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Unbridled Capital

Season 2 Episode 10: Creative Financing Structures for Franchisees

Podcast

08.20.2020

Also Listen On:

Creative financing structures are going to be a critical part of the future health of the franchise industry.

While some lenders are pulling back, operators still need a robust way to solve for their capital needs – whether they want to acquire, recapitalize, build new units, buy-out partners or create breathing room while waiting for a turnaround.

Join Rick as he discusses the following topics with Richard Fitzgerald and Wade Daniel from CapitalSpring:

1. Circumstances when Operators Need Capital
2. Methods of Financing a Franchise Business
3. How Investors Approach Making Investments in Franchises
4. How to Prepare Your Business for an Investor

Transcript:

Welcome to The Restaurant Boiler Room Season Two Episode 10. I'm your host, Rick Ormsby, managing director at Unbridled Capital. Today in The Boiler Room we will be playing a recent webinar entitled Creative Financing Structures for Franchisees. The webinar is in a presentation format and I'll be joined by Richard Fitzgerald and Wade Daniel at CapitalSpring, one of the country's best-known franchise and restaurant investment companies.

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, private equity firms, family offices, large investors, and franchise owners on a monthly basis. Feel free to find our content at Unbridled Capital's website at www.unbridledcapital.com. Now, let's enter The Boiler Room.

Yeah, so welcome. This is indeed... We're calling this a creative financing structure for franchisees and I want to just introduce two wonderful gentlemen who are just really industry experts and people who I really, really trust and have tons of appreciation and respect for. This is Richard Fitzgerald who's co-founder and managing partner of CapitalSpring. And then you have Wade Daniel who's a managing director at CapitalSpring.

These guys are experts in the financing of all things restaurant, franchise restaurant brands. And so, they're very attuned to the entire capital structure of how to think through financing the lifecycle of a franchisee's business in all these different scenarios. The reason why I'm excited to have them here today with you is they do not function just as a traditional lender. They have a much broader scope.

Whereas I'd tell people, people say, "Do you sell real estate?" And I'd say, "That's not a primary service. We're an advisory firm, but if you want to sell real estate, we know how to do it." These guys can loan you money, but their broader perspective is to figure out how to best capitalize your business for your particular situation. Whether it's debt, whether it's equity, whether it's some sort of mix and combination of the different scenarios.

They've done, I think, somewhere around two billion dollars of transactions representing over 5,500 restaurants over the past probably 15 years, which is somewhere in timeline to my career as well. And so, I'm just really honored to have them here. And so, we'll just jump right into it and I know you're going to appreciate their advice and perspective. So, there's really seven things that we're going to chat about over probably the next 40 minutes or so, and then please feel free to ask questions as we go through.

The first is going to be circumstances when operators need capital and then we'll talk about the different methods of financing a franchise business. It's not just put up some equity and then borrowing some money from a national restaurant lender, there are other ways. The third will be what to do when access to normal capital channels is limited. And so, for those of you who are in some of the struggling brands, whether it's fast-casual or casual dining or QSR that's not doing well in this market, or independents, please listen up for this.

The fourth is going to be how an investor's approach making investments and franchises... We'll do some financing outlook for restaurant segments by casual dining, fast-casual, and QSR. Opportunities and risks on the horizon. And then I think this piece of it is largely under spoken, but it's really important. So, hang in there for the end. If you have any interest in attracting a professional investor in your business, there are certain things that you should do.

And I can tell them to you from my perspective having done it, but it'd probably be interesting for Richard and Wade to tell you what attracts them to a potential restaurant investment, okay? So, that'll be a really valuable piece too. With that being said, guys, the floor is yours and we're excited to hear what you have to say. Fire away.

Rick, really appreciate you having us today. It has been quite a journey over these 15 years, and I think the last six months has capped off the excitement for the restaurant industry. It's really impressive what you've built with unbridled, and we love working with you and talking through deals with you, and helping us on transactions on both sides. So, certainly appreciate the opportunity to join you today.

As Rick said, we've been doing this for about 15 years and decided to commit our lives to financing restaurants. And really set out to do it a little bit differently than we had seen at least in our past experience. We're not a traditional bank that has a bureaucratic organization sometimes and cheap capital. We can lend and we can own, but we're also more of a solutions provider. And I think our goal typically is to figure out what the capital is being used for, what are the goals of the transaction? What are the sensitivities and really all the components that would figure into designing a capital structure or a stack of different types of securities to best fit the needs of the borrower or the counterpart?

