole bunch of stores to upgrade. You already have an established revenue flow, an established procedure right across the country as a franchise organization. Why will the banks not loan these people money? Why do you have to go to the SBLA to do this? Don't the banks look at an organization like Pizza Pizza or McDonald's and say they have a proven record and know what they're doing, so they, the banks, should be able to loan them money rather than having them go to an SBLA?

Mr. Michael Ferrabee: I'll start, and hopefully some people will jump in with their own experiences and maybe correct me if I'm off base here.

Based on conversations with a lot of people, in the case of very large and often multinational companies, that may well be the case. They may have an arrangement with a bank. The bank gives them the money because the franchises are very tightly held and operate very much as big businesses, much less so than small businesses.

In the case of small business—the people we're talking about here, despite the fact that we didn't bring the independent operator who owns the one restaurant—we're dealing with someone like Michael Whittaker. He has 91 operations of Greco Pizza in Atlantic Canada today. They are modest pizza locations, so this is not big business. The people who buy his franchises are not investing half a million dollars in a franchise, they are people who are interested in participating in the small business area. They go to the bank and say it has become clear that they have to invest $40,000 to upgrade their building because the seats, the carpeting and the wallpaper are worn out, and they need to be replaced. They have good cashflow, so it all makes sense. If they want to keep this cashflow going, keep the franchise as a going concern, and keep making money, they need to invest in these things. The bank looks at that franchise owner and asks what it can do with a bunch of used carpet. The bank doesn't consider that tangible in many cases, so that's why we have to go to the SBLA.

Mr. Jim Jones: But for an organization like Greco Pizza, generally a lot of these renovations are driven from the top down, not from the bottom up.

Mr. Michael Whittaker: In our situation, I would have to say—

Mr. Jim Jones: Let me finish.

I would assume you have probably done a marketing study and a business case, and have said that if a franchise owner does this, he's going to get incremental business. Therefore, if you take it to a bank, the bank would say it is going to loan based on that.

Mr. Michael Whittaker: Traditionally, for our upgrades and renovations, our franchisees don't use SBLs for that aspect, as a rule of thumb. If they are upgrading, they've been in business for awhile. Hopefully, if we're doing a good job and they're doing a good job, they won't have to get an SBLA. They'll get conventional financing for that type of work.

• 1700

Mr. Axel Rehkatsch: Let me speak about our particular case. As I mentioned, we were a chain that started in 1956 as drive-in restaurants. People used to drive up in their car and be served at the window of their car. With the added competition, we built inside restaurants that were enclosed. Those types of renovations were usually very large renovations that required the additional financing of a small-business loan.

Yes, we did business cases, and yes, we projected. But at the end of the day, the banks were not in the position from which they would view restaurants as good places to lend on cashflow. They just feel—

Mr. Jim Jones: But I think you made the point earlier that you have a track record. How many stores do you have? Three hundred?

Mr. Axel Rehkatsch: No, we have 507.

Mr. Jim Jones: You have 507. I think it was you who said that of your 507, you only had one case.

Mr. Alex Rehkatsch: We had one case of an SBL work out.

Mr. Jim Jones: Okay, so the banks would look at that and they still would turn you down?

Mr. Axel Rehkatsch: One would really have to ask the bankers this question, and I think it's a good question to ask them. But I would say that's why franchise owners put together packages with the banks that say one corner of their financing package is the SBLA; another corner is a letter of comfort from the franchisor; and the next part of it is a training program, the proven track record, and a continuing demonstration of repaying loans. All of those things are put together and presented to the bank. However, they'll only do that as long as it is anchored and founded as part of the SBLA.

The Chair: Mr. Rishikof, did you wish to comment earlier?

Mr. Stefan Rishikof: I was just going to add that banks are asset-based lenders in Canada, so they unfortunately do not lend on cashflow. As Mr. Ferrabee pointed out, carpet and lights are not tangible assets that can be sold. Unfortunately, the banks just don't want to touch it. Being a former banker, I can tell you that the rules are in place so that they just don't want to handle a restaurant. The hospitality industry is a high-risk, cash business. Restaurants face a slew of issues that the banks just don't like.

