Gaining access to capital in a challenging economy: five factors for franchisors to examine when considering private equity.Imagine your company is performing well and you have identified opportunities to expand your business by building infrastructure, venturing into new markets or investing in resources to take your brand to the next level. Or, perhaps you have a good company that is burdened by too much debt.
In either case, with consumer spending down, skyrocketing unemployment rates, and traditional business loans nearly extinct, hearing the words "equity infusion" can sound like music to the ears of franchisors.
In today's marketplace, when a private-equity firm approaches the leadership team of a franchise system with an acquisition offer, it would seem logical to jump at the opportunity, right?
Not necessarily. While many good franchise systems may not have access to capital to invest in their business or may currently be over-leveraged and frustrated with a lack of options to capitalize their brands right now, a private-equity acquisition may be an option to consider--but not in haste.
The fact of the matter is that while private-equity acquisitions offer significant opportunities and benefits for franchise brands, there are possible downfalls. It really is true that nothing good in life ever comes easy. Below are five critical areas that franchisors must consider before diving into a private-equity arrangement, along with some thoughts from franchisors who have taken the plunge over the past few years.
1 Factor 1: Desirability
First things first: Franchisors considering a private-equity firm partnership or acquisition should closely examine their own desirability. Most reputable firms have set criteria for potential investors. Some qualities of a desirable franchise system would include:
* Strong unit-level economics,
* Franchisee satisfaction,
* Predictable, stable cash flow,
* Identifiable growth,
* Strong market position,
* Identifiable niche,
* Solid financial systems, and
* A well-established brand in multiple regions that have operated for a length of time through several economic cycles. (Not just a fad or the "next big thing.")
It's also important for franchisors to look closely at their own objectives. What is it that they want to achieve from being acquired? In tough economic times like today, "being saved" would not be good enough reason. Better objectives would be a desire to reach growth objectives with the backing of a quality private-equity investor who shares your values and business philosophies. Other goals might be to have a great resource for new business relationships and networking, and to have solid partners to work with their executive team to guide strategic direction and provide ongoing consultation.
2 Factor 2: The Right Match
Having passed the "desirability test," the next obvious step is research and due diligence--lots of it. Choosing the right private-equity partner should be looked at the same way as one would choose their spouse--looking carefully at every quality of the firm and closely examining a potential relationship from all possible angles.
By definition, a private-equity firm is a pool of capital managed on behalf of institutional investors and high-networth individuals, with the primary purpose of making equity investments in private companies. However, like anything else, all firms are not alike. It's critical for franchisors to find a firm that shares their philosophy, style and culture, and also invests in companies that are similar to theirs.
Jo Kirchner, CEO of Primrose Schools, which was acquired by Roark Capital in 2008, said culture and shared values are always priority factors for Primrose Schools when it comes to choosing partners at any level, including franchisees, vendors, employees, and, of course, an equity partner. She noted that relationships with potential equity partners do not happen overnight.
"There had been several years of communication between us prior to the acquisition," Kirchner said. "We had in-depth, two-way discussions and due diligence prior to finalizing the deal, so we were confident their group would be a good fit for our franchise system. First and foremost, we both maintain a strong culture with an emphasis on core values. Just like we do, our equity partner places a high value on the quality of people they recruit and retain within their organization. We also share in the belief that controlled, quality and profitable growth is much more desirable than rapid growth focused solely on gaining market share."
3 Factor 3: Investment Style
Some private-equity firms are short-term investors, while others take a more long-term approach. It's not that one style is necessarily better than the other. Whether a seller is looking for a long-term partner or a shorter-term capital source, it's important that the equity partner feels the same way.
To determine if the investment style matches your objectives, examine the firm's investment history. Franchisors and franchisees considering a liquidity event, seeking growth capital or other investment opportunities may want to find private-equity firms that actively support management teams, and want to make additional investments in people, process, and systems to generate long-term improvements, even if they have negative, short-term impact. For example, Roark Capital takes a conservative approach to capital structure (not a heavy user of debt). Regarding, a long- versus short-term investment style, the firm still owns Carvel Ice Cream, having increased its initial investment more than four-fold since acquiring Carvel more than seven years ago. However, this is just one type of approach, and it's not always right for everyone and every situation.
A long-term investment strategy was of utmost importance to Batteries Plus, which was acquired by Roark in 2007.
"You want a private-equity firm who acts like a partner, not somebody who is looking to come in, turn a quick profit and run," said Russ Reynolds, CFE, Batteries Plus president. "With an unpredictable economy, you've got to feel comfortable that the equity firm is going to be a good partner in good times, and a great partner in bad times."
