Current State of the Franchise M&A and Financing Market – Summer 2018

By Rick Ormsby
Managing Director
[email protected]

After several years of robust prices and lending terms, M&A across the franchise business appears to be nearing the end of its historically-high valuations. Things are still great all-around – but expect a slow and possibly steady decrease in valuations going forward.

Unbridled has had an unprecedented start to 2018, and our perspectives below come from 25+ M&A assignments this year, representing almost 1,000 restaurants:

1. M&A activity is still very brisk as franchisees are realizing that historically-high valuations are just past their high-water mark. Concern over rising minimum wage and new unit development is another factor influencing sellers. Many franchisees are aging and do not have a succession plan. Finally, some sellers are opportunistically taking advantage of strong sales and EBITDA for a higher price.

2. M&A has flared-up in several brands like Pizza Hut, KFC, Wendy’s, Burger King and Taco Bell, while it has weakened in others that have struggled for sales and traffic gains.

3. Fast casual deals are starting to show up on the market, but they are troubled in many cases. The jury is definitely out on the future health of fast casual.

4. Lenders are complaining that refi activity is drying up as interest rates are increasing.

5. The lending market is still incredibly strong but becoming choosey. Expect continued and increasing competition for M&A loans among the best brands and franchisees.

6. Interest rates are increasing, resulting in higher borrowing costs. Watch the trend here – this is one of the primary reasons why valuations are starting to see a slow decline.

7. Due to high Corporate divestiture activity, there is now a slight supply/demand problem in some brands as many stores are for sale. However, this is mainly impacting larger deals since Corporate typically sells larger chunks of stores. Smaller deals don’t have this same competition (see point #11 below).

8. The pool of existing franchisees as buyers is shrinking slightly because many existing franchisees have acquired stores recently and are digesting them, both operationally and financially.

9. As such, new buyers/PE firms/family offices are participating in franchise acquisitions in greater frequency. Many financial buyers are having trouble stomaching high EBITDA multiple valuations, so they are increasingly looking ‘down-market’ for brands with EBITDA multiples in the 5.5 – 6.5X range.

10. Corporate offices have become stricter on approving M&A transactions and new franchisees. They are also demanding sometimes unreasonable development obligations. Do not blindly expect to get a transaction approved, even if the buyer is growth-approved or well-capitalized.

11. Smaller deals that have strong performance are getting higher EBITDA multiples than the larger ones, and this gap is growing because higher borrowing costs impact valuations on large deals more than small ones.

12. Last fall, Unbridled began a massive campaign to attract new franchisees and buyers into mid-to-large franchisee businesses, anticipating a continuation of higher-than-average M&A activity in the next 2 years. We now have a robust Rolodex of well-capitalized, prospective franchisees and investors. Our competitors do not know many of these groups.

13. Several of these buyers have now begun to make offers on our recent sell-side M&A assignments. They generally offer high prices and strong terms, better than many franchisees.

14. Today’s outside buyers generally have fiduciary responsibilities to their investors, and deals are therefore becoming more complex. Sellers need significant business and legal representation to navigate a successful closing or risk making huge mistakes.

15. EBITDA multiples are ranging from 5.5 – 8.0X depending on the brand, size, scale and average sales volume. This range is slightly wider than in the past few years as recent financial performance has changed so much for many brands.

16. Cap rates on real estate are still favorable but are expected to worsen if the 10-year treasury continues to climb. In our view, the rising 10-year will dampen further increases in real estate valuations. Realistically, there is substantial near-term risk to real estate values. Don’t be surprised to see a 5-10% valuation drop soon if cap rates worsen.

Our recommendation would be to revisit the current valuation of your franchise business and your lending situation NOW. If you are planning to sell or refinance soon, don’t wait much longer as it is difficult to see much more upside from here unless current financial performance strengthens (which is expected in only a few brands). Don’t forget that most franchise companies were selling for 35-50% less – just several years ago.

If you have any questions or would like to discuss further, please feel free to reach out anytime to Rick Ormsby, Managing Director, at 502-252-6422 and [email protected]

Rick Ormsby
Managing Director
[email protected]