— By Morven Groves —
The benefits of private-equity backing in 2023.
It’s no secret that the restaurant industry is facing a significant challenge in the form of inflation, which has led to increased costs on everything from labor to food and beverages. In response, many companies have taken one, if not several, price raises over the last 18 months or so.
While industry sales remained positive overall at the end of 2022, an estimated 95% of those sales went to offsetting the increased cost of labor and goods. There may be a light at the end of the tunnel as consumer prices fell by 0.1% in December, but the pressure to restore profit margins remains as we move through 2023.
Amid these pressures and an expectation of ongoing volatility, whether in commodity prices, supply chain more generally, or labor availability, franchisors need to focus on providing the best support they can to their franchisees. As a result, many are looking to attract the backing of private-equity investors — organizations that have the resources to help to them focus their areas of investments and who can bring breadth of experience from working with multiple concepts to the table.
Private-equity backing in the franchise industry has become increasingly popular in recent years. Acquisitions gained traction in 2021, totaling 7,896 transactions and reaching $2.6 trillion, according to Franchise Times. In fact, despite a 29% decrease in deals over the past year, M&A activity is still historically high. This trend is expected to continue as franchisors seek to navigate the challenges of inflation and stay competitive this year.
Private-equity firms can provide strong leadership and management expertise, infuse new resources into the business and enhance various systems and processes. Let’s take a deeper dive into how each of these aspects of the partnership can act in a franchisor’s best interest.
Infusion of New Resources Into the Business
Private-equity partners can boost a business with new capital, creating some cashflow flexibility — and thus the ability to invest where needed. For example, one of our portfolio companies, Walk-On’s Sports Bistreaux, recognizes that technology investment is critical to ongoing success in the restaurant industry. Being able to make these multi-year investments — whether in people, technology, products or elsewhere — can be a real source of future differentiation, putting the business on solid footing for years to come.
This can be especially important during uncertain economic times, when access to traditional sources of funding may become more difficult. Against a backdrop of increasing interest rate hikes, the additional contributions of a private equity partner can make this funding avenue worth consideration.
For founder-led businesses, this can be a particularly attractive route. Often founders have limited ability to access additional capital as they have already raised from local banks and friends-and-family investors. They may also be reaching the point where the business needs to bring in outside skills and capabilities to continue its growth trajectory. Frequently the founder will continue to manage the business, or retain a substantial management role, while still benefiting from the expertise and capital their private equity partner brings.
Contribute Strong Leadership and Management Expertise
Working with a private equity partner can give a business access to a wealth of financial, operations and leadership knowledge that it may not have readily had access to in the past.
Private equity partners often bring a more data-driven perspective to visionary founder-led businesses. The right PE investors will have relevant experience growing multiple brands and a deep understanding of brand strategy and what it takes to grow. While many private equity firms seek out concepts where the founder wants to remain involved, they can also help to formulate an exit plan and bring in new executive leadership to the business. Throughout the transition, the management team will work to help run the company.
Moreover, early-stage franchisors can benefit from the large network of existing connections that private equity firms bring to the table. By leveraging these relationships to secure favorable partnerships with financial institutions, suppliers, landlords and other vendors, the franchise is able to realize its growth goals and ambitions in a way that may not have been possible otherwise.
Streamline and Enhance Various Processes and Functions
Partnering with a private equity firm can bring a needed level of expertise and sophistication to a franchise business by streamlining and enhancing various processes and functions, such as marketing, training, site selection and technology. There will be systems and processes, or vendors, used by other companies in the portfolio. For example, several of our portfolio companies use the same development marketing firm. While each company chooses its own vendors, the executives across the portfolio freely share their perspectives. When some decisions become easy to make as a result of shared experiences, the executives have more ability to focus on the most critical issues for their specific business. Over time, this translates to faster, more profitable growth and value creation for franchisees and investors more generally.
Some private equity firms may also create “platform companies” by consolidating multiple brands with similar or the same market characteristics under one single company, which allows them to spread overhead and support costs, and therefore increasing profitability.
For example, when The Riverside Co. bought the Dwyer Group (now known as Neighborly) back in 2014, the brand began acquiring one home services brand every 4 months. Now owned by KKR & Co., Neighborly encompasses 29 brands ranging from cleaning and landscaping to junk removal and more. At the time of the sale, the brand was valued at $3 billion in system sales.
The various benefits of PE investment discussed above can open up new opportunities for the growth and development of a franchise. However, it’s crucial to know how to choose the right partner for your business and the owners within your franchise system. For our part, we spend a significant amount of time getting to know the executive team and their goals while sharing what we are like to work with and how we define success before we mutually agree an investment makes sense.
Furthermore, the involvement of private equity in franchising is continuing to evolve as investors lean into partnerships with skilled multi-unit operators as well as franchisors.
These partnerships can allow franchisees, like their franchisors, to invest in building their organizations and systems for the future too, ultimately improving their return on investment and the experience for their guests.
— Morven Groves is a managing partner with 10 Point Capital, and works closely with the firm’s portfolio of companies to set strategy and execute on their growth goals. Groves has over 4 years of private-equity experience investing in a variety of industries and branded businesses such as Tropical Smoothie Café, Phenix Salon Suites, Slim Chickens, Walk-On’s Sport Bistreaux and, most recently, Smalls Sliders.