Season 3 Episode 5. Q2 2021 M&A Market Trends



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What has changed in franchise M&A in the past few months? How is deal flow right now? What is happening to valuations? Are lenders eager or stingy?

Join Rick, alongside Derek Ball and Tony Petrunin, as they discuss these questions among the following topics and more:

1. Q2 M&A market conditions
2. QSR sales and profit outlook
3. Restaurant valuation update
4. Results from a recent lender survey
5. Real Estate financing update

We're calling this Q2 2001 M&A trends. For those of you who are geeks like me, that's a lot of numbers and acronyms in one sentence, but I hope you enjoy it. And here's who we have on the call. Many of you will know Derek and Tony. They work at Unbridled and both of them have done a great job over the last several years of helping grow our business. And they work primarily with me to bring in new clients and transactions and then work on the transactions that are before us and get them closed successfully.

One of the things I always like to point out is that we continue to hold a 90 plus percent success rate on the assignments we take and that's not easy to do. Most of our competitors and others in the industry are probably at 30 or 40%, right? So it's a shocking statistic. It would be like someone shooting 98% from the foul line. No one's ever done that in basketball. So it's kind of like that. And one of the main reasons we do that is these guys do a fantastic job. So they're going to have some good perspectives that we want to share with you here, and hopefully you find it interesting. Make sure to raise your hand again.

As we go through it, we're going to talk first about just what the market conditions are. We'll talk for five minutes about this, right? And then we'll go into... Most of our business is on QSR, we'll talk about casual dining and fast casual. And then anecdotally, I'll talk a little bit about franchising outside of restaurants, which is continuously a part of what we do, just a smaller part of what we do. It's no surprise that QSR has been dominating the M&A market here and the sales and profit environment over the last six or nine months during the COVID pandemic. And so a lot of our perspectives are going to be from that arena.

We'll talk about where valuations are right now and it's really a rocky time like Tony alluded to earlier. Things are very fluid and changing by the moment. And then we have this really cool thing that's a lender survey that I did back in October, and we're going to compare the results from this week, 15 lenders or so to what they said back in last May or last June. And so it's going to be a fascinating discussion and you'll be able to see some of the changes, not just from what we're telling you, but what collectively the lenders are showing us by their actions and by their results to the survey. I think it'll be enlightening for you. So we'll do that. That'll probably take probably 20 or 30 minutes, and then we'll finish up with a quick real estate financing and sale lease back update. Good news there as well. And then we'll finish up with some predictions maybe for what'll happen for the rest of the year. Does that sound cool with you guys?

Sounds good.

All right. Rock and roll. All right. I'll start with the first slide and I just throw that out here to you guys. I'll start with the first point and then you guys talk anecdotally however you see fit. It's our deal flow. I mean, historically speaking, I think you guys would agree if I look at the last several years and then of course over the course of the last 15 or 20 years, I mean, we're busy, we're busier than we have been in times past. And I think if you listen to this podcast or this webinar a lot, you're going to know that I predicted back in the late summer that we would see a return to M&A and a lot of people didn't think it would happen this fast. I did. And I thought it would, and it has come to fruition.

And what I said before, maybe last fall was that we had more demand than supply. Now, I think because of several various factors including taxes and historically awesome comps in the QSR sector, we have a nice balance of supply and demand. What do you guys think about some of those comments? You guys want to share any thoughts?

Yeah. I think on the demand side, I think we may have even said this in our last webinar. I think at least three times a week, I'm getting a cold email, a cold call, some kind of cold intro from a private equity group, family office, wanting to understand how to acquire a QSR, have some questions about entry fees and [inaudible 00:03:55]. From that side, I don't see any change whatsoever. On the supply side, I've definitely seen a pretty large uptick given some of the tax policy considerations that you just mentioned Rick. It almost feels like, gosh. And since I've been here, this is by far the busiest time I've ever seen at Unbridled. And I think it's a testament to a lot of people wanting to come around the bend in fiscal year of 2021 here and having their deal behind them. They were considering maybe a sale in year three, four or five from now. And they're looking at this window as a unique time to exit.

What do you think Derek?

Same here. You've got the 2020 sellers that weren't able to sell last year, just didn't think it was the right time, it was all too rocky. So you've got people that wanted to sell this year, you've got people that wanted to sell last year, you've got people that maybe thought like Tony said, they'd sell in the next few years, which we can talk about. But then you've got people that maybe had no desire to sell for the next 10 years. And now they're just at that point in their life and they see things being so rocky in the market and with government and just general things and they're tired and they're having to deal with staff in their stores, and they're just tired and they say, "You know what? We're going to let the younger generation take over and be done."

So you've got a lot of factors pushing into one short period of time, I think 2021. And we'll see, I mean, at the end of the day we don't know what the future holds. We'll see what '22 and '23 bring, but I think you've essentially almost got three years of people that are wanting to sell maybe pushed to a very short 12, 18 month timeframe. And that's why you're seeing so many deals out there.

I think it's a really good point, right? If you think about 2020, a lot of people paused their M&A plans. Now for us, Unbridled, we were able to jam through a record year basically, almost a record year for us. That's not normal. I don't think anyone else was able to do that. A lot of people paused their M&A decisions until the back third of the year or back fourth of the year, until things started to somewhat look like we could predict what was going to happen. So you're right.

I think we have the 2020 circumstance where we had an under penetration generally in the market of M&A. We have 2021, which just absent any other year and any other circumstance would have been normal. So you have the normal amount of people in any given year that would have sold in 2021 or thought about selling. And then you have this extra layer of people who might be pulling forward because of performance and because of potential tax considerations.