Regarding "bad times," the Primrose Schools acquisition occurred just as the economic free fall began, yet, according to Kirchner, the capital provided the means to continue to invest in areas vital for brand growth, including people, technology, training programs and building a new professional development center on the corporate campus.
Unless you are contemplating an outright sale and will no longer be involved in the company post acquisition, you should strive to find a partner whose interests and capabilities align with yours, not necessarily the firm offering the biggest price. You should seek out private-equity firms that invest in companies with management teams that are motivated, committed to your corporate culture and dedicated to the success of your franchisees. And even if you are contemplating no continuing involvement, when considering what is in the best interests of the brand, the franchisees and the company's associates, price is one of many considerations, but certainly not the only one.
4 Factor 4: Team Composition
The best management teams take balance into account, and that's no different when it comes to private-equity firms. Franchisors should look for a careful balance of operating and financial team members in their equity partner, including a healthy combination of former CEOs, chief development officers, chief financial officers, and marketing executives that complement the financial team members. An ideal mix would be a team that has numerous collective years of both operating and investment experience in franchising.
Size of the firm should also be taken into account. Some private-equity investment firms specialize in large companies, such as those with more than 1,000 operating units, while others may only invest in emerging brands with under 25 stores, or somewhere between the two. Because the issues and opportunities facing a 10-unit franchise organization are vastly different from that of a 700-unit chain, franchisors should try to match themselves with an equity firm that typically invests in companies of their own size.
The like-minded professional background of an equity firm's managing partners is also important to consider. Partnering with an investment firm with in-depth industry experience who understands the ins-and-outs of franchising presents obvious benefits. While managing directors may not "run" any of the franchise companies in their portfolio, it's important for at least some of them to have walked in the same shoes as the management partners and understand the opportunities and challenges that a franchisor faces each day.
"Leading a franchise company is vastly different than running other kinds of businesses, so it's important to have an equity partner that has operational experience and insight in franchising, so that you are not dealing with a PE team focused solely on financial results. The right partner for franchisors will understand the necessity of investing in new initiatives to drive improved unit economics, increase franchisee satisfaction and build brand value," said Catherine Monson, CEO of FASTSIGNS, which was acquired by Roark Capital in 2003.
5 Factor 5: Portfolio Focus
In private equity, some firms focus on either one, or a small number of industries, while others invest in a wide range of business types across several categories. As most franchisors know, the world of franchising is an entirely different animal from most sectors, with specific and specialized dynamics and sensitivities.
One "perk" of being a part of a portfolio of companies in the same industry is the ability to share problem-solving techniques and success strategies with other companies in the private-equity firm's "investment family." By partnering with an equity firm that works mainly with franchisors, the companies can leverage each other's best practices and borrow and share programs, instead of re-inventing the wheel every time. Each year, for example, Roark-owned companies gather for a summit to share strategies on several fronts, as well as ways they can leverage collective buying power to reduce purchasing expenses.
Says Monson of FASTSIGNS: "It's also beneficial to have other franchise companies in the portfolio to consult with. That way, your key managers from all critical disciplines--franchise development, real estate, franchise support, training, IT, marketing, finance and HR--can meet with managers from other portfolio companies to share best practices, Key Performance Indicators, and to learn from each other."
It's important to note that being acquired is not always the best option for all franchise organizations. The healthiest private-equity partnerships are those in which the investors view their relationships with their partners' management teams, third-party advisors, lenders and investors as critical to their own success. They treat each other as valued partners. Their interests and approaches are aligned. And it certainly helps if you are set up for success with a conservative approach to capital structure to ensure management is free to operate the business.
Private equity works well when there has been in-depth due diligence on the part of both entities to make sure they are a good fit. As in all successful relationships, there has to be strong two-way communication and clarity surrounding the responsibility and accountability of both sides.
Any franchisors considering a liquidity event or acquisition should talk with other franchise organizations with private-equity experience to gain insight into the importance of relationships, shared vision, values and business philosophies. They should make sure, during the due diligence phase, to delve deeply into expectations regarding short-term and long-term goals on the part of both parties. Just as in a marriage, there are likely to be uncontrollable factors, outside stressors and changing circumstances, such as fluctuating economic cycles. But with a solid foundation and clear expectations established at the outset, there's a higher likelihood of a successful and satisfying relationship for both sides.
BY STEVE ROMANIELLO, CFE
Steve Romaniello, CFE, is managing director of Roark Capital Group and chairman of FOCUS Brands, Inc. He can be reached at stever@ roarkcapital.com.