Global Franchise 9.1

INS IGHT What should franchisees do if their brand is acquired by private equity? First, recognize that if the brand has a high-quality operating model and is growing, it will eventually attract PE attention. While some founders want to hold out or pass the business onto their children, for many there comes a time when a private equity transaction makes sense. Franchisees should be prepared for that possibility. Second, post-acquisition there will be a push to lift same store sales. Often this is via marketing investments, new product and service launches, and other growth initiatives. But you can also expect corporate to accelerate efforts to exit underperforming franchisees and transfer outlets to better operators. Franchisees often go into business without an end game in mind. Hopefully, owner or management team transitions bring positive changes. But if you don’t like the changes, or it’s no longer a fit for other reasons, you need to prepare to make a good exit and move on to other adventures. The book talks through how to prepare properly, and things for founders and franchisees to think about when preparing for an ownership change. Finally, it’s important for franchisors to establish a franchise advisory council (FAC) early on and really listen to feedback. FACs you’re unlikely to attract a PE buyer. Some firms have gotten burned taking on turnarounds and there are case studies in the book with some of those stories. Although the average PE hold time is six years, PE often hold franchise businesses, especially multi-brand platforms, for longer. Although a dominant player, PE has only invested (as one example) in less than 20% of active U.S. brands. That means there’s a very long tail of brands that could yet be investment targets, but most will remain too small or aren’t attractive without a change in approach. When has PE not been successful in franchising and what were the lessons? In the early days when PE first entered franchising, many underestimated how difficult franchise turnarounds can be and were too aggressive with debt. Franchisees are independent WHAT PE BUYERS ARE LOOKING FOR IN FRANCHISES Strong unit level economics, operating margins ideally 15-20% or higher Sustained, proven, and growing customer demand Proven resilience across different markets Good return on investment for franchisees Differentiated product/service; not a fad Any issues must be fixable within PE’s hold period Good franchisee validation Some scale achieved (depends on buyer how much scale they want to see before investing) Strong demand for new franchise licenses, especially from existing franchisees Great management teams can help filter change requests, provide franchisee feedback on new product or service trials, and promote best practices in the system, providing continuity and institutional memory across multiple ownership changes. Change is part of business. A well-functioning FAC-franchisee- corporate relationship increases enterprise value, whereas a poor relationship and communication dynamic does the opposite. How can franchisors position their businesses to attract interest from private equity? Private equity looks for a strong operating model and open space to add units. Any challenges need to be fixable in the short term. The best way to attract PE investors is to build right in the first place and to remain laser-focused on improving unit level profitability. If franchisees can’t make good returns, the business can’t grow. PE pays for growth potential. Some business owners think, “If I build it, PE will knock on my door.” But in truth, PE is looking for very specific attributes in the businesses they acquire. And they kick tires on many concepts simply to learn about the marketplace. Sellers can waste time and get false hope having conversations that either lead nowhere or generate disappointing valuation feedback. It’s better to start planning early and build what buyers covet. If you’re a franchisor, this approach coincidently also creates value for your franchisees, so it’s a win-win situation. This is the focus of my consulting practice. Are there any misconceptions about private equity related to their franchise investments? Yes – there’s no bank truck rolling up to fix your problems! If there are any major flaws in your model, “It's better to start planning early and build what buyers covet” 44 GLOBAL FRANCHISE | ISSUE 9.1