Stepping back, when you think about it, what do people need capital for? I think the list here is fairly obvious. One of the most frequent ones that we see are people who are looking to either sell their business or buy a business. Maybe more so on the selling the business, you want to make sure that the buyer has the financing. But when you are the buyer, obviously, it's important to have the financing. Hopefully, a good sense of it going into the transaction so it doesn't hold up the ultimate transaction or take terms that you don't expect and introduce risk into getting a deal ultimately done.

A big one I think for us is people that come to us for capital in order to buy a business. Sometimes that's an existing operator that's looking to grow their business that's buying a franchisee in the next town over. Sometimes it's a number two or a number three in an organization that wants to buy a business from their boss who wants to retire. Sometimes it's a manager at a brand who's trying to buy stores from corporate through a refranchising transaction.

We've seen a broad spectrum of situations and we approach each one with a clean sheet of paper or a clean whiteboard and try to figure out how best to design a security or design a financing package to meet the needs of that specific transaction. Oftentimes, it may not be a situation where people want to sell their whole business. I think a lot of people going through a period like this probably think about it and some who may have thought they wanted to sell in the next five years may say, "Well, I may not want to wait through this rollercoaster over the next five years, I want to do it sooner."

But there are options to do things in between. We've had people approach us that say, "Look, I'm not quite ready to retire yet. I'd like to take some money off the table. That may be for estate planning reasons or just my own derisking of my life's work and this investment." And so, we have people that come to us and say, "Look, I don't want to sell. I don't want somebody else to come be the new boss or my new partner, but I do want to take some money off the table.

So, a partial liquidity then is one reason why we have people that approach us looking for capital that may be a little bit different than they can go get from their local banker or maybe a little bit different than their brother-in-law or their friends and family writing a check to buy into their business. And then the last-

[crosstalk 00:07:09] doing like a-

Yeah, go ahead.

A simple man's view kind of like a refinancing of your home mortgage or whatever, right? You can take a little bit of equity out of your business or a little bit of value out of your business and take it and put it in your pocket by having a [inaudible 00:07:25]. It's maybe something that most people on the call are not as familiar with actually.

Sure. No, absolutely. We've had situations where sometimes it starts out where they just want to take a little money off the table, and they may realize that over a few years, they may want to take the rest of the money off the table. So, it doesn't have to be a final decision to do a partial liquidity of transaction and that can evolve in different ways.

[crosstalk 00:07:51]-

[crosstalk 00:07:50] keep control or lose... Whether they keep a majority ownership there's all kinds of different structures there, right? So, some people might say... Because people come to me all the time and they'll say, "Rick, I may want to find an investor for my business." And I say, "Well, the standard approach is that you sell 80% of your business and keep 20% or 15% of it and you have all kinds of upside to grow and access to capital that you don't have yourself."

But that's not necessarily the only way to do it, right? There's other ways to do it where an operator might actually be able to monetize a minority share of the business, right?

Absolutely, and Wade, I'll kick it over to you, but I'll give one example that may be helpful. We had a situation where a family had inherited a business from a founder and the family was involved, but really didn't want to write a lot more checks into the business to really grow it. They thought it had good prospects, but they came to us and said, "Look, we'd like to monetize part of the business, but we'd like to keep a chunk of the business, but let you put money in to continue to grow the business."

But hopefully, we can almost have two bites of the apple. We can monetize some of it to get them cash out now. We can partner with a firm like CapitalSpring or others who provide maybe an alternative to them to go and partner with us to go help grow the business. We can write checks to help them grow the business, and hopefully, the stub that they've kept will be worth a lot more maybe than they would if they had just sold it all that same day.

So, they may think that it's got growth prospects. It's not something that they think there's no upside in, but they want to monetize and then roll into the next deal and monetize again. Maybe I'm [inaudible 00:09:21], but that's the situation that we see.

I bet you see a lot of this too. I know we got to keep going, but I'm just thinking about the generational change between franchisees. I deal with this all the time. That 75-year-old founder and owner of the business and the second generation, they may not have the same growth goals and the same risk tolerance that the founder had when they got into the business, but still wants to keep the business and grow it.

