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If you follow what is happening in the franchise world, it will come as no surprise to you that there is a virtual feeding frenzy going on in the marketplace, with private equity (PE) firms and others buying franchise companies at a record pace. Not only are deals getting done at a frenetic pace, but the valuations that PE companies are paying in today’s market are nothing short of stratospheric. More and more PE firms are interested in the rapid growth of franchise companies and they are sitting on mountains of cash that they have to put to work or else face the wrath of their big money investors.
Of course, not every franchisor’s dream is to grow his or her concept into a big deal that will attract a private-equity company’s bankroll. And even if selling your business your goal, the timing has to be right from the standpoint of your readiness and business valuation. But if a sale is a part of your future plans, there may never be a better time to consider the move. Bear in mind that even if you cannot achieve your financial goals with a sale today, many PE firms will allow you to remain on board to run the company and to hold a significant piece of the equity in the business. So when they sell the company – and most PE firms buy businesses with the intent to resell them again in a five to seven-year time frame – you will get “a second bite at the apple.”
The advantages to going the PE route
The benefits are considerable. They range from the obvious cash infusion to the ability to leverage management expertise and corporate connections. Often, the PE firm will insist on bringing on top talent to your company, which may add substantially to your ability to sell and support your franchise network.
Related: A Beginner’s Guide to Private Equity
One of the ways that PE firms have been getting involved in franchising of late is through the creation of “platform companies,” where multiple franchised brands that share certain common market characteristics are consolidated under a single company that allows them to spread corporate overhead and support costs across a broader network – thereby increasing overall profitability. Back-office systems and other technology platforms can be much more efficient with multiple bands on the same platform. In some cases, cross-referrals at the consumer level can improve franchisee unit economics in these platform companies. Moreover, franchisees of one platform concept may buy additional platform franchises to fill out their portfolio of brands and benefit from their own synergies and cross-referrals. And ultimately, these improvements in the business model can allow PE firms to improve valuations/multiples when it is time for them to resell the company.
Companies employing this platform model range from those that invest in a single segment, such as food or home improvement, to ones that buy brands with synergy or similar operational structures. And the good news for some smaller franchise systems is that these firms are now targeting much smaller franchisors than they did in previous years.
The downside of private equity
With an outside cash infusion, you will have to give up a degree of control, and investors will want to be involved in any major decisions. Founders who are used to making all of the strategic and operational decisions may find this challenging. Knowing the degree of involvement your equity partner will expect is just one of the many things to consider.
Assuming you have decided to bring in outside capital, it is often advantageous to consider hiring an investment banker who can take your company to market and help you obtain multiple offers. Remember, it’s often not the final selling price but the terms of the deal that are most important, and these advisors can be invaluable in helping you to understand the implications of the deal terms – as they will have been down this road numerous times before. While an investment banker will get paid handsomely, don’t try to go it alone unless you have done this numerous times in the past.
If you are ready to make the leap, understand that PE firms are looking for good unit economics, a portable concept that has market adaptability, and a strong, stable relationship with its profitable franchisees. All, of which, are of course benchmarks for any good franchise system. They will hope to see that you have the personnel and resources for growth, as, contrary to what you may have heard, they do not want to run your business on a day-to-day basis. A strong management team that can grow a concept with the help of an infusion of cash is an ideal scenario. Be able to tell the PE firm precisely how you will use that cash infusion to take your concept to the next level. And, of course, a healthy pipeline of franchisees is attractive to PE firms, as is an active R&D department that is both creative and nimble.
Information is king
Before reaching out to investors, complete an assessment of your competition, and start gathering information on your own concept that an outside funding source will expect you to have at your fingertips, such as historical financial statements, capital needs, unit level economics and the drivers of unit-level profitability. Come up with a compelling narrative on not just your numbers, but also the culture you’ve built and want to maintain.
Your franchise legal documents should be in good order and your intellectual property properly protected. Because we’re all still living with the aftereffects of the pandemic and two years of struggling and downtime, this is the perfect opportunity to dig deep into your operations and agreements to ensure everything is in good working order and up to date. The market has changed, along with consumer spending habits, so you’ll want to show you have adapted – and can continue to adapt – to the new world order.
Finally, make sure your financials are “clean” and there are no skeletons in the closet. Due diligence by a PE firm will uncover everything, so if there is anything that might pose an unpleasant surprise, it will be up to you to bring it their attention rather than hiding it. If they do find something that you have intentionally hidden, expect that it will kill the deal. And if they find out later, you can be sure that they will have built provisions into the transaction that will allow them to come back after you for any misrepresentations. Be transparent.
Ultimately, private equity is changing the face of franchising. The days of an entrepreneur growing a franchise company from the ground up to a thousand locations or more are largely over – as most will see an offer that is too good to refuse well before they hit the century mark. Today’s new franchisors need to focus on getting their franchise off to a strong start – at which point they can bring in a team that will take it to the next level.
But in doing so, don’t forget the franchise mantra: Do your due diligence. Aligning with a private equity company is not a silver bullet, nor should it be a quick decision. Take your time to reflect and research. And make sure, as with any relationship in franchising, that there is a good financial and cultural fit on all sides.
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Mark Siebert is CEO of the leading franchise consulting firm iFranchise Group. Reach him at 708.957.2300 or firstname.lastname@example.org. His book is Franchise Your Business: The Guide to Employing the Greatest Growth Strategy Ever.