Mr. Jim Jones: If the person owns the store and wants to make the improvements, and if he has no debt on the store, then they probably will grant the loan.

[Translation]

Mr. Alain Villeneuve: I just like to add something to help you understand our industry's situation a little better. Our rate of growth is among the lowest in Canada for all retail industries, primarily because of everything that was said earlier and because of the additional charges weighing more heavily on us. Currently, in Quebec, legislation respecting gratuities could push over half of restaurant owners into bankruptcy by 2001.

It's clear that operating a restaurant is not the path to wealth. Restaurant owners generally create employment for themselves and for others, but they do not as a rule amass a great deal of capital.

After he has done some renovations and after he has made his loan payments, there is no money left in the bank, only enough to cover his salary. He has nothing in the way of additional guarantees that he can give to a banker who is demanding such guarantees. That's why the Small Business Loans Act is so important to our industry.

[English]

Mr. Jim Jones: You said that one-half of the restaurants are going bankrupt. In looking at this table here, I would venture to say probably less than 2% of your franchisees are going bankrupt. We're really not talking about you folks, then; we're talking about the one- or two-restaurant type of owner. That's who I thought we would have here, because I'm surprised and shocked that the banking industry would not look after your needs, given your very low failure rate. Anything you would make as improvements, or even in terms of selling a franchise, is well researched. It's almost that you don't fail, right?

Mr. Michael Ferrabee: If I could respond to that, along with the question raised by Madame Lalonde as well—the issue that we're larger companies here—this is still small business. I guess I misjudged, and I apologize for that. I deliberately wanted to bring to you people who are long-headed in the subject of the Small Business Loans Act. In their operations, it is used extensively and they have dealt with it individually. In the case of Mr. Rishikof, who was a former banker, I went through our industry from top to bottom to bring him Canadian-owned—in most cases, I guess, with the exception of A & W—regional chains that franchise a great deal and have a lot of experience with it.

• 1705

My apologies for not thinking to bring perhaps an individual as well, but I think it does highlight the issue that you just raised. Look at the people around the table. These are not people who have just taken their RRSPs and decided to start the concept of a restaurant. These are people who have long years of experience. In the case of Mr. Rehkatsch, it's 23 years at A & W. The banks still won't give them any money, so I think it brings into stark relief the reality of the funding crunch and the access to capital problem that exists in an industry like ours. It's one that is incredibly labour-intensive and one that we rely on to provide jobs to Canadians across this country.

Mr. Michael Whittaker: Also, in all fairness, the franchise industry is not immune to closures. We'd be misleading you to suggest that we never have any failures, because we do have failures, although hopefully few of them, or fewer than outside the industry.

Mr. Axel Rehkatsch: We have fewer than the average.

The Chair: Thank you very much, Mr. Jones.

Mr. Murray.

Mr. Ian Murray (Lanark—Carleton, Lib.): Thank you, Madam Chair.

That's one of the dangers of being slow in getting one's name on the list of questioners. What I wanted to ask has already been asked. So I want to come back again to what we were just discussing. This whole issue of incrementality is important to us in terms of whether or not these loans would be made if the SBLA was not in place.

This is for Mr. Ferrabee. Are chains like McDonald's and Burger King members of your association?

Mr. Michael Ferrabee: They are.

Mr. Ian Murray: And would they be large enough that they do the financing themselves, or would they also have franchisees going out looking for small business loans?

Mr. Michael Ferrabee: You've put me in an awkward position. On the one hand, I'm not keen on identifying individual companies within the industry, which I think you'll appreciate. Also, the nature of the food service business is all over the map, in common with the franchise business itself, with the nature of the manner in which franchisors interact with franchisees. There are food concepts in this country that are little more than essentially the renting of a trademark. In some cases, the nature of the relationship between the franchisor and the franchisee is a little more sophisticated than that, but not a whole lot, right down to a system in which you'd be hard pressed to call them a franchisor. They're a sort of owned manager in terms of what's happening.