And so, the tax piece, we've talked about several times over the last few months and no one really knows what's going to happen or when it's going to happen. I think it's pretty likely we're going to see capital gains taxes increase. Now how much they're going to increase, I don't know. Biden has publicly said that he wants to support 42.3% capital gains tax. Right now it's at 23.8%. Not quite a doubling. Depending on whether you have real estate or not in your portfolio. I mean, this is a wide barometer, don't take my word for this. But typically 60 to 80% of a transaction when you sell a company, 60 to 80% of it's going to be capital gains tax. Maybe even more as opposed to ordinary income tax.

So when you sell a company, the impact of capital gains taxes is very important to you. And that's an important point to pause on because some of our smaller operators and friends here haven't thought of it that way. I've run into that several times. But when you look at selling the $20 million, if you have a $20 million gain in the sale of your company, and you're looking at your blended tax rate on the federal level going from 26 to, who knows, 36%. That extra 10% is $2 million. And so who knows when that would be implemented, whether it's January 1st of 2022 or not. Who knows whether, if it gets passed what the number is. I mean, there's Joe Manchin and some other senators are trying to make the changes more moderate. Maybe if it's not such a big cliff and we get a change to capital gains tax from 23.8 to 28%, it'll be more of a muted impact and we won't see as much of a deceleration of M&A activity on the selling side.

I mean, for buyers, you still have really low interest rates. You have great P&Ls. So for buyers, I think you're in good shape but from the seller standpoint, we continue to hear people saying, "Well, there's a risk out there that if I was going to sell it five years from now, I'm going to spend the next couple of years having to work to pay the difference in taxes potentially if the tax rates increase." So what would you guys say about supply and demand? Let's talk about that for just a few minutes. I mean, I-

I think and I don't know if this is the full point it comes into. I mean, like Tony and I just said there's a lot of supply out there. The most supply we've seen yet we're still getting a ton of offers on every single deal.


So there's still a massive amount of demand for these deals even though the deal flow is picking up... I mean, Rick you've been in here 20 years, my guess is you've never seen anything like this in 20 years in terms of supply. And we're still seeing buyers salivating for almost every deal we put out there. And this isn't really a point on here, but something that is important to know, and I tell a lot of people this is, there are a few trains of thought and I don't know who's right. We're selling businesses and just getting deals done. But you've got the train of thought of buyers that are massively bullish on the near term and the long-term for QSR, which is really what we primarily focus on at Unbridled, for the most part. And then you've got buyers that are more cautious, reserved and want to put a normal multiple on a normalized [inaudible 00:09:53] that number for 2019 plus 5% sales left or something like that. And I don't know who's right or who's wrong, but you got a lot of smart people out there that are thinking both ways.

So I can't sit here and say that one school of thought is correct. You've got a lot of different smart people. And that's why you're seeing just a massive amount of demand because we're still getting offers that aren't winning from the cautious people. And there's nothing wrong with that. It's whatever makes sense for you individually. [crosstalk 00:10:31]-

And how you can get it financed too. Obviously, financing is an interesting piece of this. For those of you who are listening, who are lenders, who are going like this. Like, "How do I get my hands around how to underwrite the risk associated with the business that's at 30 or 40% EBITDA over the last year?" And so that's a material consideration. By the way, Tony I want to hear what you have to say. I got a text from someone, it's funny. He said his dotcom loser was CMGI back in the '90s. For those of you who are in your mid 40 or older like me, we have all those buried bodies of all those stocks that we invested in and lost all of our money in, man. So you lost money in CMGI, I lost it in If you have any other stocks that you lost it in, send along, it's just humorous. Any comments you got Tony to...

Yeah. We talked a little bit about the supply side and the pinch in some of these sellers who are looking to exit, but I feel like on the demand side, really, the tax implications have very little bearing. I hate to say that because it's a pretty big statement, but I think demand is seeing through this. And to Derek's point, we have a lot of people we're looking to acquire long-term.

And so Derek's right. You have the two school of thoughts. You have the people who are more conservative and want to look at normalized EBITDA pre or post COVID, take a midpoint, be a little bit more, I'm using air quotes, more rational in that sense. But you also have these people who are saying, "I'm going to hold this asset for 10, 12, 15 years and I've got PPP money sitting here. My other QSR businesses have generated a ton of cash. I've got a lot of money sitting on the balance sheet and if I need to inject another 10, 15, 20% into a capital structure to finance a deal that I'm sure I'll win." Some people are willing to just go ahead and do that.

It's well said. I think that's right. And so we might say that supply and demand are pretty much in equilibrium I would say. It feels that way to me. Thanks for you all's comments. I'll flip to the next slide and just chat a little bit about outlook, right? For sales and profits. And for those of you who operate businesses, you know what your restaurants or your franchises are doing, but, what do you guys think? I mean, look at these points, grab a couple of them, and again, share some thoughts. I mean, QSR is still winning big, right? With the industry rebound. We're starting to see our casual dining friends and our fast casual friends really start coming back, which I'm really happy to see as we get past this mask mandate.

I was just looking at the CDC COVID tracker yesterday and the amount of COVID cases is dropping like a lead weight. I mean, like yesterday, they were below... I was just looking at a graph, eyeballing a graph, but it looked like it was lower than it's been since March of last year. So around where I live here in the Panhandle Florida man, I mean, there ain't no masks and the indoor restaurants are 100% full. But QSR is still winning, although decelerating a little bit. What do you guys see in sales and profits?

I mean, we're still-

Sill comparative.

Like I said, QSR is still doing really well. I think and I don't know if this was on the last slide or on this one. We've heard from some people sales have started slipping a little bit. I think it depends on the brand. It depends on how well you did last year during COVID. If you just started off last March and April plus 20, you're probably looking a little worse now compared if you started off negative 10, negative 20, you might be looking really good right now. And there are some brands that are in both situations. A little bit depends on where you are too.

