The Art of the Deal
The franchising community at-large knows the big players. When Inspire Brands acquired Dunkin’ Brands for $11.3 billion, it was headline news. But across a growing landscape of umbrella companies and the investors that are behind many of them, where and how does the smaller franchisor fit into the picture? What does capital investment mean to that player?
This year, the 2022 Home Services Summit, a virtual franchising event, dedicated an entire session to the topic of selling your franchise called: “Preparing your brand for global domination: How to use capital to supercharge your system.” Attendees included franchisors, lawyers, accountants, bankers and more from across the U.S.
With many franchise leaders looking for future investments as a means to stay involved and grow a concept to the next level versus exiting altogether, the feedback was unanimous. In today’s environment, be prepared even if you are not ready to do a deal yet.
Eric Williams, partner with the Akin Gump global law firm, told franchisors, “You ought to be thinking about this before you even have your book out on the street. You need to be ready at any time. [Because] while it may not be your plan to engage in a transaction for a number of years, you never know when someone is going to come knocking on your door.”
Williams compared the process to selling a house. “Before you list a home, you might invest in painting, fresh flowers out front and looking your best to get the best return on investment,” he said.
What exactly are investors looking for in this hot M&A environment when that happens?
“The culture piece is super important,” said Doug Kennealey, Co-Founder and Managing Partner of Princeton Equity Group who has vetted and invested in multiple concepts. And he should know. Franchise Times magazine recently recognized Princeton Equity Group in this year’s Dealmakers of the Year Awards, noting that the firm acquired seven franchisors since July of 2020 for $175 million total enterprise value.
“The relationship between the franchisee and franchisor is just paramount,” Kennealey said at the summit. “Not only is the corporate culture important, but how that franchisor interacts with franchisees. Whether the franchisees trust the management. Whether the franchisees have a shared vision. Whether they feel the franchisor has met expectations. We want to find happy franchisees. Energized franchisees. Franchisees investing more and more with the brand.”
However, there’s a real chance that smaller franchisors are more into deal-making than documentation.
Jay Duke, National Managing Partner of Advisory Services for BDO, said some of the biggest disasters are when franchisors don’t even have all of their agreements signed. “They are doing handshake agreements.”
For people who want to be taken seriously by potential investors, the numbers have to make sense. “There’s no such thing as a cheap accounting firm or a cheap law firm,” Duke said. It’s about “making sure you’ve lined up the right professionals to actually help you get ready for that sale.”
Williams also advised franchisors to ask for a due diligence request list and find out: “What will I have to disclose?” Then you can get ready with those guidelines. For example, “Has the founder promised equity to employees or owners?” he cautions. “Because that can really cause purchasers a lot of heartburn. Like we go to do a transaction and we really don’t know who all the owners are.” When time and energy is taken away from the actual sales process to figure out those issues, it sends the message to potential investors that you are not as buttoned up as one might think.
Understanding the KPIs of the business, knowing what’s required to scale that business and having a solid management team should be standards when trying to attract investors. “You started the business. You have five locations. But what do you need to get to 50, to 100, to 500?” Duke asked. “If you’re not prepared, or you don’t understand your books or your records, the investor will walk away.”
That doesn’t mean a business has to be in perfect condition. After all, franchisors look to seasoned and knowledgeable investors to reach those goals as well. That’s how they benefit not only from a capital infusion and a wealth of business-building know-how, but also the chance to join an umbrella company in a growing number of cases with a great track record of doing that for multiple franchisors.
“These are not huge companies with a full c-suite,” Kennealey said of prospective franchise concepts that he evaluates. “We would expect some level of unsophistication. These are entrepreneurs busy running their business. So we would expect some of that messiness.”
What shouldn’t be messy, however, is the FDD. The number one thing Kennealey cares about are the ROI or unit economics for the franchisee. And how does that compare to similar companies in their space?
“The first thing we ask for is monthly revenue by franchisee since inception,” Kennealey said. “It’s amazing to me how many companies don’t have monthly revenues by franchisee. We like to see continued same store sales even as franchisees mature. It means they are hungry to grow. And it means there is growth left in the system.”
Mark Jameson, Chief Support and Development Officer for Propelled Brands, echoed this sentiment in a recent interview for the “Success Made to Last” podcast, saying that the profitability of franchisees is the first of four key pillars for how Propelled supports it multiple brands [FASTSIGNS, NerdsToGo, My Salon Suite and Salon Plaza].
That also paints a good picture for the strength of royalties.
“The royalty streams that you have based on existing happy franchisees,” Duke said at the summit, are extremely attractive. “As long as you can map out getting those royalties sufficiently, that adds a lot of value. A lot of investors give value to that as opposed to selling a new store.”
In other words, awarding franchise agreements is good, but opening franchises is even better.
“If you sold 20 to 30 new stores in a year and you’re able to open them in reasonable amount of time, that adds incredible value,” Duke said. “If you’ve sold enough (however) but you haven’t opened them, that’s a red flag that you aren’t able to get them open in a credible amount of time.”
[NOTE TO READERS: BizCom Associates supports Neighborly, Best Life Brands, Stellar Brands, and Propelled Brands with a combined 41 brands across those umbrella companies.]