And that can be a family member that wants to take over and step in. And maybe the owner of the business or the franchisee wants to take some money out. Doesn't want to just maybe give it to their children. Wants to monetize some of what they've worked hard to build. And oftentimes, the son or daughter wants to take it over and needs a capital partner to both give their parents liquidity, but also capitalize them to take it to the next level.

And that could be a family member, that could also be an employee. We've seen time and time again so many situations where there is someone in the organization that has been there from the beginning that has really helped build this business. And as the owner of the franchise, if he wants to take maybe some more time off and step away from the business, this person is stepped up.

Oftentimes the franchisee, it would be the ideal situation to have their number two or number three who's really worked hard, maybe not had a lot of equity in the business, to be the next owner of the business. But oftentimes, that number two or number three doesn't have a rich family member or rich friends and family or contacts to go and actually get a deal done.

And so, we have a lot of situations where we've been introduced to the number two or the number three by the owners of business to say, "Will you partner with them to buy my business and let them become the next owner? Because they kind of deserve it."

Interesting. No, thanks for sharing. Yeah, keep going [inaudible 00:11:00] battle, yeah.

Yeah, so this one obviously is a pretty generic category, Rick, but I think a lot goes into it. I would say in general, what we're talking about here is, "Bring us a problem, we'll look to structure around it." So, if you want to buy your neighboring franchisee, you don't think you have access to capital to do it and you want to take some money off the table at the time, I think there's combinations of all of those to be done.

Richard just mentioned partial liquidity events, selling a business, and capital for growth, but I don't think any one of those are necessarily mutually exclusive from the other. I think where we would approach a [inaudible 00:11:35] solution is mixing and matching to accomplish the end goal that a franchisee has.

I don't think I'm in a position to buy my neighboring market, but it's the one time it's going to become for sale. And so, this is my once-in-a-generation shot to buy it. I think we'd like an opportunity to discuss or to understand [inaudible 00:11:51] with a strong operator who can prove that they can make two to 400 base points of margin improvement by integrating into their organization and others. And that's something we're willing to take a look at and understand that all acquisitions aren't created equal and that a lot of times an operator can create equity value for themselves by integrating into their organization.

We do a robust benchmarking of businesses and this is all we do. We've got a data set of over 7,500 underlying businesses that we can benchmark against and understand do we think that's a credible play. And if it is, I think it's something we can generally support and get behind and move pretty quickly on. So, we can talk about ways to do that on the following slide, but it's a pretty generic heading for, I would say, overall creative solution.

And then some of the other things obviously that we see people needing capital for, new development. Obviously, within existing markets, some brands, some acquisitions are coming with required development agreements, and people having to get ready with those. Stay in good graces of the franchisor so you can acquire your next market and be in good standing. So, obviously, we tailor capital around that.

And then as well partner buyouts. I know you and Richard both mentioned those and this could be a partner. This could be another shareholder. One member's retiring, the other wants to stay on. I think generally what we'd say is it doesn't necessarily force a sale of a business if one member wants to leave and the other member wants to stay. I think oftentimes we've seen people lean into their equity and one member says, "I want a liquidity event." The other member says, "I'd like to stick around longer." And one member increases his ownership.

We'll even pair that with a little bit where both people take some capital off the table. So, I think that's that component and then the recapitalizations and refinancing. Obviously, everyone's debt has term to it and especially in markets now where the [inaudible 00:13:44] people are looking generally for refinancing. I think that's a common need, and I think I'll kick it back over to Richard to run through a few of the pieces of the capital structure.

I think in general, the most common here is what we'd recommend to people. The most common form of capital is traditional bank debt. That's going to be your lowest cost of capital. I think when the situation merited it is the wisest choice for a company. But I'll let Richard run through the various points here.

Sure. And so, maybe taking the range from least dilutive, usually least expensive oftentimes could be the most restrictive in terms of covenants and other restrictions on the debt. The lender, the traditional deposit-based lenders. I think this is, obviously, the largest source of capital, I believe, in our industry. Lots of banks have dedicated groups.