But a lot of the country's been open for a while. Maybe you've got downtown LA or New York city that hasn't been, but really a lot of the country's been open for several months. And obviously people have been getting those stimulus checks and doing pretty well that way, but what we're hearing and we don't work in casual as much. We really mostly focus on QSR generally. But I've talked to some wonders that said a lot of their casual dining clients are back up to 100% of pre-COVID levels or higher. And if you really think about it, if you think of all the mom and pops that have closed, long-term, I hate saying this, but it might not be the KFCs or Taco Bells or Burger King that benefit from that, it might be the Applebee's or Chili's. If you want to go to a local dine-in place, maybe just going to find a new dine-in place. And if that happens to be the big guys like Applebee's, Chili's, Denny's, IHOPS, maybe that's where you end up going.

I would say this. I mean, we'll talk about this a little bit more. I mean, who knows, I'm just postulating here for a moment. But let's say some of the QSR M&A activity is pulled into 2021 because the P&Ls looks so strong and the threat of higher taxes for 2022 and beyond are there. So it stimulates demand. A lot of the casual dining brands are starting to rebound and have been for the last month or two.

Oh, by the way, sometime Q1, Q2 of next year, the casual dining brands may be looking pretty darn strong and may not have the same amount of supply in the marketplace from the QSR deals that have been pulled forward into this year. And maybe, just maybe if the tax increases that are getting negotiated don't end up as eye-popping as we would think they would be, then maybe we could see a really interesting M&A market emerging in the casual dining and fast casual space and also in the fitness space, maybe in Q1 and Q2 of next year. So I don't know if you guys have thought about that but that's just Rick's wild idea that might be something you could see.

What else do you see on here Tony that you like or want to comment about?

I was going to maybe pull on the thread of what Derek alluded to is about the sales lapping and some of the complexity there. I've got about a third of our clients right now who I think would be even beating last year's pops right now if it weren't for having reduced hours. There are some that are right there. I mean, slightly below, slightly positive, but they've had to go to summer hours or just hours and open later and close sooner, et cetera, to basically compensate for labor shortage. So it's crazy. You've got more patrons than you could ever serve, but you're having an issue fulfilling that demand with labor, which I think that's what happens when candidly the government puts their finger on the scale a little bit here, but it's created a unique dynamic, especially as you start thinking about lapping and which brands are able to meet or exceed that lap from COVID.

And to Derek's point, I'm not seeing it across the board by brand, it's kind of hit or miss in certain pockets. I think in a few more months, we will have a better read on it. I'm sure a lot of the lenders here are nodding their heads too, because I think they're in this awkward phase too, where they're looking at weekly comps probably from all their clients and trying to get a feel for which brands are going to see through this, capture customers, retain customers or lose customers. And what the new normal looks like I think will be pretty clear come October or November or December.

Before we get off this phone, we'll make sure we all throw in our hat in the ring on what we think will happen, because several of the questions Tony, Derek, that have come up along the last couple of days on emails to me have been like, "What do we think is going to happen to everything once the stimulus spending is over?" What's going to happen to sales that [inaudible 00:17:52]? Have these brands picked up long-term customers, or is this largely a short-term trend? Is there somewhere in the middle of that we should be thinking about?" And let's hold that idea, but let's put that in the back of our head and talk about it in a few slides.

I mean, I do think, and the only thing we didn't really talk about here, one is, it's, labor inflation is here, right? With competing with the government for employment and it's probably here to stay. It's a good article on the Franchise Times, I think, or the restaurant monitor in May this last article that talked about that, that it's probably here to stay on the low end. And it'll probably move its way up into middle management to if you're a restaurant manager or an area coach. And I know that it's really fascinating if we just take a simple chicken brand and you look at some of its stores across the country, franchisees who are helping, you may see a seven or eight or 10 point shifts in same store sales or comps over the last year based on different geographies.

So it's almost like these little microcosms that didn't exist so much beforehand. So that's something to note too. What's happening in Idaho maybe way different than what's happening in New Jersey. Okay, valuations. What do you think boys?


If I can put... [inaudible 00:19:15].

...valuations are up and they have been for months. And you said everybody give your prediction. I mean, heck, at this time last year, maybe last April or March, everyone thought it would be 30% discounts in QSR for the next year. Obviously, that changed drastically. I think most people's surprise, to my surprise personally, we thought valuations would drop for sure last March and April before we started seeing the big upticks in most brands.

Multiples are still very high. Some brands you maybe see multiples slip a little bit if even as of drastically, maybe to see people [inaudible 00:19:58] a little bit, but not in them. Most of the deals we're doing you're not seeing that very much. You're seeing that very slightly. Like I said though, you've got two trains of thought. You've got really, really bullish buyers that are willing to still pay big multiples on current EBITDA and you've got more conservative buyers and I can't say one school of thought or the other is correct. [crosstalk 00:20:19]-

How does someone come up with a price on today's assets? I mean, you have two major factors, right? You've got EBITDA. I mean, if there's way more than two factors, but let's just boil it down to the two most important ones really, EBITDA, whatever you think the EBITDA is and EBITDA multiple. So one multiplied by the other typically comes up with a price. I mean, we got to talk about G&A, we got to talk about remodeling, we got to talk about development obligations, we've got to talk about real estate. There's all kinds of other things, but essentially you've got EBITDA multiple and EBITDA, and that comes up with the price. I mean, you guys are in the marketplace talking with buyers as we have these assignments. I mean, give a landscape to those listening and watching. I mean, how are people thinking about that?

I think the, this is just me speaking in my personal experience. I think the brands that performed extremely well, they have a lot of M&A activity that are the most coveted. I think we all could probably think of the top call it, core tile of brands. You're seeing that second camp that Derek was alluding to where people are willing to look out in the future and pay beyond what they would have pre-COVID, regardless of what EBITDA or EBITDA multiples are doing. They're willing to sharpen their pencils even further.

