Welcome to Restaurant Boiler Room episode 25. I'm your host, Rick Ormsby, managing director at Unbridled Capital. Today in the Boiler Room we'll talk about the restaurant finance and development conference a little bit and a panel discussion I was on about how to bring a family office investor to your deal. We'll give some general thoughts and observations from our FTC and then we'll have a couple of deal announcements in KFC, Taco Bell, and in the Papa John's space.
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Now, let's enter the Boiler Room. I just returned from the Restaurant Finance and Development Conference in Las Vegas at the Bellagio and it's an annual event hosted by Franchise Times. I want to say there are three or 4,000 people in attendance. It's really a fantastic event to learn all things deal-making in the restaurant industry broadly, but really also the franchise industry too.
I was invited and thankful to do it on a panel and to answer the question, "How to bring a family office investor to your deal?" It was a pretty popular panel because I looked into the crowd and it was standing room only. There had to have been four or 500 people there listening and I did it with two other speakers and those speakers were Paul Edgerly, who is managing partner at Vantage Partners. They own a couple of hundred KFCs, Jamba Juice, and Dunkin Donuts restaurants. Then also Matt [Aley 00:01:55] of [GenRock 00:01:56] and Matt has an oh couple of hundred Pizza Huts and also some Arby's franchises as well. Matt's a private equity fund, and then Paul is a family office, and then it was moderated by Bob Balenski. Who are a lender and investor for AB Private Credit Investors, which is a division of Alliance Bernstein?
There were about seven questions that I answered specifically, individually. Let's go through them a little bit and let you guys kind of hear them. The first one was they wanted to know, the panel wanted to know, "How to define private equity funds versus independent sponsors and versus family offices?"
My answer to that is just private equity funds typically go out and raise a bucket of money let's say from investors and these investors are called limited partners. The general partner is the fund manager, the private equity firm, and they raise a bucket of money from call-it limited partners. It could be sovereign wealth funds, or they could be teachers pensions, or other pension plans, or wealthy individuals, or institutions. Then these individuals or these companies put money into the bucket. There's a lot of investors and then this bucket is a fund and this fund goes and buys assets.
Now private equity firms then once they invest these assets in this fund, then they raise another fund. Typically, it can be two to three or four years after the first fund and then they continually raise other funds over time as they're successful to bring in new investors into buying new assets.
Some of the distinguishing characteristics of a private equity fund or they typically have a hold period of five to seven, sometimes on the outside 10 years to hold their assets, but they are set up so that assets are bought and then an IRR is achieved both through the operation, but mostly through then the sale and disposition of the company at a higher price. They've been known typically to have high historical returns in the private equity world and have a big fiduciary responsibility obviously to a bunch of potential investors that they have.
Now a family office is a little bit different. A family office is typically set up where the manager invests the money for a wealthy person or a wealthy family. So because of this, there's not as much group decision-making that needs to be made to make an investment and a family office typically because there are fewer owners presumably as few as one, can be more flexible to change their investment strategy. They might own their investments indefinitely. They might be opportunistic sellers at the right time, but typically when they buy assets, they're not buying them with a predetermined hold period and sell period.
In this model, these are typically going to be preferred by franchisors because of the fact that they don't have a typical buy-and-sell period. Most of the growth in investing in franchisees across the country over the last four or five years, which has really been meteoric in many senses, has been through the family office pipeline.
Then independent sponsors would be, let's just say a guy or gal who has an investment thesis and they go out and they find an opportunity. In this case, maybe they see a 50-unit franchise business or 200-unit franchise business that they want to acquire and they find the opportunity, but they do not have the money. They will find the opportunity, then they will go find the money and the money typically comes from maybe a wealthy investor, or a private equity firm, or a family office. Then they will take a fee, a management fee, or a percentage ownership in the company when the deal closes. That is the difference between a private equity firm, a family office, and an independent sponsor.
Now, the second question was, "How has ownership of franchisees changed and when did institutional equity investors get interested in franchising?" Now, I've answered this question in several different indirect ways in other podcasts, but I guess just looking at the timeline again, most of the legacy franchising brands started in the 1960s and 70s, maybe even 50s and 40s when you think about the first ones. It was a great avenue for entrepreneurship in our country's history and really an untold success story in my opinion.
