Hot M&A Market 2019



The topic of this episode is, why is restaurant M&A so hot? Many asset classes have appreciated significantly in the past five to six years. For example, real estate prices currently are high and the stock market has had an unbelievable run. If you're reviewing your investment returns over the past few years, you're likely very happy, but you're probably also having trouble deciding where to invest your money now to get a decent yield. Everything seems fully valued. For institutional investors, this same problem exists. Increasing wealth and cheap debt have created huge appreciation in most asset classes, and businesses and real estate don't look as cheap as they used to look.

With a ton of cash on hand, these investors begin to ask themselves, "Where can I go to find a better return and get some diversification?" The answer to this question inevitably leads them in two different directions. Number one, acquiring different types of businesses that previously were overlooked. And number two, journeying downmarket to find smaller businesses that are undervalued, can be consolidated, and don't have access to sophisticated capital. As the ball has rolled downmarket, franchise restaurants have benefited from this trend. When I first started working at Yum! corporate in the early 2000s, there were almost no private equity investors as franchisees, for example. No one even knew what a family office was.

Most legacy franchise systems were populated with the original franchisees who were smaller in size and unsophisticated in terms of their capital structure. Only a few franchisees in each brand were doing larger acquisitions. Imagine the famous painting American Gothic by Grant Wood. It depicts a farmer with a pitchfork and his daughter right next to them. This visual can give you a rough idea of how franchising started for many operators years ago. Fast forward to the 2010, 2013 timeframe, and the consolidation trend started to pick up. It started mainly by independent operators acquiring smaller franchisees. The mid-size franchisee started to double in size while there was an occasional large institutional buyer entering the business usually making big headlines.

Smaller operators didn't have a succession plan and no longer wanted to fight tighter profit margins and increased regulations. This initial consolidation was instrumental to what we are seeing today because institutional investors would never have had the patience to acquire four or five restaurants and grow little by little through smaller M&A consolidation. But the mid-size operators were happy to do it. In recent years, franchise M&A has really snowballed. Professional investors have started following the cycle I mentioned earlier. And all the while, the size of the average franchisee has increased dramatically as mom and pop operators were replaced with mid-size franchisees who eventually became larger franchisees.

We now see $2 to $10 million in EBITDA as the entrance point for investors in franchisee businesses, which is quite a bit lower in size than what we've ever seen. Again, going downmarket has created more opportunities for investment. Deal flow is now high. Credit remains relatively cheap. New family offices are looking at deals seemingly every day. And acquiring restaurants is suddenly something that's cool to do. If you have any questions or would like to talk about any topics related to M&A in the franchise space, please feel free to reach out. Thanks again.