You have the more conservative folks that I think are, I would say, are looking at normalized EBITDA pre-COVID. And I think they're probably paying multiples that are similar, or I'm sorry, they're paying values that are similar to what they were pre-COVID. It's just that EBITDA has expanded, but maybe the multiple they're applying has softened a bit to compensate for it. And they're still winning deals too, right? So I think it's, you have these two worlds colliding, but also who wins the day depends on what kind of deal it is, which brand, what geography, right?


The most coveted assets are going to be attracting that second group of buyer that's willing to sharpen their pencils and good assets that perform well with a really good narrative, with good ownership changes like you see some of the Inspire Brands, et cetera. Those things are, I think, continue to fetch really strong multiples. And you've got other brands that maybe a little bit more challenged, or maybe a little bit more picked over, but they're still transacting evaluations near pre-COVID or even slightly better in some cases.

So you're saying that they are seeing deals that are trading on trailing 12 months, current trailing 12 month EBITDA at multiples that were the same multiples in 2019 for certain transactions.


Others are not. Others are seeing maybe multiple gets dropped a little bit to compensate for the higher EBITDA or multiple stays the same and the EBITDA multiple gets proforma down a little bit to be an average of the last two years or something like this. But you're seeing it all over the board, but the good deals, they have a lot of demand. And I guess I'm asking, but I'm also telling, right? Are seeing the EBITDA multiple hold the line and even the EBITDA itself getting priced on current trailing 12 months financials. Any comments on that? You guys agree with that?

But I would say even that pool of coveted deals pre-COVID to now has expanded, right? You've got a lot of sellers to Derek's point and your point earlier who've come out of the woods. We know they're wanting in 2020, but now they've got the nudge from the tax man. They're saying, "Okay, now's the time to take my quality assets to market." And so in some of those, you get a great improvement in multiple, and you've got a nice COVID pop and somebody who's willing to pay for it. It's a real unique window to be exiting.

You agree with that? Any other comments? Yeah, it's absolutely right. What about the other brands? I mean, Derek, you particularly have had a couple of assignments with brands, tier two and tier three brands. And so I want to address that a little bit, because I think there's a little bit of a disparity here, right? Like you're on the playground, you're picking up a pickup game of basketball and you look at the little short kid and you say, "That little short kid, no one wants to recruit on their team." Right?

Yeah. I'd say that the top tier one brands are getting the best treatment just across the board like what Tony just said. So we're working, I believe in nine brands right now. Most of them are the top national tier one brands working in a couple, I would say, just smaller, regional or tier two brands. And buyers are not viewing the EBITDA increases the same way, they aren't. They are paying what I would consider a slight premium, but they're not paying current EBITDA times [inaudible 00:24:48]. So the multiples, if you're in a tier two or a regional brand, I believe the multiples, you've seen big EBITDA increases, you're seeing the multiple straw quite a bit.

The net valuation is still higher than it would have been pre-COVID, but you're not getting the same old multiple times 100% increase in EBITDA. You might be getting a four times number now that looks like six on historicals or something-

Seven or eight. Yeah. Right.

But you're not going to get that five or six times on current. I don't know if that's just the deals we're seeing but we've seen it and heard it just through the market, through the grapevine on several deals that we've heard about in the market, including the ones that we're on is the buyers just aren't looking to pay the same multiple premium for current EBITDA once you get out of those national brands.

30 seconds. What's going to happen if sales comps go negative? Do you think they'll go negative? What do you think? When will they go negative? Any commentary on that? I know it's such a broad question that can't be easily answered, but anyone have any thoughts?

I think a lot of buyers are already predicting sales go negative. I think it depends on specific buyers and how they do it. Like I said, everybody has a different opinion. And mine definitely is not the end of the whole deal. I think a lot of buyers are already expecting negative comps though. So they're putting in offers, potentially hedging that already. Whether they disclose that to the seller and exactly show how they get the calculation there, I think most buyers are expecting some form of negative costs to where you're still going to be hopefully sizeably about 2019 numbers, but maybe a little bit below here in 2020.

I think it'll ship valuations down slightly, depending on how big the comps are negative. I mean, if we're up 30 in 2020, and down by five in 2021, I don't think buyers will look too hard at it. If you're up 30 in 2020 and down 25 in 2021, well, that's probably a bigger issue and buyers will start looking back at what was 2019? Really it depends on the size of the negative comp.

I'm kind of bullish. I mean, I don't know if you guys... Maybe I'm always bullish in the eyes of the people who are watching and listening, but I'm kind of bullish actually. I expect we'll have a deceleration. It's already occurring and I'm always too of the opinion that if franchisees are going to keep 100% of their sales in profits during COVID and it's going to go back to 2019 levels. I'm always somewhere in between. I think there is some new that some of the things, some of the technological changes, some of the delivery changes, some of the way that the platforms have changed, the products that in the way in which the drive-through has sped up and been more emphasized, I think those are lasting things that will enable some QSR chains, especially the ones that are taking market share generally to settle at a higher place than where they were prior to the pandemic. I think that's natural.

I mean, that happens all the time in our competitive free market enterprise, right? Someone takes what someone else has and they grow at the expense of somebody else. So I think some of that is definitely going to happen. I mean, how much of it? I don't know. But I remain more bullish. I thought probably three months ago that we're going to be looking at a really big cliff once we hit May. Right now over the last year, once we started to hit this timeframe in 2020 where sales and profits started to really peak at QSR, particularly, and because of the government stimulus and maybe also because of an increased demand in general and a difference in the way we eat now, we're not seeing it quite as much.