You see small and mid-size franchises emerge through an initial wave of consolidation when the initial mom-and-pop franchisee needed to sell his business or retire, and there's really no liquidity, so he sold it to the neighboring franchisee. This kind of happened organically over the 70s, 80s, and 90s as mom-and-pop franchisees were bought out by other franchisees.
When I started working for Yum in the early 2000s, there were, I think, less than 10 institutionally backed franchisees in the space, just a few large ones, but it was certainly not common. You saw a decent boom cycle in the mid-2000s followed by a huge recessionary period. During that time consolidation happened. Banks and frankly, franchisors were working out of franchisees that were unsuccessful and went bankrupt, distressed, and weren't making payments. I think everyone through that process realized that the capitalization in the space needed to be stronger and stronger financially backed operators were potentially a good thing. Especially when there wasn't liquidity.
As you saw the restaurant turnaround begin in 2012, franchisors started selling company assets in 2014 and '15, and franchisors prior to this time had a, maybe 20, it depends on the brand, but maybe 20 to 30% ownership across their brands on a corporate side. They would typically hold big unit counts in large metro areas that they could easily service with GNA, flights and they could have the marketing kind of tightness of marketing in a big city to be able to implement test products and things like that.
When they sold these assets, they were selling large chunks of assets and there just wasn't enough capital in the existing franchise base to buy these things. What you'd initially started seeing was very quietly and slowly, if a 30-unit package of corporate stores became available and the price was let's just say 30, 40, $50 million, who's going to buy that? It brought in the family offices and private equity groups. It started happening in large measure, but really started happening by this phenomenon of millennial, Ivy League trained MBAs with prior investment banking or hedge fund or private equity experience that found family offices and started investing in restaurants or franchises.
A couple of groups did this, they bought these corporate assets. They kicked butt with them, frankly. Great returns. They started consolidating other franchisees around them. Maybe they jumped in a second brand and then we pop up and they've got two or 300 stores and they become a big storyline in the franchise space. This really opened the pipeline for another generation of folks to come into the franchise world who are just like them.
Then I kind of teased at the conference and said, "This secondary and tertiary wave of young millennial sharp folks backed by family offices now can be seen in the hallways of the restaurant finance and development conference each year. They are distinguished by their colorful socks and their high water suits." That's kind of how they've come into the space over the last 40 years franchising has really kind of transitioned to more sophistication.
The third question that I answered was, "How do invest investors think about the restaurant industry, the pros and cons, and how do they view the competitive environment and other industry dynamics?" I've kind of answered this a little bit over the years too and over other podcasts. I think there are a lot of pros.
First of all, you look at the franchise space before that maybe you look at the MNA space globally. I mean, people want to buy assets. We've been in our 10th year of consecutive GDP growth. There have been low-interest rates, and this is bolstered the returns of buyers and spurred MNA activity across a lot of different sectors. A lot of these sophisticated investors are finding themselves with a lack of places to invest for a good return.
They look around and they say, "Okay, well, first of all, I need diversification, and second of all, I think maybe the stock market's played out and commercial real estate opportunities are limited or expensive." They look into the restaurant world in particular and they look at the revenue growth and they say, "Okay, with the exception of the mom and pops and casual dining, which have really struggled, maybe this stuff is pretty robust and it hasn't been Amazoned and the cashflow stability is there. The success rate of franchises is pretty strong historically, especially if you pick the right brands."
On top of that, the aging of the franchise base with little succession planning has created a lot of fragmentation and a lot of opportunities. Where frankly capital is needed in order to effectuate the consolidation. It's kind of an area that is ripe for MNA activity for the right group and the right thesis.
Certainly, there are cons to investing in the franchise business, particularly in restaurants, you've got wage inflation and the cost of development. Sales growth is not high. I mean, a two or 3%, same-store sales growth is a good yearly same-store sales growth target. It's not like investing in technology for example, but again, there's probably not the risk as well.
The franchise business can be difficult to manage. It's a day-to-day in-the-trenches warfare type of thing. You've got to do it every day well and there's heavy competition on every street corner in America. I think in general, the high growth rate of financial buyers in this space is because of some of the factors that I point out.
If you go to question number four which is, "What size deals are these financial investors looking at and what brands are getting more interest than others from family offices?" I kind of talked about this a little bit, but I'd say first of all, every investor that comes into a brand wants four or five things in common.