If you're looking for a more vanilla financing solution, we get calls all the time saying, "Could you look at this?" And we'll just say, "Look, you can go get cheaper capital than we could." We're built for more complexity or speed or something that is just outside of what a traditional bank can do. And so, lenders, usually a template. It's not as much creativity involved and really can't even price above maybe a certain amount of leverage or an advance rate.

I think I'm going down the spectrum, mezzanine financing. Mezzanine financing is what typically fits under a senior lender. It's a little bit more expensive capital. It's subordinate to a first-lane capital provider typically. There's often an intercreditor or most often. Almost always an intercreditor agreement [inaudible 00:15:14] as provider and a senior lender. So, it's a way to bridge the gap. If you've got equity and you're talking to a bank and the equity won't quite stretch there, oftentimes mezz capital or mezzanine financing is the way to get through that to bridge your equity with senior lender.

Maybe something you might see become a little bit more in vogue in a more difficult financing environment.

Yeah. Absolutely.

[crosstalk 00:15:39], obviously, when things are really strong.

Yeah, as advance rates may lessen a little bit given bank's risk appetites, you do see mezz come in and play that. So, it's going to be more expensive than a senior lender because they're taking more risk. I think in terms of bringing mezz into a deal, obviously, you've got another party at the table. You have to make sure that the mezz and the senior lender that they're negotiating well and don't get to an agreement. And an intercreditor, which more parties at the table sometimes introduces more risk, but certainly a good option. Obviously, real estate lenders [inaudible 00:16:14] using other pieces of your deal or pieces of collateral to help finance an acquisition or some sort of initiative and it's a source of capital or need for capital.

Non-controlling owners. What we see a lot of times here are friends and family or your brother-in-law. A lot of businesses in the restaurant industry it's often passing the hat. And so, we just see so many deals where you've got a lot of small investors that may be passive in the business, but they show up for a free meal from time to time. Oftentimes, we're asked to come in and maybe buy out a group of smaller investors because people are sick of talking about the business at Christmas dinner or Thanksgiving meals or on the weekends and it's gotten to a point where it's awkward especially if a business may not be always performing well.

People may have different expectations or time horizons, and oftentimes a small business that's grown through lots of small investors that are passive gets to a point where they may want to clean up a capital structure and just streamline it and buy out smaller investors and bring on one larger institutional investor.

Same way on the debt side too, right? A lot of these businesses this way are financed by local banks or SBA loans where just the entire financing piece of it from the equity to the debt was just started on a shoestring. Heck, we all started from something, right? And if you make it successful at some point in time, you get too big for your britches so to speak. So, that's common.

And I think oftentimes it gets somewhat complicated because you've got a lot of different financing sources maybe with different locations and it can be limiting as you really scale your business. And oftentimes it's sometimes easier just to reset the entire capital structure with maybe larger providers that can help take you to the next level.

Majority equity providers, these are oftentimes family offices or private equity firms maybe most often. This one in the franchise world is varied in terms of how different brands view majority equity providers. A lot of brands that we work with want to see the operator as the franchisee, not a private equity firm in New York City or some other town being the owner and calling the shots at the end of the day.

I think some of this comes out of some past experiences where if things don't go perfectly, franchisor-franchisee relationship is unique, and do we ever really understand what role the brand plays and what role the franchisee plays? And that doesn't always sync up with some control majority investors use on how to run businesses or take a different direction if something's not working.

And so, this is something that I think if you're looking for a majority equity provider, I think it's important to understand their experience maybe with the franchise restaurant space or the franchise space in general. There are so many nuances to franchisor-franchisee relationships. Some brands may not even... If you're selling business and maybe one of your employees or there's another buyer in there backed by a sponsor. We've seen a lot of situations where a lot of people put a lot of money and a lot of work into a deal and ultimately the brand doesn't approve the sponsor because they're worried that a sponsor wants to flip a business in three or four years, or may not understand the dynamic, or just is not a good fit for their system.

So, I think really understanding how the brand feels about having this type of institutional investor in the business and then understanding who the partner is and making sure that they understand the rules of guarantees and all the different nuances of the franchisee space.

That's a clear issue. I'll say it's one of the values that our company provides, right, is that every franchise owner thinks of these things differently. Will they allow private equity into the business with the defined predetermined buy and sell period of a private equity firm? Do they prefer family offices for one reason or the other? How are they going to look at the ownership, like you said of a franchisee who might be personally guaranteed with the franchise and only 10% of it?