I expect we will see some deceleration and sales comps may go negative over last year when we start trailing into Q3 who knows, and how much who knows, but it's largely I think a pretty positive story. I mean, I don't know how you guys feel about it. I go walking down the street and if I ignore some of the news networks, I look around and I feel like things are moving okay. Then I see the labor situation in the back of these restaurants and I change my mind a little bit. But just a commentary, I'm rambling.

Someone asked to speak of the labor stuff. A couple questions to answer.

You can see and answer them. I can't see them without stopping share, so go ahead.

Yes. I'll do them. There's two of them here. I won't say the full name, but Mitchell if you want to talk at another time about multiples of TTM EBITDA, please do because that's an hour discussion. Well, it varies widely. So feel free to reach out to us directly after the webinar. The other one, what do you think about Chipotle and McDonald's announcements about starting wages will do to the franchisee margins in the near term? I might be out of the loop on exactly. I'm assuming that just, they announced that they're going to have starting wages much higher than before is my guess. But the question is, [inaudible 00:29:58].

In the very, very near term, in the next month, I'm not sure [inaudible 00:30:04] unless they're paying 20, 25 bucks an hour, I think you'll still see people sitting on their butts at home getting paid by the government. Fortunately, we've got 19 states, I think that are getting rid of the national benefits sometime in June, obviously, hopefully more to come. And then the rest of it September 6th if it doesn't get extended. I see, 15 bucks and 15 bucks and all their company stores. That might get people to come back to work, but they're making the same amount or more sitting at home. So have a nice free summer of having fun and not working if you don't have to, that's the mentality, I guess, of a lot of people.

So in the next month, I don't know if it impacts wages. I think it will impact wages once people start coming back, obviously. And maybe the restaurant industry will just have to immediately go to 15 bucks an hour [inaudible 00:30:57]-

I mean, it's not coming down. That's my perspective. Since when have you ever seen a government policy or a government tax where they all of a sudden take it in and they reduce it. I mean, once you have this kind of a salary threshold in place and people start getting comfortable with it, prices are going to raise, employees aren't going to go back to work and now they have more and more options at $15 an hour. And they're going to just take them. I think it's going to take the whole industry upward. It's interesting. I'm still sitting yesterday at the grocery store down here it's Rouses, I don't know if you've heard of them. They're out of Louisiana.

But my daughter is almost 17. We're going through the checkout line and the checkout lady is like, "Hey, do you want to come work for us? It's $15 an hour and if you stay till September 1st, we'll give you $1,500 bonus even if you're only working part-time." And she's 16 and never really had a job before. And I know down here at the beach, it's different, but I mean, that's the sentiment I think once we come across that threshold, it's going to be difficult to move back down. So you've got to have a brand that's going to have the pricing power.

That's the key.

That's the key, isn't it? If you're a national brand that doesn't have a national competitor and you're like anything else, and you can price a little bit more for your product. I mean, then that's what you're going to have to do to keep your margins up and I suspect that the good brands are going to show, even in the midst of big labor increases, they're going to show profit increases too. And that's the wonderful thing about it is, if you can run your darn business the right way, manage the drive-through. How many times you guys have been through a drive-through in the last month where you sat for 10 minutes waiting to get served? If you can manage your business and operate it well, and you have a brand that's doing great. I mean, I think the market will show us in a year or so that your EBITDA is going to be doing just fine. Unless we have a nuclear missile hit some tall building somewhere.

I think Rick that's the key. You need to be in a brand that has pricing power. You can be elastic and take price when everyone else can. If you're doing national 7.99 pizza, and that's how it's got to be coast to coast, then that's a different story, but it's less going to be something that we could probably guide franchisees on and more of something that they're going to do a grassroots movement and get on their advisory council boards and lobby the heck out of their franchise orders to make something happen.

Well said. We've got 20 some odd minutes. So we've got a lot of this lender stuff to go through. We'll get through it all just to go quickly. It's interesting. Here are the high level points of this lender survey, and it's going to dovetail back into M&A, right? Whether you're financing your business, refinancing your business because interest rates are low. You're trying to lock in a longer term, or whether you're under a development obligation. And now there's been a hiatus at the franchisor level. And now they're re-instituting this process of developing new stores, they're remodeling. Whether you're doing M&A activities, and you're trying to buy, or you're trying to sell, you want to know what the lending market's like, right? And so the high level survey here is going to tell us that the lending market has rebounded really pretty strong. You're going to see some pretty, not startling, but pretty significant trends that are going to mirror the comments that we're making. And lenders are typically more conservative than we are, right?

So when they're positive, it means we're really positive since we're used with the tip of the spear. Underwriting the run rate EBITDA is a challenge for some brands. So we're hearing that at the risk department level. We're definitely seeing the flight to quality and the flight to legacy brands with 3,000 or 4,000 units or more. And rates in terms of course are very, very favorable. Rates are at incredible lows. Like 90-day LIBOR or is 0.15% or something crazy like that. So we're seeing 2% loans. And then there's really no fluid casual dining marketplace right now from a lending perspective. And again, my hope is that's going to change as we probably the QSR deals get pulled forward and we roll into the fall and maybe early 2022 when you have maybe a stronger more robust P&L.

But let's go through this first one. The first one's just pretty easy. If you just look over to the left, I don't know how your screen looks, but we had 15 or so surveys, lender surveys back in respondents in June of 2020. And then we have today May of 2021st or 2021, pardon me. And so that's how every one of these slides is going to be set up here. So you'll see a question at the top, and then you'll see the answers at the bottom. And the answers to the left are going to be last year in the middle of the pandemic. Remember where you were in June 1st of 2020, right? This was like two and a half months after the pandemic started. And then here we are today.

