Season 1 Episode 23: 10 Reasons Why Franchisees Shouldn't Delay Their Decision to Sell their Franchise Businesses



Also Listen On:

10 Reasons Why Franchisees Shouldn't Delay Their Decision to Sell their Franchise Businesses

Welcome to the Restaurant Boiler Room, episode 23. I'm your host, Rick Ormsby, managing director at Unbridled Capital. Today in the Boiler Room, we're going to discuss 10 reasons why you shouldn't delay in considering a sale of a franchise business. The Restaurant Boiler Room is a one-stop shop for multimillion dollar merger and acquisition activity and financial complexities affecting the franchise restaurant industry. We talk money, deals, valuations, and risk, delivered to the front door of franchisees and private equity firms, family offices, large investors and franchise doors on an every other week basis. Feel free to find our content at Unbridled Capital's website at Now let's enter the Boiler Room.

So the topic again is 10 reasons why you shouldn't delay in considering a sale of your franchise company. Now, the tone of this topic will be a bit pessimistic, which for those of you who have listened before is a little bit different from my style and general demeanor. Franchise valuations are really high right now. So much of the news is still very good. However, I think you need to hear a different perspective too. Balance is always a good thing. I'm not trying to be a fearmonger, but every franchisee should consider these 10 reasons when evaluating their strategy and their legacy. So here they are.

Number one, historically high prices persist. Over the last few years, we've created a massive shift in the franchise industry as family offices have entered the space with increasing regularity. Franchisees have gotten larger, become more inquisitive and are diversifying across several brands. Consolidation is the name of the day and smaller franchisees are selling at a fast clip. Why? Because prices are way up. And they've been there for a few years. Most brands are trading at EBITDA multiples and cap rates that are 15 to 30% higher than just several years ago. Pricing remains very attractive and it can't stay this level forever. Reversion to the historical mean would imply a huge drop in valuations for sellers in the near term.

Number two, restaurant sales and comps. By 1 source, July, 2019 comp sales were lower than they've been since September of 2017, almost 2 years at -1%. Comp traffic was a horrific -4%. No one seems to be predicting a turnaround here, sales and traffic problems may worsen. Additionally, third-party delivery is largely unprofitable yet it is propping up sales numbers across many parts of the country and potentially hiding a deepening problem.

Number three is labor pressures. About half of the states have now implemented a minimum wage that is higher than the federal minimum wage. I've personally seen what rising minimum wage has done to restaurant P&Ls. And I can tell you, it is very, very ugly in almost all instances, unless your brand has a ton of pricing power. Congress is trying to pass aggressive federal minimum wage increases currently. And as an aside, most of my friends in the Southeastern US particularly are ignoring the impending wrecking ball. And what I mean by that is that minimum wage won't stay the same forever in these states. And when it changes, you could lose 10 to 15% or more of your EBITDA overnight.

Number four, the high amount of leverage. The M&A boom over the last few years has been driven by cheap debt and easy borrowing. Even though they have plenty of cash, family offices and private equity buyers want to spend as little of it as possible. High prices and big consolidation have led to a huge amount of leverage in the franchise space. Some franchisees are now close to breaching covenants and a downturn would mean immediate workout or bankruptcy. Also many of the new buyers are young millennials. They simply don't have the experience to know what it was like back in those brutal days of 2009 and 2010. Now, why does this matter? It's simply a question of supply and demand. Distress causes more supply. More people are forced to sell or restructure and that in turn causes less demand. Prices drop for even the best franchise businesses and it can happen really, really fast on the drop of a dime.

Number five, chilliness from the lending community. Several banks have recently shuttered their national lending platforms. Others have started to ratchet down their loan originations, even though they won't loudly proclaim it. Still further, some healthy lenders are reducing their lease adjusted leverage when issuing new loans. Off the record, many lenders tell me that trouble is brewing in parts of their portfolios in several brands and geographies. So right now, though, a restriction in lending isn't really a problem because there's been such an over-saturation of lenders in the past few years in the franchise space. However, my guess is that the chilliness of the lending community will continue and could get worse. When fewer lenders compete, loan terms worsen. Simple as that. For franchisees, this means that buyers simply won't pay as much for your business because they can't get favorable loans to do so.

Number six is overdevelopment and really store closures too. Now I'd ask you to drive down to the nearest retail area in your community. What do you notice? Too many restaurants and many new names. In Louisville where I live, I sit in franchises almost every week that have very little business around the lunch hour. Overdevelopment is hurting the industry. Restaurants are not the tech sector. It's a very slow and steady industry. When overdevelopment leads to mass store closures, which is sure to happen at some point, maybe soon, valuations will drop like a lead weight. Especially on the West coast, expecting good to see a bunch of large franchisees closed the doors and less franchisors step in and save them.

Number seven is third-party delivery economics. Now again, most of my contacts are lukewarm at best on third-party delivery. The economics for the franchisees stink in the current fashion. And business is propped up right now with a ton of free delivery, coupons and incentives. The future of delivery is likely not going to save a struggling franchisee. People are price sensitive, and when they must pay 25 bucks for a burger to be delivered to them, I believe that most will choose not to do it. Delivery is not a panacea.

Number eight is geopolitical risk. The presidential election in late 2020 is likely to bring uncertainty. Now keep in mind, and remember that four of the top ten, one day losses in Dow Jones history on the stock market occurred during the lead-up to the presidential election at the end of George W. Bush's second term. Could the same thing happen again? I mean, who knows. But with trade wars with China and infighting, like I've never seen it in Washington, risks of some kind certainly seem to be rising.

Number nine is tax risk. Now like it or hate it, the current administration has implemented some favorable tax policies for many of us. Some of these policies are helping sellers of franchise companies with higher take-home proceeds and easier allocations of assets during their negotiations. One can only opine that a change in administration would bring negative tax consequences for sellers. While some of the political rhetoric on tax changes is farfetched, a few of the proposals I've heard are downright frightening, and honestly, guys would make me want to retire and go fishing.

And number 10, the increasing likelihood of a massive collective risk. So what happens if several of these negative items come to fruition at the same time? The chance of a cataclysmic shock to the system, meaning a drop of 25 to 50% and valuation of your franchise business is still low, but it's certainly increasing. Now it is true, we're all generally going to be screwed if a cataclysmic event happens. But if you can avoid the risks by accelerating your timeline of selling your franchise business, why wouldn't you consider it? None of us lives forever and most of our children want nothing to do with the restaurant industry.

Well, thanks for listening and I hope I haven't been a downer to you. Realism can be a good thing. Give us a call all, and let's talk about what your business might be worth and how to monetize your life's work. Or just talk about the valuation trends in the business before the headwinds start. We'd be honored to hear from you anytime. Thanks so much for entering the Boiler Room today. You can find our podcasts on iTunes, Google Play, Stitcher, TuneIn and Spotify. If you like these podcasts, please listen, rate and review. I also encourage you to visit our website at for the best franchise M&A and financial resources in the industry. Our website includes podcasts, videos, white papers, and the list of our M&A transactions. Please note that neither Rick Ormsby nor Unbridled Capital LLC give legal, financial or tax advice. These podcasts represent opinions that have been prepared for informational purposes only. We expressly disclaims any and all liabilities that may be based on such information, errors therein or emissions there from.