What's their track record of bringing different types of groups into their franchise system? Some are really antagonistic towards professional groups, others are open-minded to it completely, and really, it's all over the board. It really is. [crosstalk 00:20:19]-

We say the same thing.

Yeah, it's a good point.

Yeah, Rick, that's a good point. I mean, I think it's a good reason for people to consider working with someone like you. It's less so from even that they need help selling a business. You need help getting a transaction over the finish line, which I think when you're bringing institutional capital in the mix, that's incredibly difficult if you haven't navigated that previously.

Thank you for saying that. You know how many calls I get from these people in tall buildings in New York with the same punchline that they read over and over and over again. They use keywords like... Oh, let me see if I can pick one out. They'll say headwinds and tailwinds. You know how when you're sitting around in the corporate environment if someone uses a term and everyone giggles. It's the same term that they all use over and over again, and it leads you to really quickly realize they don't know much about the actual restaurant business or the particulars of franchising.

So, those things are important when you're getting courted about those folks. There's no doubt about it. Sorry to belabor that point, but clear financing structures is where you guys obviously have a large voice. You got a large voice in all the other pieces too, but tell us your thinking on that.

Wade, I'll let you take that one.

It's creative structure, so I was actually just reading one of the questions that came through, Rick.

Yeah, you want to hit it? We can hit it right here if you want to. The question is what are your mezz rates generally for [inaudible 00:21:41]? He's just looking for a range since it depends on size, experience, and existing capital structure.

Yeah, it's a good question and it's a question that varies a lot because of those things. I think if you had to tell me to pick a number off, just pick one number, I'd tell you anywhere between 12 to 14-and-a-half, 15% is mezz range. However, all mezz is not created equal. And so, if it attaches higher up in the capital structure, and what that means is if your senior debt isn't as much.

So, let's say a company could have had four, four-and-a-half turns of senior debt, but they only got two-and-a-half to three turns of senior debt. And the mezz goes from two-and-a-half to four-and-a-half times, that's going to price lower. You're probably high single or double digits at that range. On the other side, if someone pushes leverage high and you're talking about four, four-and-a-half-plus times of senior debt, a turn, turn-and-a-half of mezz, you're really bleeding into some preferred equity rates at that point. You're probably getting up into the mid to high teens. So, it's a long way of answering the question just because I think mezz can look different depending on how it's structured.

Yeah, well said.

I guess, Rick, to move onto your next question on the creative financing, so it's really a blend of what Richard just walked through of all the pieces of the capital structure as well as the prior page we just walked through on the needs. And so, I think where we see ourselves playing a role in a lot of these transactions, I'm looking at the slide and the brown and blue boxes at the bottom, you're almost drawing lines and seeing how many of these you can mix and match together.

That's probably the way that I think about creative financing that someone can go out and they can source a capital structure with a traditional senior lender, a mezz lender, a non-control equity provider, and likely get to a very similar solution. Sometimes that paralyzes the company because there's too many people ultimately in the capital structure that way. We have the ability to work through that. In general, I would frame up the creative structures.

Our approach here is we're a dedicated restaurant investment firm. We focus on the branded restaurant space. We support proven management teams with structured capital solutions to facilitate growth and navigate complex situations. And so, I think really what we like to do is not necessarily box ourselves into any one structure on this page. Would say, "Bring us a problem, bring us a challenge," and we'll see if we can structure a piece of capital to solve that problem and accomplish the end goal for the owner of the business.

And so, I think this was a great introduction to this. I mean, there's a lot of detail, guys and gals that are on this phone call that we probably just don't have the time to get into. But when you think of things like one of the words on here is [inaudible 00:24:29] where, basically, you're getting all the financing from one person at one rate or something like that. Or you have convertible preferred, or you have some sort of a passive ownership where you don't have as many voting rights.

There's all kinds of different pricing and applications for all these different types of financing types. Like Richard said at the beginning, the plain jane vanilla way to do it is to buy the truck and put 20% down and borrow the rest from your local bank, you know what I mean? And so, a lot of restaurant deals happen that way, but some of these creative approaches that are on this page enable some special circumstances to happen or like Richard said too, things can happen more quickly outside of a normal 180-day process that typically a lot of these transactions take.