And you can see, this first is, how many M&A deals are you personally trying to fund right now? And you can see that it doesn't look all that dissimilar, which is surprising to me, but you do see a small cadre of deals. The lender is saying that they're looking at 11 or more deals. A lot of them are still in the one to five less or not looking at any. And so that's just to get you started in terms of the changes.

Let's go to the next slide real quick. And I'll have you guys comment on this but digest this for a minute. How is your bank looking at new franchise M&A loans going forward? And this is probably the most important slide maybe, or one of the most important slides from the survey. Looking back in 2020 in June, you had the yellow box was saying, "Cautiously lending for the right circumstance." And that was probably 70%, 65% of the respondents, right? Now you look over in the light blue over here it says, "Open and looking to take market share." And that was maybe, I don't know, it looks like a slice of pecan pie. That's about 8%, right? 7% or something back then.

But now look at what's happening here. Looking to take market share among the lenders you have, I mean, you tell me guys, 60, 65% are responding that that's what they're trying to do. A majority of the lenders are looking to take market share now and the rest of them are cautiously lending for the right circumstance. And nobody is saying unlikely to lend or not lending. Quite interesting, quite a change. What do you think?

I think if you took that 65 and you were to sit down with them and talk to them, I think they would say, "We're looking at anything and anything because we want to be there to see where the dust settles." But I think a lot of them will say, "Gee golly whiz." Over some drinks and say, "I'm not sure about this lapping issue." Right? It's going to probably give their underwriting team a lot of heartburn if a brand was up, let's say consistently 30, 40%. I don't know. In the most outlandish cases, right? A few of the brands that we would operate inwards just incredibly high.

I think they'll have some pause there, but I do think a lot of them are bullish, especially the ones that don't have as much exposure in casual dining who've done really well with their portfolios through QSR. So that [inaudible 00:37:35] is what I'm seeing.

I mean, if you just look at the timing it makes perfect sense. Back in June of last year, that's when banks were finally starting to somewhat reopen really late June, July. So now you've got restaurants doing great. If you're a lender, you definitely want to lend. Obviously you have to make sure you're lending on the right numbers. But even if you just think of the timing of when these polls were done, it makes perfect sense that last June people were pretty cautious. I don't think it was just lenders that were cautious last June, it was everybody. So it makes perfect sense to me.

Yeah. Maybe for us, it's a done no brainer to see these numbers, but I think for some people who might be watching or listening, they may be surprised at how quickly it has shifted so forcefully. So that's good. It's really good. The next slide says, "How soon will franchise lending get back to pre-COVID-19 levels?" What do you make of this slide? Back in June of 2020 people said 12 to 24 months. Here we are 12 months later and half people are saying somewhere between three and 12 months, and the rest are saying 12 to 24 months. So it would be what you'd expect maybe.

It makes sense. I almost wish we would have phrased it differently and put first half to '21, second half of '21, '22. But I mean, it just goes down in months. So it makes sense to me after 11 months here that the 12 to 24 has dropped down to three to six. Some of the six to 12 has dropped down to three to six. So it makes sense if you think about the timing there.

Tony you take the next one. What do you think, post-COVID who will you be most likely to make loans to? So basically this looks almost a mirror image-


...of last time. There's a story here. I don't know if you have any thoughts on the story, but there's a story here, but go ahead.

I think what this tells you is bailiwick of these brands. Their sweet spot is to find that franchisee. Again, 10 to 50 unit operator probably in the top whatever, 20 brand, but they're also open to looking at anything else. And I think that's what you see here and that hasn't changed at all, which in some ways isn't really surprising. I think if you ask any lender, candidly, what are you going to be looking at and making loans against? I think this is about where we would have landed. If you asked what this slide would have looked like, I would have guessed that it would be about the same.

To me it's a little surprising, I guess. I mean, not overly surprising, but in the middle of the pandemic to after the pandemic, the answer has not changed at all. I think you're right to have 40% of the respondents blenders preferring the 10 to 50 unit operator. That speaks a lot into how people are looking at the type of the type of operator who knows their markets, knows their RGMs, knows the ball teams in their small towns, knows the band, can cater to the local school. But those are still probably not by any means everybody that they want to finance, but it does garner a lot of attention.

And you don't see anyone individually saying the one to 10 unit operator, they didn't last year, that's becoming a harder and harder thing to do. And if you're a one to 10 unit operator, you understand this, that unless you have a lot of real estate and incredible AUVs and own nine stores, it's really hard to find a national restaurant lender that wants to finance your deal. It really is.

And so you're usually looking at regional lenders, or you're looking maybe to SBA lenders or something that's local to you. And that has some reason behind why you've seen so much consolidation in this industry since I started and left [inaudible 00:41:37] '05. I mean, it's just been consistently this kind of abandonment of the one to 10 unit operator in favor of either the 10 to 50 unit operator or the family office private equity buyer, which has been more of the last five or six years. So, yeah. Interesting.

Okay. What about this, what segment of franchise lending will your bank most favor going forward? There's maybe a little contingency of people last year who said, "Hey, I want the highly leveraged QSR brand, like a Taco Bell type brand." That the respondent was probably like, "That's the most secure brand maybe." I'm just guessing. Whereas now maybe it's more shifted just towards a split between the mid leverage legacy QSR brands, and then the ones that have re-surged. Anything here that strikes you guys that'd be worth the network that they're talking about?

It just continues to show people are looking for stable, strong QSR brands, where they don't have to go to 575 or six they suggested. You'd got to maybe five to five and a half at least adjusted, and have a brand that pre-COVID was doing great. Maybe they're up now, but worst case scenario, the franchisee's not going to miss debt payments, maybe they're not making quite as much money as they otherwise would have liked. But still have the strong capability of making those debt payments. So I don't see anything too shocking here personally. I think it makes sense that one lender, whoever it was, went back down to mid leverage from high leverage just based on all the other conversations we're having with lenders right now.