Mr. Ian Murray: With many of your member companies, for somebody to obtain one of those franchises, they have to go through hoops that appear incredible to some people. I've heard stories of individuals who are very well off and have good business track records, but they are still being turned down. So again we come back to this question of due diligence, which your member companies do perhaps to a greater extent than the banks when they're lending them the money. You're really put under the microscope if you want to own one of these franchises.

Mr. Michael Ferrabee: In the case of some companies, absolutely.

Mr. Ian Murray: You don't see too many Pizza Pizzas or McDonald's restaurants or Burger Kings with “for sale” signs on them because they've gone out of business. Perhaps they're rolled over somehow; I have no idea. Maybe it's an unfair example, but I keep coming back to this point that it's important for us to know if these loans would be made if the Small Business Loans Act were not in place. It strikes me that it's just such a comfort level for the banks.

I'm not sure I heard the figure correctly, but something like 40% of restaurants in Canada are now franchise operations. Maybe I misunderstood something I heard earlier on. If that is the case, though, that means there's not a huge amount of risk for a lot of the lending to restaurants in Canada under the Small Business Loans Act, as compared to what it would be if somebody did not have to save $40,000 to put down as a franchising fee to begin with. That's a vote of confidence in somebody right there if they have that.

I know we've beat this thing. I'm the third or fourth person to raise it with you, but I'm having a hard time understanding that this is the case.

Mr. Michael Ferrabee: There are two things I'd like to raise.

First of all, the SBLA is not a cheap program. The reason the SBLA works is that it actually allows us to get in the door. When you get there, you have a whole lot of other costs associated with it. There's nobody in the business, nobody who has a reasonable financial mind, who is going to suggest that you pay a huge premium on top of the prime rate, an administration fee, an upfront fee, and all the rest of it for the pleasure of getting something you could have had at basic bank rates.

• 1710

Mr. Ian Murray: That's a mystery to me. I wonder why your industry.... You must have enough clout as an association to go to the banks and say that something looks a little fishy here in that you have an excellent track record but they're not willing to—

Mr. Michael Ferrabee: Maybe they haven't hired the right person. Maybe after Parliament, you can join us and deal with the banks.

Mr. Ian Murray: Perhaps I should leave it at that.

The Chair: Mr. Rehkatsch.

Mr. Axel Rehkatsch: The SBLA is only one part of a larger jigsaw puzzle. I won't speak for McDonald's, Burger King, and others, but there really is one very distinct difference among franchisors. I think Michael was trying to demonstrate it to you. Some actually build the building, equip it, and then rent it to the franchisee. Some pay for part of it. In the case of A & W, the franchisee builds the building and owns the assets, etc. Those are two different types of models, so they therefore require two different types of financing.

The real magic here is that the banking industry has discovered franchising and they are more willing to now form relationships with franchisors to form programs. Very clearly, they have specialty departments in the Royal Bank, Bank of Montreal, Canada Trust, and CIBC just for franchising. That's all they do. They want that segment because it's more risk-averse than others.

But they still maintain that they require, as part and parcel of that, the small business development loan. There's also the other security for the small businessman. Only a portion of his assets does he personally have to guarantee. Therefore, the small businessman also wants to take advantage of that to secure his family and his net worth on another basis. I think that's a win for the small businessman as well as for the bank.

Mr. Ian Murray: Thank you.

The Chair: Thank you.

I want to thank the witnesses for being here today. I have a couple of questions.

From my understanding of the testimony we heard and from the group that's here, you represent a group, from coast to coast, of small business operators as well as a large number of franchisors and franchisees. You must have been quite surprised by the regulation that dealt with franchisors, because as Mr. Rehkatsch identified, he can only think of one in 23 years, yet he knows a large number of his business operators or owners are using the SBLA. Mr. Whittaker as well has identified a large percentage. Obviously there are going to be case-by-case scenarios of people who fail in business for whatever means.