We can always talk more about that later, but I just thought we'd go to the next slide. And I saw there was another question on here. Why don't we take it while we're at it? Do you only... Oh, well, it's the same person. Do you only provide mezzanine or equity for franchises, or would you look at proprietary brands? That's you guys particularly, maybe you can also speak more generally, but to you particularly I know you look at proprietary brands, so-

Sure. We do both. In terms of proprietary brands, if it's multiple locations and it's got a good operating history, we're probably not the best partner to do a startup brand or something that has one or two locations and wants to go to 50 or 100. But we've got plenty of deals that we've done that are 15 units that have been around for 75 years and just need a partner to come in and help them with the technology and all the different things you would do in supporting a business today that a family member or family may have not have wanted to invest in over the years. So, certainly do independent brands as long as it's multiple locations with a proven track record.

I had a question that I've gotten a lot. I'll just ask it, it's not on this screen, but it was earlier. How do you guys look at... Because I get this question a lot. How do you guys look at investing with a franchisee? It's a specific example: franchisee has 75 locations, 50 locations, okay? Let's say he owns... And just make up a brand, Arby's. Let's say he owns 50 Arby's and he wants to form a new group that doesn't affect his ownership in the 50 Arby's, but wants to go build another group based on his reputation and brand experience and history to acquire either more Arby's separately or another brand separately as a roll-up strategy. What do you guys think about that general request? And I hear it a lot.

Sure. Wade, I'll let you take that.

Yeah, sure. I think that request and certainly working with a proven management team, that's something we always want to consider. It really probably depends... So, Rick, I've seen that play out in a few ways. Sometimes someone does not want to give up equity ownership in the brand in their other business, but they're willing to look at that as a credit enhancement. I think in order to maximize their equity on the acquisition of another business, that would be something that someone should consider. Are they willing to not give up ownership, but expose it from a cross-collateralization perspective?

So, that's one way to do it. The other way to do it could be to sell a piece of minority equity in the other business if you're not looking to [inaudible 00:27:44] into the new acquisition. Then a few other things that I think we'd consider bringing to the table. Obviously, there's going to be G&A scale. So, an acquisition can probably tap into the existing G&A infrastructure, take on the incremental unit at less than it would cost to build a G&A infrastructure from the ground up.

Obviously, the ability and past experience of the prior management team. What we'd probably look at there is your example that if they were in an Arby's or they were buying an Arby's. But let's say they were in Arby's, we'd probably take a look at their units and benchmark those to the Arby's system and say, "Is this an operator and a management team that's proven that they can run two to 400 basis points better than the system? If that's the case, it makes a pretty compelling system of how they'd be successful at another brand as well.

Yeah, a lot of it is just as simple as the good old supply and demand thing we talk about all the time in our business, right? If someone's got something that's really in high demand because they operate it well, well, then there's going to be plenty of supply for it too. And there's one question that came in through here, maybe we can catch it again. It's can you list based off your past experience some of the hurdles in getting the deal closed after the start? Well, gosh, how about this? [inaudible 00:28:56]. There's plenty that we could go on forever on that one, but we'll answer that question later. Go ahead, guys, on this next slide, and we've got probably another 15 or so minutes to get through the next four or five slides.

Yeah, Rick, I think largely on this slide, thinking through it, and just given the timeframe that we've got here, I think we probably covered this and we can wrap up towards some of the other slides. And that way it'll give Richard a little bit more time to hit on why people won't invest in the restaurant business, and then we can circle back to what makes an individual business investable.

Great, great. Do you want to tackle this slide or you want to go past this one too?

I think, Richard, do you want to take this one and the next one together?

Yeah, I'll take it. Yeah. No, I think maybe we just tell our own story. We started CapitalSpring 15 years ago to focus exclusively on one industry and it's an industry that we love and we've obviously learned a lot of lessons and met a lot of great people in. But I think stepping back and looking at why we and others have been attracted to investing in it, it's pervasive. It's the daily recurring meal demand has been shown to not change that much depending on the economy, depending on the stock market, depending on the capital markets.