I think it's good news. Ain't it good news Tony? What would you say? I mean, you came from Pizza Hut.

Yeah, I was going to say-

It's good news for the resurgent brands, isn't it? It's good news for the... Remember back in June of 2020, we'd already seen pizza and chicken going bonkers, right? And a lot of people would say that a lot of the pizza companies were saved by PPP and by the surge and drive-through and take out business. I mean, those deals weren't all that easy. If you're a pizza franchisee, it wasn't all that easy to get finance back in '18 and '19, was it? And now it is a lot easier. What do you think? What were you going to say?

I was just going to say the last thing probably before we change slides is that, it's good to see that the lender's risk profile and appetite is still the same, more or less outside the one person in 2020 that wanted higher leverage. It's business as usual, similar risk tolerances as before.

If I would've had this graph back in June of '19, I bet it would have been 80% or 90% on blue and 10% on yellow. So the 2020 results already have the baked in impact of a resurgence in some of these chicken and pizza brands that really took the brunt of the increases in sales and profits. So looking year to year doesn't tell you maybe the story that we all know that those deals were harder to finance in '19 and they're a lot easier now. So if you're an operator or those types of brands have had a big resurgence, especially if you're a legacy QSR brand with over 3,000, 4,000 units, I think the message is particularly strong for you. You've got more outlets to finance your business than you did before the pandemic started.

Okay. Post-COVID-19 how likely will it be for your bank to lend to a casual dining brand?

A piece of info that I'd like to see is, which of these lenders wouldn't have done it pre-COVID as well? But obviously we can't ask them every single question in the book. But not a lot of change as you can see since June of 2020. You've got more unlikely, almost nevers that took over some of the somewhat unlikely category but then the green and blue is pretty much the same.

A little bit less. You'd say a marginal if slight, but not much change, but a marginal, probably less positive view on casual dining now than then. Maybe. Why? Doesn't that surprise you? I mean, ain't it doing better. Casual dining is doing great now. A lot of people are back at 100% capacity, sales are doing great, but yet-

I think it may though. With the data here, you're probably not out of the woods 100%. You can't tell if it's a growing trend. I think if you ran this again in November, October, if these brands continue to produce the comps that I'm hearing from our previous and current clients, I think that could change a little bit. I think you're going to have certain banks that say, "Heck no, we're not going to touch casual dining ever again just because of what we just been through." But I think the ones who had them and they're stable, who already have that equity with those clients, they start comping 15, 10, 20%. And consistently I think the tune will change quite drastically if you rerun this question.

But how are you going to get through all those casual dining brands and all the deferred rent and everything that they had to write off through the pandemic? I mean, I don't know that those guys in many cases might not be fighting for another seven or eight years just to be able to get back to where they were in 2019 from a net worth perspective. I mean, hopefully everyone's taking write downs and all those things that happened, but they had such a pronounced period of difficulty that it's difficult to see a lender looking at a deal that has $3 million of deferred rent and wanting to lend money to it. You know what I mean?

Yeah. I think the guys and girls who will do best for this are the ones who were diversified, had the QSR business overcompensating for the casual business. We have a few of those clients that are really well-diversified. I think they'll benefit the most with what I was discussing. But I think if you hang your hat on the one or two brands just in casual dining, I think you're right. That pain is deep and it's going to be a while before you get anywhere close to recovery, true recovery.

[inaudible 00:47:48]-

And because of that you don't see... Oh, go ahead.

If you're a lender right now and you're seeing the QSR deals, you want to spend your time on that. If QSR slows down in '22 and then casual dining sales are back up to 100% and there's more M&A in casual and not as much in QSR, well, I bet you'll see some of these lenders go back casual if that's the only option [inaudible 00:48:08]. They'll just do it in the right way.

Well, and this is my opinion, but a lot of the buddies that I keep in this business are QSR people who have a second fast casual brand where they own 10 of those units and 100 units of QSR and 10 units of fast casual. And those fast casual are just being hidden in their QSR portfolio. And so they're not going to ever sell those things in my opinion for much of a gain. So they may not be affected by capital gains tax increases and that's another sector of the market that you may see as it comes back a really resurgence and people trying to sell fast casual companies. And if you're listening and you want to own a seven or eight or nine or 10 unit fast casual business, just a smaller one, which a lot of these big franchisees got into a second brand in a small way. I mean, those deals are probably coming in 2022. They're not coming now probably but they're probably coming in 2022. Might be an interesting regression back to a smaller operator in those fast casual brands.

Okay. We're running out of time here. Let's see, we've got what? Seven minutes. So this is interesting. What part of the loan process getting the biggest increase in scrutiny? It was interest rate was an equal split back in 2020. Now, no one's saying there's a lot of scrutiny on interest rates. So interest rates have been diving and they're at all time lows, and they're not as big of an issue when making a loan now. So what that means to me and what we see practically in the marketplace is that the banking market is competing pretty heavily on interest rates and that's an area that if you're an existing borrower or doing M&A, you probably know that you can improve your circumstance or expect really attractive terms in that way. But you are seeing amortization and term getting the corresponding increase in scrutiny at the banking level, which makes sense.

That to me says, we're still employing what the next slide will say, which is a really heavy look at some of the financial metrics like lease adjusted leverage, fixed charge coverage ratios, and straight leverage. I don't know that this sample survey really tells me anything other than, I thought back in June of 2020, only about an eighth of course of respondents were saying lease adjusted leverage was a primary method of making a loan. And now that number looks like it's doubled. Maybe it's just the sampling size and such.