They're all going to want a platform investment. A platform investment is something that's at least 20 to 30 units, it could be as high as 50 or 100 units, but it's a big enough substantial enough investment that has enough girth to it to support a professional management team and the GNA costs associated with administering it and conserve as a platform to consolidate.
They want a platform investment, all new entrances into the space need a good existing management team. Now not necessarily the owner of the business, but a step lower than the owner. The operations team, the financial piece of the equation, HR benefits, payroll, and the area coaches that are in the field. A good management team's important because these guys and girls who represent these funds and family offices are financial investors, they're not operators. Everyone wants a future consolidation opportunity and everyone wants a platform of growth of some kind.
Now, when you look at private equity firms, most private equity firms want six to 10 million and many of them want more than $10 million of EBITDA for their first platform investment. There aren't many franchisees this large. When you were at places like the RFDC, you see a lot of private equity firms there, but really with their investment thesis needing 10 plus million dollars in EBITDA, there's one opportunity in 100 of them. Thus, if you have a business that large obviously, it's going to attract a premium because you've hit that threshold where more eyeballs want to see it.
Since some franchisors don't like private equity firms because of their defined, buy and sell period and the short-term nature of their investments, private equity is particularly active in buying franchisors.
Now family offices typically target three to $10 million in EBITDA. That makes the window of opportunity for their investments much larger because there are many, many, many more deals in that three to $6 million EBITDA range. That would define maybe a lot of the mid-scale and mid to larger-scale franchisees and small franchisors in the space.
As demand badly outstrips supply, as we see these family offices now just multiplied and thousands of them now are in place, you see family office investors and private investors coming down the market to find better opportunities. They're looking for less competition and they're considering smaller EBITDA businesses than before. Maybe the two to $3 million EBITDA business really didn't attract their attention two years ago, but now it is starting to.
I would say that that's a phenomenon we're seeing and then also they are also going down the market on the brands they invest in too. I mean, Yum Brands is always the gold standard, really with KFC, Taco Bell, and Pizza Hut. That was the tier-one brand that really started attracting years ago, the bigger investors into the space. Now I see family offices with a lot of interest in brands that may be second or third-place segment leaders.
Maybe they're in pizza, or chicken, or burgers, and brands that have 2000 units, or maybe even less are starting to get attention. I would say that the biggest beneficiary of this trend as we start going down the market is not only the smaller size deals but also the large franchisees in tier two and tier three brands.
Back three or four years ago that wasn't the focus of these family offices, but now if you're a smaller brand, but you're a big franchisee in that brand and there's some fragmentation and you offer a really nice platform investment, those are the franchisees I think that are the next wave of investors will be interested in.
Number five on the question list was, "The best way to connect with family offices and private equity and how does their interest in restaurants change the transaction process and how important is it to hire an investment banker?"
We kind of laughed about this one because it was kind of throwing up an easy ball to hit for me. I said, "Hire Unbridled Capital," but I do think that finding the right investment banker is key. Both of the other guys on the panel, both Paul and Matt said the same thing.
Their answer is going to be, "That look if you don't have an investment banker representing your business, number one, how are you going to find the right buyers for your business? And then number two, as investors, if those guys see a deal that is not represented by a group, they may not even have interest in it because they know it hasn't been due diligence. It hasn't been thought through. The financials haven't been underwritten and the business largely is going to require from them a whole lot more time to get to the right answer of Am I interested and at what price? They may not have time for it, with all the deals going on. So they may just say, I'm not interested, but yet if it's being represented by an ibanker, they, they will look at it probably with greater certainty."
I made the comment that "Everyone's connected in this wonderful world now. You can pick up your phone and you can call Indonesia with a push of a button, but people really don't have much personal relationship anymore." I told the people in the crowd, I said, "Look to your left. And right, when you walk out of this room today, I bet you don't know the guy to your left or to your right. We're in a lonelier world than we've ever been." It's changing so fast, especially with thousands of these family offices coming into the business every couple of years. It's just one of these things where it's impossible to know everyone.
Today's buyers of franchise businesses are younger and they're smarter. They're very process-driven, they're demanding and they're often inexperienced too and they're hard to reach. They don't pick up the phone. They'll text you. They're social media savvy. They don't really watch print media and read newspapers. You can't mail anything to them. They don't really come to conventions that much either. It's very difficult to know all these people if you don't specialize in being connected with them all the time. It's a full-time job.