People are still eating three meals a day. At some periods they may go to a grocery store, but looking over the long term, the stats are 70-plus-year trends of more meals consumed outside the home almost every year for the last 70-plus years. Millennials spending twice as much as baby boomers. We think there are a lot of attributes of it that point to it continuing in that direction. Obviously, the strong cash flows, the stable cash flows particularly in certain segments, the quick service, and the fast-casual have been very resilient in good and bad economies looking back historically.

Not everybody, but for the most part, we're even seeing it in this current pandemic environment which, I guess is a recession and a pandemic at the same time looking at the brands that have proven very resilient. The quick service and some of the fast-casual not exclusively, but a lot of the big brands out there. I think people are seeing that they're stable. They're even what we consider the worst stress case you can imagine. A lot of businesses are still putting up positive comps straight through it.

Low failure rates. Again, I think most people think of restaurants as a riskier place to invest, which is why we picked it. It certainly has less people, I think, focused on it because of that, but looking at the franchise space and the big franchise brands, I think it's hard to argue that it's not less risky than starting your own from scratch. Massive industry, lots of consolidation opportunity, super fragmented. All the things that are the buzzwords that you probably see in the first-page summaries of any private equity or debt opportunity out there, the restaurant industry has it.

It's funny, I got off a phone call today with a guy out west. We were chatting about the Pizza Hut business. He doesn't have a Pizza Hut, but he wanted to know about the branding, whether it's something to consider for acquisitions. The first thing I said to him was, "What the heck are you thinking wanting to get into the Pizza Hut business?" I was joking of course, but I looked at this and I'm thinking, "What the heck are you thinking wanting to get in and invest in a franchise business? You must be crazy. You must be off your rocker."

All brands go through cycles and there's almost no brand out there no matter how big, you can't point to a period of time where they had headwinds. Pizza Hut obviously has had headwinds. Now going through the pandemic, it's actually looking a lot better. But I think that's the other thing to think about as you're picking a capital partner, whether it be a bank or private equity fund. Understanding the industry is important because you do have those cycles, you do have those quarters that for whatever reason, it may be a foodborne illness. It may be your competitor is promoting with a movie that they drive some competition or they introduced a new kind of taco shell that is very popular.

It's not always a straight line, and so, I think finding partners that have been through it, the ups and downs of the industry typically may be a little safer bet than someone who may be approaching it with... Excited about it and thinking it's a great opportunity, but may panic if you get a slow quarter or a few quarters because the brand has [inaudible 00:33:03].

I would love to hear if we have time later on what your best investment and your worst investment were. [crosstalk 00:33:11]-

We've learned a lot of lessons. We've learned a lot of lessons.

Yeah, I could talk about that kind of stuff too. It's always interesting to hear how people evolve with their professional thesis. But yeah, go ahead here. I think we maybe talked about this a little bit already, right? The general gist of this is just that the restaurant business has all the positive attributes that really drive your thinking. I love the consolidation piece. The gentrification of the franchise base. I love [inaudible 00:33:39] business. It's one that everyone wants to talk about. It's a business that's really easy to talk about, but it's really hard to do well and do well every day.

Cash-rich business. Brands have low failure rates. Great people in this industry. So, I'm a big believer that this is more than a national pastime of playing baseball. This is where the legacy of American innovation and entrepreneurship really started in many ways is in the franchise business in the 1950s and '60s. So, it's a great place to be man. I've staked my career on it. How about talking a little bit about your outlook for some of the folks that are on the call here?

Yeah, sure. Happy to talk through this and sort of give some real-time feedback of what we're seeing. Obviously, there's been a lot of ups and downs, and the markets have changed very quickly here. So, what we're saying now may be different tomorrow, may be different the next day, but a large range here from the haves and have nots on access to capital side here. And I think QSRs, what we're seeing are largely unaffected by their access to capital going forward.

That's driven by most of the underlying brands we're seeing that performance is in line from a same-store sales basis to last year to slightly up. And most people are operating several hundred basis points higher margin than they were the prior year because they're doing it with the drive-through only with closed dining room, with times limited operating hours doing the same volume just results in a slightly more efficient operating model. And that's resulted in year-over-year increased earnings.