But that's really the, I know that lenders look at fixed charge coverage, straight leverage, and least adjusted leverage, but the least adjusted leverage calculation is really, we think the one that you hear the most about from the lending community and the one that we'll since check our valuations to our clients who come to us and say, "Well, what's this worth?" And we'll say it's worth $50 million. And then they'll say, "Why?" And we'll say, "Well, this is because of the EBITDA multiple and the way we model it, but also look at what someone who's going to be a buyer is going to have to put down in a down payment based on the least adjusted leverage at 5.75, and how much debt that they can assume on the business and borrow on the business." So any comments there real quickly before we move on?

No. I'll just answer one quick question. The sample size was 15 and 17 lenders.

17 back in 2020 and 15 today. This is one, least adjusted leverage, which is a calculation again, we just talked about that we use a lot. You can see the general tone of this says that back in June of 2020, everyone was like, "Oh crap, we're going to be ratcheting down the amount of money that we're going to be providing our restaurant franchise clients because there's more risk." And so you can just see that in these results. And then now you can see that it's less so, it's more muted. Most people are saying, "Yeah, we may." Overall that blended average here is that, looking in the future, least adjust to leverage might get a little bit lower and maybe that's because of some of the big increases in sales and profits but it's nothing like what it was in June of 2020, where people were frankly expecting to loan maybe 10 to 15% less in total proceeds than what they are now." Right? If you just look at the layout of these numbers.

So that's a good thing. That means that lenders are willing to lend more money on better terms, at higher levels and hopefully on a responsible basis. And then we have, this will be, I think the last side. There's not much to glean here about interest rates settling in the next one to six months. You really have basically people have shifted a little bit, lenders have shifted, but if I'm looking at this slide I would say, most lenders are looking like it's going to be flat to marginally higher, but more of a muted interest rate environment for the next six months. And I think that's pretty much what we'd all expect right now. Whereas back in June, there was a lot of fire.

Everybody expected massive interest rate increases and looking back the opposite happened. So-

Yeah, that's a point.

...a little more bullish now that you're going to see flat to a very marginally higher increase too. One or two have said lower actually, which going lower from today is a pretty bullish statement.

Yeah it is.

But everybody back in June was pretty much saying, I mean, half of the people were saying 50 plus basis point increases. That obviously did not happen in hindsight. So lenders definitely are more bullish. Just overall sentiment, lenders are more bullish than when they were 11 months ago.

Yeah. And that's good for our business. Okay. We got just a couple of minutes. Cap rates are mostly unchanged, still an incredibly awesome levels. There's a lot of pressure going on to get these deals done in 2021. Part of Biden's floated tax policy says it's going to cut off capital gains tax deferrals on 1031s above $250,000. I can't imagine that's going to make it into law, but if it does, it's going to have a remarkably bad impact on the fluidity and the pricing of cap rates. And because people can't do 1031s into further taxes.

So right now that's stimulating demand as you might know. Interest rates are still low, lack of inventory is driving pricing. The 1031 market is strong and the REIT market last time we did this in October, that was the last thing to come back, it's wobbly. It was really wobbly before because of a lot of these write-downs that these REITs were taking. But now the REIT market is back and actually quite strong for QSR. And some of our deals where someone buys the operations and then someone in a REIT buys the business at the same time with the simultaneous close producing way better results than what we would have expected three to six months ago.

We will look at this slide here in closing that just basically says... This is what we put out last October. And I just repeated this slide just to go through it. You'll get a kick out of it. EBITDA increases might last until Q2 of 2021 that was seven or eight months ago. Were we right? Probably going to be right. What will M&A supply and demand look like? They look like they're in balance. I think that was the nature of the question back then in October of last year. Expect Q1 and Q2 to be busy driven by the fear of tax increases and strong EBITDA tailwinds. That's exactly what is happening.

Less sellers if taxes increase, more distressed deals with fewer buyers. We don't know that yet. We're not seeing that, we're seeing the opposite now, right? More sellers, because they're trying to beat the tax policy increases. Distress deals really aren't there as much right now. Q3 could begin a natural slowdown. We've been predicting that for a long time, maybe. And that's from an M&A perspective, maybe that will happen. We'll see what happens to the tax increases. The tax increases are somewhat muted or not crazy. Maybe we've just seen maybe a natural six to nine month pull forward of QSR deals and we'll see a soft landing and M&A will stay strong.

Uncertainty is never a seller's friend. I mean, that still remains the case and why our phones don't stop ringing at this point in time. And then lock in gains and agreements soon. I guess I would say this, if you're watching and you're a seller of your business, and you're concerned about big capital gains tax increases, you really got about another 30 days to get your business on the market if you have any reasonable chance of closing it before year end. And I'm not saying that taxes, if they're going up, will delay until January 1st of 2022, but a lot of people think they probably will if they are enacted, but it takes six months to do a deal. And towards the end of the year, you've got holidays. And so not to sound like a used car salesman here, but that's just the reality of the decisions you need to be making if you're considering selling your business or refinancing your business or doing any sort of M&A action going forward.

Anything you guys would say in closing before we jump off here?

I just think in general, I think the world's in a lot better place, especially our world than it was maybe last March. I mean, I think to have this as an outcome and this be an environment for selling and buying is phenomenal. Despite all the considerations that we've talked about, I think it's still a really healthy market. And if you're a buyer, there's ample opportunities. If you're a seller, there's no time like the present. I think Rick may have frozen there, but Derek what do you think?

I agree with Tony. There he is. Rick you're back. No, I agree with Tony. I have no really closing remarks other than thank you everybody for listening in.

Appreciate it. Really appreciate everyone's time. Check this out.

Thank you everybody.

Thank you so much for everything. And watch out for a replay of the webinar and check out the podcast. We're thankful that you were able to join us today.

Thanks guys. Thanks everybody.