Franchise mergers, sliced five ways
We’ve heard what the operators had to say in our annual Dealmakers project published in April. But behind the scenes are investment bankers, brokers, lenders, attorneys and more who are pushing the levers to get deals done. We asked some of them for views on the franchise mergers and acquisitions market today.
Rich Greenstein of DLA Piper notes the rise of large blocks of franchises being sold to multi-unit operators. “You’re seeing in fact more of those than you’re seeing the sale of franchise companies,” he says.
The result is more sophisticated buyers with financial muscle to match, which limits the franchisor’s ability to reject a deal based on a former go-to reason: that the franchisee lacks the capital to do the deal.
Instead, attorneys like Greenstein say they’re negotiating more covenants and commitments on behalf of their franchisor clients than ever before. “These could be restrictions on the ability of the new franchisee to transfer stores, or it could require them to have certain capitalization if they’re going to be operating multiple units,” for example.
“It also allows the franchisor to go beyond what’s in the franchise agreement and often get non-competition covenants up the chain, to get the parent committed that they won’t buy competitive brands.”
When DLA Piper represented the group that bought the largest Pizza Hut and largest Wendy’s franchisees, for example, “the biggest part of the agreement was the relationship agreement. It was the covenants the franchisor forced on the new owner,” he says. “Sometimes there’s an agreement that the franchisee won’t go public. That’s the newest thing I’m seeing.”
The second big trend in franchise M&A is great emphasis on privacy and data security. His and colleagues’ work “used to be the bread and butter diligence questions: Are all your franchise agreements signed? Are you registered in all the states you’re selling?”
Now franchise lawyers need to investigate the state of the internal IT infrastructure at the target company, and its compliance to state laws including PCI (payment card industry) and marketing.
Further, “there are rules about text messaging, and oftentimes franchisors are allowing their franchisees to be potentially in violation of state laws,” he says. Although these issues have been important for years, “there’s a step up, and they’re more important than ever.”
Amy Cheng of Cheng Cohen, who served as a judge for Franchise Times Dealmakers this year, noted the trend toward one umbrella company adding multiple brands underneath, and in sectors other than restaurants.
ComForCare, for example, formed a new parent company called Best Life Brands, acquired Care Patrol and formed an alliance with another healthcare service provider. “That sector is going to be an important sector for franchising over the next 10 years,” she notes.
She cited Neighborly, formerly named the Dwyer Group and with multiple home services brands under one roof, as another example. “It’s impressive they’ve been able to re-brand from the Dwyer Group, to see Dwyer get sold, get bought back, get sold, and yet each time it gets stronger. And that’s hard to do.”
Navin Nagrani of Hilco Real Estate, also a Dealmakers judge, notes the ambition and complexity of recent deal-making in the franchise space, especially the formation of Inspire Brands, the new parent of Arby’s, which then took private Buffalo Wild Wings and Sonic. “To take two public companies, both over a billion dollars, that’s just bananas,” he said, and notes that BWW in particular needs considerable reinvestment.
Alan Gallup, a partner at National Franchise Sales, specializes in restaurants buying and selling along with his colleagues. He notes a continuing increase in private equity groups backing operators as the restaurant industry matures and the leadership at brands becomes more stable. “It is considered less risky than it was 10, 20, 30 years ago, so conservative investors” including institutions can enter the game.
Gallup also notes a departure from the one-brand loyalty of old. He got involved in restaurant franchising in the early 1970s, and at that time franchise ownership was largely dedicated to a single brand, he says. “It was kind of like your alma mater. You wouldn’t think of owning a KFC and wanting to buy a Taco Bell,” he says. “Over the years those barriers have broken down. As the founders sold out their chains, the successor management of the franchisors became less concerned and more reliant on the experience of multi-unit franchise owners.
“We’re seeing someone looking for their second, third, fourth, sometimes fifth brand, if they have deep expertise,” he continues. “They can spread their risks in different industries.”
MPK Equity Partners, co-founded by H. Ross Perot Jr., son of the businessman and third-party presidential candidate, is only three years into the franchise investing game but has already carved out a distinct philosophy, says managing partner Doug Kennealey.
Its investments are Urban Air, an active indoor entertainment franchise; European Wax Center, a waxing chain; Vision Source, a network of optometrists and eye care; and Cheddars Restaurants. The latest purchase is Sola Salon Studios, which provides fully equipped salons for hair stylists and other beauty professionals.
He ticks off the attributes that attracted MPK to Sola. “Sola is the market leader in the salon suite business, twice as large as its next larger competitor. It’s a business that has a great management team. Because of its size, 440 units in the United States, it’s very well diversified. It’s also a business that’s recession-resistant,” he says.
And there’s this: “It is kind of Amazon-proof. Amazon has unseated and caused a lot of problems with many businesses, but there’s only one way to get a haircut”— so far, until the robots take over, he says with a laugh.
All MPK’s investments share a theme. “There’s got to be a uniqueness to the franchise, to the offering. In each of those cases, with the exception of Cheddars, they were either the category creator and/or the market-leading company,” he says.
Another attraction to franchising: Lots of interest from lenders to be part of the deals. “Franchised businesses tend to be very well diversified, they tend to be very profitable businesses. It’s kind of hard to put a franchise business with 200, 500, 800 units out of business. There’s a lot of down side protection there, which makes it attractive.”
His firm spends a lot of time during due diligence talking to franchisees. “Are they happy, are they being taken care of, what do they think of the future of the brand, are they going to open up additional units,” are the questions they explore.
10 Point Capital is another relative newcomer, at least in its current form, to the private equity game. Tom Wells, managing partner, echoes Kennealey when he talks about his firm’s attraction to working with companies still owned by their founders.
Wells also calls his firm’s money patient, with no particular time horizons to create an exit for investors. And he and business partner Scott Pressly insist on having skin in the game. “We have the lens of wanting to invest our own money, personally,” he said, along with that of family offices and high-net-worth individuals. “Absolutely. I wouldn’t expect anyone to invest in something if I didn’t.”