For private equity partners, growth is everything
Jimmy John’s founder Jimmy John Liautaud was all smiles after attracting private equity firm Roark Capital as a majority investor in 2016.
Photo by John Kraynak
While the funding hunt is always hard, one large and growing portion of the franchise capital world is private equity. It seems like every day there is a new boutique firm jumping into the industry or a major private equity sponsor coming in with a huge check to acquire a brand.
The private equity industry is massive and varied. Even after making more than $380 billion in investments in 2018, it still had $2 trillion in uninvested capital, what they call dry powder, in the latest full look at the industry. This has increased competition, spurred new funds that want a piece of the action and driven the price of private equity investments higher and higher.
For growing brands and franchisees, private equity can offer an incredible path to further growth, and that excess dry powder has investors eager to put money to work. But getting attention from either that boutique firm or the billion-dollar investment fund does take some special qualities.
What does private equity want? It’s simple: money. No matter how much a firm talks about its passion for X, Y or Z industry or its love for a management team, these are financial institutions beholden to their investors. Their No. 1 goal is return on investment that beats the market. Generally, they aim for better returns than they would achieve on Wall Street, which sees annual returns of 5 to 10 percent—depending who you ask and when. According to Bain & Company, the returns are slowing down, but the broad category it dubs “consumer” still returns 1.5 to 2 times equity and beats the market by low single digits in every holding period.
To grab some attention from these firms, they have to see growth, either natural sales or unit growth or via better operations. Growth potential holds true in all of the more than 20 private equity transactions targeting franchisors or franchisees over the last 12 months.
The majority investment in Bandon Holdings, a 38-unit Anytime Fitness franchisee, by Fireman Capital Partners, for instance, had ample growth potential. The company projected 100 locations in the next five years; 163 percent growth in a short timeframe is what gets private equity investors really excited. Together, Fireman and Bandon now have the capital to acquire or build new locations and finance the necessary overhead. That’s also what’s known as a strategic acquisition, where a private equity firm buys into a strategy and a management team and that team continues to execute.
Deals like this on the franchise side are changing the landscape, and will for years to come. Franchisee entities that partner with private equity can be explosive. One just has to look at a few companies that got into private equity early to get a sense of the transformative power. Falcon Holdings, for one, began with a private equity sponsor and 97 distressed Church’s Chicken holdings. With a strong partner in Sentinel Capital Partners and $35 million for the initial restaurants, it grew to more than $350 million in franchise sales (with some non-franchised operations as well). The capital and expertise from Sentinel helped Falcon acquire, invest and add overhead to manage the operations.
On the franchisor side, Roark’s acquisition of Jimmy John’s was an active engagement, with the fully-held parent company Inspire Brands coming in to support growth and overhead but also lead the company and tweak the model. The $2 billion deal plugged the concept into a group of top leaders with experience to actually operate, not just finance, a large but growing brand as it enters its next phase.
Of course, to unlock the return, private equity backers generally have to sell their stake. The historic average hold term is five to seven years, but lately that has sunk to a median hold period of 4.5 years as of year-end 2018, down significantly from 2013 and 2014 when the medians were just below eight years, according to Bain & Company.
As hold times ebb and flow, it changes how private equity looks at and invests in an asset; is the opportunity good enough to hit growth goals in that hold time or before a recession makes it harder to sell?
This is the second in a three-part franchise finance series leading up to the Franchise Times’ Franchise Investment Conference March 9-11, 2020. Learn more at Franchisetimes.com/Conferences.
• Franchise Finance Series Part One: For franchise lending, 'reduce the friction'
• Franchise Finance Series Part Three: What family offices want in their franchise investment