Founder of Emergent Growth Advisors and author of Big Money in Franchising: Scaling Your Enterprise in the Era of Private Equity.
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Private equity swept into franchising to become a dominant force. In my research, I found that more than 700 US brands have attracted PE investment at either the brand level, franchisee level or both. This is not a US-only phenomenon. PE investment can also be seen outside the US in markets where franchising has achieved meaningful scale yet still has attractive growth prospects.
But it’s a common misconception to think that PE acquisition is “just a matter of time” for any franchise system these days. According to FRANdata, there are approximately 4,000 brands in the US. That means only 17.5% of brands have attracted PE interest. And that’s after 30+ years of PE activity, starting in the 1990s when PE first discovered franchising and then accelerating after the financial crisis of 2007-2009.
So what’s going on? To understand why a relatively small number of brands attract PE, consider PE’s investing model. The average PE hold time for an investment is six years and the average fund life is around for ten years. The clock is ticking for PE to invest, grow businesses and hopefully sell them for a profit. There are other creative ways for PE to take money out of course, via dividends, debt recapitalizations, making loans to portfolio companies, charging management fees and so on. Tuck-in acquisitions can also drive tremendous accretive value. And sometimes PE sponsors will hold companies longer or trade between their own funds to extend hold times. But the basic formula is: “buy-grow-sell.”
PE’s usual success formula in franchising is straightforward:
• Buy good brands with proven, sustainable customer demand;
• Back (or install) strong management teams;
• Fund added support, staff, marketing and various initiatives to accelerate growth;
• Maintain (or better yet, improve) franchisee profitability. Positive validation attracts new franchisees and encourages existing franchisees to add more units.
Although execution isn’t easy, the formula is clear. But most systems just don’t have what PE is looking for to attract investment in the first place.
PE generally avoids excessive risk-taking. Their mandate is clear, and time is short. Unproven franchises, those with excessive franchisee litigation, stale offerings and turnaround situations often aren’t viable investing candidates. This often comes as somewhat of a shock to founders who wish to exit or bring on expansion capital.
The franchise model, executed through independent business owners–franchisees–is a brilliant expansion engine. It’s also notoriously difficult to turn around a stalled-out franchise because change initiatives must be broadly adopted by franchisees. Although franchise contracts enforce compliance, franchisees can still drag their feet and fight change. Getting franchisees on board with change can be a herculean task, especially if franchisees have trust issues due to management or sponsor missteps along the way or if there is a communication breakdown.
Looking across the landscape of approximately 3,000+ remaining unaffiliated brands, there are of course a few holdouts that are very attractive businesses but remain firmly under founder or family control—at least for now. PE investors have already cherry-picked the best brands willing to sell equity up to this point. PE continues to probe and waits for new opportunities to open within the small hold-out, high-quality group of closely held brands. But the rest of the field are simply too small or fundamentally unattractive. Regarding size, according to Vetted Biz, over the last three years, 41% of active franchise brands added 20 or fewer units…total. That’s just not enough growth to tempt PE buyers.
With so many brands already under PE control, larger firms can also simply wait until the time is right and the business trades again from one PE owner to another. Roark Capital, franchising’s most prolific investor, has followed this exact strategy for many acquisitions. Or the largest firms can take large publicly traded brands private again. Some investors are now consolidating units (at the franchisee level) in strong systems as an alternative approach when they can’t find brand level acquisitions that fit.
With few unaffiliated, high-quality franchise systems of scale coming to market, other investors get around the problem by building out platforms that specifically target acquisitions of emerging brands because the lift (at least in theory) is easier with shared infrastructure and cross-selling/cross-marketing. Some have found this more difficult than planned. Platforms targeting emerging brand acquisitions remain a bit of a specialty approach for this reason. You must have the time and patience, a thoughtful franchise sales strategy and a best-in-class operating team. PE has also found opportunities within infrastructure companies serving the franchise sector: technology platforms, outsourced sales and broker organizations, marketing, suppliers and various enablers.
But for the remainder of the franchise field, there is essentially a “long tail” of franchise systems that are too small or just not that interesting in their current state to PE buyers. PE has tremendous capital available yet to deploy, $2 trillion by some estimates. Founders wishing to tap this pool of capital and strategic support should revisit their brand’s fundamental operating model and value proposition for franchisees. PE won’t break their core model to acquire troubled brands; instead, great brands will enjoy price inflation as more buyers compete over fewer trades.
Businesses can aim for the following to make themselves more attractive to PE firms:
• Strong unit level economics
• Proven resilience and growth potential
• Sustained customer demand
• Good franchisee validation and satisfaction surveys
• At least $2 million EBITDA (emerging brand specialists can invest in smaller companies)
• A backable management team
At the root of everything, if your model is a good one and you can prove the growth potential, money is out there. If PE isn’t knocking on your door, if PE looked and passed or if buyers provided a lowball offer, hear that market feedback and get to work.
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