I just want to be clear that as the regulations go forward, if this buyback is not feasible for any of the franchisors seated here today or for any you represent, Mr. Ferrabee—

Mr. Michael Ferrabee: I haven't been able to call them all.

The Chair: To clarify for the committee's sake, my understanding from my past practice is that every franchise agreement is very different, as Mr. Rehkatsch was explaining, and every business opportunity is very different. The banks—we heard this from Mr. Rishikof, who had the opportunity to work with the banks in the past—have different practices in place that I think not all committee members are aware of when it comes to lending in general. They change from time to time. But for example, in real estate, there's a real policy in banks not to lend on vacant land. You have maybe a most valuable waterfront piece of property, but there's a real policy within the banks not to lend on vacant land.

As for the restaurants, in my experience and from what we heard, there are unfortunately failures in this service sector that have caused the banks to be shy in lending. However, there's also a real depreciation of assets that occurs very quickly and rapidly.

This buyback doesn't really cover that, because you're in a very special industry, from what I can see. We talk about others who unfortunately don't make it and have their assets sold at 10% on the book value. Banks know this. I just don't understand how we can be refinancing at the original value, because it's standard practice to know that they're not worth what they paid for it. It's like when you drive your car off the lot; it depreciates in value immediately.

• 1715

So to have a bank lending on existing values or old values.... I'm assuming that if someone buys a going concern, one of your franchise operations, there's goodwill built into that. I don't know if you can explain how that's broken down into lending or not.

Mr. Michael Ferrabee: Do you want to try that?

Mr. Axel Rehkatsch: The sale of an existing business, a going concern, is very much different. Effectively, the way it's valued depends on the franchisor again. In a franchise chain, goodwill can never be sold. It belongs to the franchisor against the brand. What does happen, though, is that the existing operator has a stream of cashflow, and that's really what the value of the business comes towards. That's where this notion about cash flow lending, as opposed to asset-based lending, really comes into play.

We've been working very diligently with the banks for the last four years to get the concept of cash flow lending done. I would say that I'm pleased to tell you we have been relatively successful in recently having done that, because we've just franchised a hundred of our corporate restaurants. In that project, we were very successful in convincing banks about the proven track record of a cashflow that was being bought. To that extent, if it is a long-established cashflow, they will buy on cash flow lending. Because it is then valued differently, most of those are not on the small business development loans. They really are of such a core or large-dollar value that it's just not economical to put the loan together in that way—and let's just put an example together.

I will use a hypothetical case. If you sell the restaurant on a cashflow of four times the multiple of its EBIDAT, which is the earnings before interest, depreciation and taxes, it might be $200,000. Actually, that says that's the value of the business. What one then does is ask how much one can allocate to the equipment and how much one can allocate to the leaseholds. That really is done on an arbitrary basis. There is no appraisal done; no appraiser comes.

When they come to us as a franchisor, they ask what the replacement value of the equipment is. We take a look and we take an inventory. We try to give that to the bank, and the residual goes against leasehold improvement. That's because what the individual is really selling is a space that people drive by or come by to take advantage of that trademark.

There's a notion in the Income Tax Act, and it's actually quite a famous case. It's called “goodwill of location”. In other words, what's really at play here is the value that's placed against being in that particular location, because that particular location attracts more customers than another. Therefore, that's the one that attributes the cashflow to that business. So that's what is being sold and that's what's being financed, often under the umbrella of leasehold improvements.

The Chair: Thank you very much, Mr. Rehkatsch.

Mr. Axel Rehkatsch: I hope it wasn't too long an explanation.

The Chair: Again, I do appreciate all of you coming in from very long distances to make your points known. As a committee, we hope there will be a resolution to this. I do have some concerns about the letter we received from the Canadian Bankers Association. It talks about how the current SBLA and SBLA regulations can remain in force. There are deadlines and time lines on this, so we'll have to work within those, obviously.

The meeting is now adjourned.