I said in the convention, "I mean, I probably talked to a different family office every other day. It's really a full-time job," and these guys are full-time negotiators too. When you bring them into a deal, they're younger and all that stuff, and they're smart and they negotiate all the time for a living. You're going to get crushed if you're a seller or you're looking to recapitalize your business, and you're wanting to talk with these guys.
Since they're not dealing with their own money, but someone else's, whether it's a wealthy family or other limited partners in a private equity setting, you've got much more scrutiny on the deals that are in front of you.
I just think in general, I made the comment which might sound kind of belittling, but if you're an owner of a franchise business, you don't want to bring a knife to a gunfight. What do I mean by that?
If your business is attractive to 32-year-old Harvard MBAs who worked at Goldman Sachs, you don't want to have an investment banker working for you who's 60 years old and went to a third-rate business school 30 years ago. That would be kind of an incompatible type of advisor for you to be able to get the best outcome for you in the sale or capitalization of your business.
The sixth question was, "What to expect when negotiating with a family office or private equity firm, what's different about doing a deal with them versus a deal with another franchisee?" This would be I guess, targeted to people who are selling their companies.
I guess I would say that obviously, investor-led deals are going to attract a higher price. Oftentimes it's going to be one probably more than one up to two, or maybe even a little bit more turns of EBITDA above what the neighboring franchisee will pay. That's the base argument here.
I mean, the deals are going to be more complicated. What you're doing is you're trading a much higher price and you're trading may be much more stable access to capital for a let's call it a more rigorous process and a more complicated process. If two turns of EBITDA might be a 30% higher number in terms of the valuation, that's certainly worth a little bit of that extra cost and complexity to do the deal.
Again, I mentioned that these guys are sophisticated negotiators. As opposed to an existing franchisee nearby who might buy your business and has known you for 40 years. They have specialized MNA attorneys and they have complicated asset purchase agreements with heavy indemnification clauses.
Then they're going to mostly perform quality of earnings studies, hire third-party firms to come in and do that, and dig through the financials of a seller's business. Why? Because they have a fiduciary responsibility to their investors and the due diligence requirements are certainly going to be much heavier.
Now, the process is typically tighter with an investor-led group versus a franchisee. That's potentially a good thing, but the timing it's almost in all cases going to be longer because there are more steps. They're going to have less emotional ties to a brand than a franchisee and this could be a bad or a good thing.
Think about it. The neighboring franchisee has known you for many years and loves the brand that he represents. What does that mean? He probably knows where the bodies are buried in the business and he might be grouchy about the future of the brand. That might be a bad way to be emotionally attached to the brand, but in a good way, he might hang in there a little bit more when times get rough during the process of acquisition because he's more interested in the brand than a financial investor who's really just managing for a return. That has a kind of an element of surprise at times.
Then an investor-led deal was going to have corporate approvals that are going to be more subject to negotiation and thus more complex. I mean, especially with a new financial investor coming into a brand, the question is who's going to be the operator? How much equity are they going to have? Who's going to sign the relationship agreement? Who's going to personally guarantee it? What are the development obligations going to look like? Are there letters of credit? Yada, yada, yada, all these kinds of questions that may be an existing franchisee would already have cleared those screens and hurdles many years ago and are more comfortable with the brand and the franchisor.
All right the last question I answered was number seven. It says, "It's good that family offices have taken an interest in the restaurant industry, right? Especially in franchise systems?" That was a kind of a good question I thought.
I'll just say generally speaking, yes. Family offices are good for restaurants and for all franchising and you might ask why? Again, I say generally speaking, right, but the reason why is, if you just go back to the franchising that really started after the great recession back in '14 and '15, I talked about it earlier. There was a ton of capital needed to do this M&A and there was not enough capital in the existing franchise systems to do the deals. You had to have outside capital.
They provide a huge amount of liquidity to these various brands that others don't have the liquidity internal to the system already. When you layer that in with the aging of franchisees that's happening and all the fragmentation in these brands, there just physically isn't enough capital in my opinion in most of these brands to pull off the generational transition that needs to happen without outside capital coming in. Just in the MNA side of it, but then think about the legacy brands that are going through their third or fourth iteration of remodeling.
