How to get your piece of ‘deal fever’
The franchise world has an acute case of deal fever. The consolidation that grew through 2016 and 2017 shows no sign of slowing down this year.
Headlines are filled with deals big and small, and the amount of “dry powder” or un-invested capital is at historic highs—many reports put it at $1 trillion. This flurry of activity can be intoxicating for owners who are plotting a course to something bigger.
For owners, however, becoming an attractive target of private equity funds, family offices or strategic buyers is pretty far out of even the most sophisticated operator’s wheelhouse. Just discussing a sale with one of these firms is the first hurdle to cross. Unless a franchise operator has a direct line to a private equity fund, those conversations generally start with an investment banker or adviser, and they are busy people these days.
“I think in this market, I’d say you need to sell yourself to the adviser,” said Rick Ormsby, managing director at the franchise-focused Unbridled Capital. “There are several of us, but we’re all busy. On every assignment I take, I have to look at the opportunity cost for me and my staff.”
That means having as much as possible ready for a potential sale: cleaning up the books, recording everything and thinking about why a capital partner is necessary.
“It’s easy to sell, but what’s harder is the alignment of capital with a partner,” said Leigh Hudson, managing director at advisory firm Headwaters MB. “Going into a process, it’s really important for the owner to know what they want. What do they want from a strategic partner? Do they want help with real estate, do they want the network or Rolodex for hiring C-level people? How fast do you want to go?
Some founders aren’t comfortable with aggressive growth.”
Just like signing a franchisee agreement, these deals last a long time. But a capital partner can be even more personal when it comes to finances and operations—these funds, family offices or strategic people are going to be deeply involved with the business. It’s not just a matter of writing a royalties check.
Alignment is key
“We talk a lot about this philosophical alignment with a partner,” said Hudson. “And those conversations are really necessary and need to be vetted up front so you can see who is aligned with the seller or founder.”
And once those big goals are solid and an adviser is on the job, it’s all about what the investors want.
“The first thing is, is it in a brand that has interest from the investment community? There’s a huge delineation between the first 10 to 15 brands on the list and the rest; that’s the first filter,” said Ormsby. “The next thing I look at is unit count and earnings before interest, taxes, depreciation, and amortization,” also known as EBITDA. “That’s second or third. Then I look at location.”
He said it’s incredibly difficult to sell a stake in West Coast and Northeast operations just because of regulation as well as the high cost of labor and rent.
He said if the brand, earnings and location all fit, the next consideration is the capacity for general and administrative (G&A) spending.
Investment funds and family offices don’t want to be flipping burgers or dealing with customers. That’s why firms are looking for businesses with at least 10-15 units and EBITDA in excess of $1 million to $2 million—that means there is at least a decent team involved to keep the stores running and enough G&A to afford a seasoned operator to manage the day-to-day business and future growth. The ideal deal will not be muddied with a lot of upcoming remodeling expenses or major development obligations—there are specialized buyers that are happy to do that, but they don’t typically want to keep the original owner.
Ready for a long haul?
For operators, one big thing to remember is all the due diligence and the conversations take time, a lot of time.
“Running a process takes longer than one would ever think,” said Hudson. “We’ll let company management continue to do what they do, but that’s not to say that we don’t need access to the CFO. What we can’t do, and where it gets time-intensive, is when you narrow it down and you have first bids and you’re going into management meetings with buyers. Those will be long days and weeks depending how broad you want to go. That’s kind of unavoidable.”
For owners that aren’t quite there, some polish can go a long ways, but that can easily add a year or more to the timeline.
“You might want to get out in front of the decision by 12 to 18 months. You want to look into remodeling, the strength of leases. You can’t go out and find a partner if you don’t have a minimum of 10 years” on leases, “but we’d like to see 15 to 20 years,” said Ormsby.
As for the valuation, don’t aim too sky high. “The devil is in the details. I suppose people throw around EBITDA multiples and cap rates, but what they don’t factor in is all the various components that make the valuation,” said Ormsby.
“Are your sales trending up or down? What are your food and paper and labor costs compared to the benchmark of other franchisees? Do you have R&M expenses that are higher because of remodeling? Is your new store development heavy and weighing down your EBITDA multiple?”
There is a frenzied level of deal activity on the franchisor side as well. Mega-deals like Buffalo Wild Wings selling to Roark Capital in February, and unique deals like FAT Brands acquisition of Hurricane Grill & Wings and Bonanza last fall, get a lot of attention, but there are plenty of smaller deals being done, too. As private equity and family offices do the math, they’re expanding their acquisitive behavior and picking up smaller and smaller brands.
Another growing source of acquisitions are the former franchise juggernauts like Anand Gala who are putting their hard-earned wealth back into the industry.
“There are a variety of us, and I think you’ll see that become more common for people who want to affect the success of businesses, who want to reinvent or reinvigorate the business,” said Gala, the longtime Applebee’s and Del Taco operator who created the private equity firm Gala Capital in 2015. “It really does align for performance substantially better than the norm. We are students of the industry and we are taking what we think is right and what has been proven to move the needle.”
And even longtime industry insiders like Gala still want someone to run the business. At Mooyah, that person is Michael Mabry, who took over as president and COO in the acquisition, enabling founder Rich Hicks to focus on building other brands.
Mabry said he, Gala Capital and a second partner, Balmoral Funds, are still “learning to dance with each other” but has some advice for franchisors looking for an evolutionary deal.
“The first thing is, of course, you’ve got to be profitable. Particularly in franchising, when outside investors come and buy a franchisor, they’re not buying operating restaurants, they’re buying a royalty stream,” said Mabry. “You’ve got to ensure the unit-level economics are solid and that existing franchisees are showing growth, or at minimum are satisfied, that’s box number one.”
Lean machine or robust team
Like a franchise operation, the rest of the boxes really depend on the capital partner. Some want a robust, top-heavy management team that can absorb growth; others want a lean machine that they can plug into their own overhead or spread another portfolio company management team across the new brand. It’s just a matter of finding the right buyer, which can be a grueling but rewarding process.
“It caused us to truly put our finger on the pulse of the business. We were running it before, but now we really know the heartbeat,” said Mabry.
That’s a good thing because the smaller the deal, the deeper the due diligence. Shortly before the Mooyah deal closed, last fall, the Balmoral team was “really, really probing hard” when one of the founding partners of the fund explained why.
“He said, ‘Listen Michael, when AT&T buys Dish Network, they don’t go look on every roof to see if there’s a dish on the roof because the bucket is so big and the money is so big, they have an assumption of loss. Deals this size are so small comparatively, that every dollar makes a huge difference, so we have to make sense of every dollar,” said Mabry. Mabry said preparing for that deep, deep dive means a lot of work for the selling company.
“I think my biggest learning, when a company feels like we either need to find outside investors or sell, there’s got to be a team. Our team was two or three people that were dedicated to the sale, because it’s a full-time job,” said Mabry. “And in order to free up that time, you have to back up six months and put procedures in place or people so that when you do go through that, nothing skips a beat.”