Schlotzsky's converts to LP

Nation's Restaurant News, April 17, 1989 by Rajan Chaudhry

Schlotzsky's converts to LP

AUSTIN, Texas -- In 1988 the concerns facing Schlotzsky's were no different from those confronting any other franchising company -- maximizing returns to investors, building its system, and creating the financial where-withal to attract new capital.

The company's answer, however, was offbeat.

In December Schlotzsky's, which franchises a system of 240 sandwich shops, converted from a corporation to a limited partnership.

A limited partnership consists of a general partner or managing partner whose liability is not restricted -- in this case, Schlotzsky's Inc. -- as well as limited partners who have no right to participate in management but whose liability is confined to the amount of capital they contribute.

Initially, Schlotzsky's Inc. sold a 20-percent stake in its limited partnership -- Schlotzsky's Franchising L.P. -- for $2.4 million, according to chief financial officer Paul Simar. Schlotzsky's sold partnership units to 15 outside investors -- nearly all of them Texans -- while 18 key employees purchased a 25-percent stake. Schlotzsky's Inc. has since raised an additional $3 million through separate limited partnerships in San Antonio and Houston, Simar said.

In both San Antonio, where 10 restaurants were built and four are under construction, and Houston, where six new units have been added and five are being built, Schlotzsky's Inc. -- the general partner -- holds a 25-percent share of the restaurants.

Through similar partnerships, each with its own group of investors -- and possibly through the acquisition of existing franchisees -- Schlotzsky's intends to continue branching out, Simar said. He targeted Orlando, Fla., and Nashville, Tenn., as two prime possibilities for expansion.

The partnership's goal in each market it enters, Simar noted, is to build eight to 10 restaurants without any leverage. With several debt-free stores against which to borrow, the partnership hopes it will be able to finance further expansion within the market, he said.

And the partnerships offer extra incentives to investors, he indicated, because the company pays out excess cash from operations quarterly and because partners also avoid the double taxation of a corporate investment.

Unlike shareholders in a corporation -- whose returns are first taxed as corporate earnings and then as dividends -- investors in a limited partnership are taxed only once.

Diverting cash flow to investors clearly wouldn't be in the best interest of many chains, but because Schlotzsky's is essentially a franchising company, its capital isn't earmarked for building or remodeling.

"A franchising company does not really need to accumulate capital," Simar noted.

According to him, the savings and loan crisis -- while a disaster for many in Texas -- is providing new opportunities for restaurant operators.

With the troubled thrifts in new hands and free of many of their bad loans, they are now seeing the wisdom of diversifying beyond big oil and gas loans.

"They're actually competing like crazy for regular business loans," Simar explained. "They're really being aggressive again and going more to small businesses."

Shuttered S & Ls are also prime locations for site-hungry restaurateurs, Simar noted.

One bank closed a half-dozen branches in San Antonio a few weeks ago, he said, leaving openings in an area that Schlotzsky's has been struggling to crack.

Schlotzsky's was quick to cast an offer, Simar said, and the landlord was equally quick to bite.

"The landlord said: 'It's a shame. I've got two offers from S&Ls, one from a credit union, and one from a sandwich shop. And I have more faith that the sandwich shop is going to be here in five years than the financial institutions,'" Simar said.