A lot of these brands have really new beautiful assets that the franchisors are mandating on the franchisees. These things cost three, four, $500,000 a store. If you have 60% of your franchise base and you've got 5,000 units, and each remodel is $400,000, think about the amount of capital that is in the system that needs to be supplied over maybe a four or five-year period. That is just something that is going to naturally force consolidation because the existing franchisees can't take it down fully.
Then new brands, of course, are pushing for huge rapid unit growth. Especially in some of the bigger systems, like the fitness systems that have huge capital needs per unit when they build these things. If you've got a 10-year development agreement that you have to fulfill in three years, and the average box costs $5 million to open, I mean, who in the heck can do that if you're just a mom-and-pop or smaller midsize franchisee? It just necessitates extra capital into the system.
On top of that, you've got franchisors and lenders that just kind of want larger franchisees in the business for many reasons, but one of them would be the professionalization of kind of their brands. Two, they're getting special franchisors, but lenders too are cutting their GNA right and left, and they don't have the cost and the time to administer the franchises to these smaller franchisees anymore.
As margins get pressured, you just naturally see consolidation and new capital coming into the system. The answer is generally yes. Now I would just say with a word of caution that the next recession may bring a bunch of uncertainty for us.
I've always loved the 25-unit franchisee that started with one store and a pickup truck in whatever 1985. Knows their stores, knows all their people, and knows the towns where they operate, and the catering managers, and the high schools and everything. I love that kind of guy. I think that kind of a guy or girl is a type of franchisee that will always make it through the ups and downs of this business because they're the ones that have boots on the ground, in their stores, and in their markets.
In the last part of today, we have a couple of deals that we'd like to announce that were recently completed. One is Zack Family Foods, which we're really kind of thankful for, and Jason [Zacarus 00:30:16] and Jerry and Debbie Zacarus own 25, mostly KFC a couple of Taco Bells and we provided sell-side advisory to them. Zack Family Foods in the sale of 25 KFC, Taco Bell, and co-branded restaurants in Iowa, Illinois, and Nebraska.
They were sold to FMI Dollar Bell Inc, which is a related entity to Canada-based young franchisee FMI Group. Their quote and testimony were, "We were very thankful to Unbridled Capital for their help in selling our family business. It was an emotional decision to sell and Unbridled took care of us throughout the course of the transaction."
Jason Zacarus says, "I have experience with other MNA advisory firms and I'm convinced that Unbridled is the best in the business." Thanks a bunch, Jason, that's really cool by the way. He said, "Our family is a happy customer, and we would recommend them unequivocally to anyone considering a sale of their franchise company. They are great people and they will be missed." As always, we make contributions to the KFC Foundation for KFC deals that we complete. That was a great transaction that was completed recently.
We also had a Papa John's transaction that closed and we represented Papa John's USA as a franchising agent. We provided sell-side advisory services to them for the sale of 24 locations in the South Florida area. These were awesome stores by volume and location. We acted again as a franchising agent for Papa John's in the transaction. The market was sold to existing franchisee Ricky Warman and his related entities.
The CFO, Joe Smith of Papa John's had this to say about the transaction. He said, "Unbridled is now helping us in the franchising three markets, South Florida, Macon, and Minneapolis. They've been an excellent and very valuable partner throughout each transaction and they have a vast network of buyers inside and outside the Papa John's brand and across franchisees, investors, family offices, and private equity firms. They have vast experience too in valuations, deal structuring, and due diligence. Perhaps most importantly, they are trustworthy and passionate about their client's interests. For these reasons we," they being Papa John's, "Continue to use their services and would recommend them wholeheartedly to any seller of a franchise company." So thank you Papa John's and Papa John's Corporates honor to have worked for them as well. Good group and we hope that their business continues the turn with the new management and some of the exciting things that they're now a part of.
Well, that's it today for the Restaurant Boiler Room, and thanks so much for entering the Boiler Room today. You can find our podcast on iTunes, Google Play, Stitcher, TuneIn, and Spotify. If you like these podcasts, please listen, rate, and review them.
I also encourage you to visit our website at www.unbridledcapital.com for the best franchise MNA and financial resources in the industry. Our website includes podcasts, videos, white papers, and a list of our MNA 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 disclaim any and all liabilities that may be based on such information, errors therein, or omissions there from.