And so, I think largely we're seeing that market still exists. I know I saw a handful of senior lenders on the invite list here that have dialed in. They can speak to this certainly in greater detail, but I think what we're seeing at least for the access to capital on that side, it's still there. Maybe the terms have tightened a little bit. We adjusted leverage maybe at five, five-and-a-half to six times a couple of months ago that that's now stepped down to let's call it five to five-and-a-half times depending on the brand. So, maybe a cold return to half-turn step-down.

Tightening on a couple of the covenants occasionally, insertion of a minimum liquidity covenant, and then LIBOR floors of around 100 basis points or so is what we're seeing. But access to capital is still there, I think, for fast-casual. We're seeing a bit of a mixed bag there. You've got brands that are down less than 10%. That probably mirrors what I just outlined for QSR as far as access to liquidity and what the financing outlook is for those businesses.

And then you've got casual dining businesses that some of them, unfortunately, have taken much larger hits and it's going to take some time for them to come back. Until customers are out and about and fully going to dine-in. I think we've seen some brands that have done a very good job of replacing dine-in sales with off-premise, but it still doesn't get you back to [inaudible 00:36:31]. And so, I think largely, unless it's a unique situation, we're seeing access to capital being limited for those brands.

How do you solve for that? I don't want to belabor the point or take a lot of time on it, but I spent so much time talking about QSR where, like you said, the access to capital is there and is actually pretty strong. The rates are incredible and terms are great still. I mean, so I'm a cash-dining franchise and I've got 50 locations in North Carolina, whatever, and I'm struggling. Sales are still down 35% and I need capital. What do I think about? How do I think about that?

Yeah, sure. I think that's probably going to be some form of alternative capital. I think that's a difficult pure senior refi in the casual space, in the casual space right now. I guess the way that we would probably approach it and look at it for some of these brands is understanding the pre-pandemic performance and then looking at a burn rate for the business. It's just understanding they are going to burn some capital, burn some liquidity, and what's a reasonable outlook when same-store sales necessarily come back to full capacity. And then how much liquidity is burned over that period. That's the gap that you're having to solve for.

I do think it's to the extent that operators have access to liquidity elsewhere and have all of those programs that help supplement liquidity for businesses. I do think if you're tapping liquidity that route in casual likely they're going to be more expensive capital or have some form of equity component to it right now in today's market.

So, if you're in bad shape and your sales haven't rebounded and you're looking for capital, the punchline is likely that you're going to have to give up some and have a lot of equity in the business to keep it going, right? That's basically [crosstalk 00:38:15]-

But that's a decision... Yeah, and I think some people have that decision. But also, if I look at where opportunities may be across the spectrum, there's largely going to be more closures in casual than there are. QSRs have performed very well. Very limited closures. Less closures than the fast-casual side. And so, on the other side, you probably see a little bit more of a disproportionate benefit to casual due to some of the closures elsewhere.

So, if there's silver lining to it, it's that. I know it's a tough spot to see the silver lining and then be patient and wait that long, but there probably is some.

What's your sense too for these types of operators about how forbearance is happening with the senior lenders and things? Do you guys have a window into that? Or a lot of our clients and friends obviously got interest-only or got deferrals of their payments for a certain amount of time. How's that looking right now for a lot of your clients and friends in the industry?

Yeah, I think most of what we're seeing is largely shorter-term forbearance agreements and putting it out three to six months, and people understanding that they want to come back to the table and have a discussion when things normalize a little bit. We've seen a handful of situations that have a longer-term forbearance agreement given, but that's more of the exception than the norm. I think largely what we're seeing is people come back to the table.

But I think right now, generally also seeing lenders remain pretty constructive out there. People understand the nature of this, that there was a hit, and I think seeing that people that have recovered from it are able to structure some flexibility, and where there are ongoing discussions are people that are still down a little bit or liquidity is tight right now.

Sorry, I've asked so many questions. I'm probably messing up your presentation. We've got two more slides and maybe five minutes to get there. Just like Smokey and the Bandit, "We've got a long way to go and a short time to get there." You remember that movie, man? That was great. I don't know if it's politically correct or not, but it was a great movie back in the day.

Wade, do you want to [inaudible 00:40:19] on some of these?

Yeah, I think just with our timeframe, I think the more meaningful slide's maybe to get to the explanation of how an investment decision is made and how to prepare a business.

That's great stuff.

Yeah, and I think one of the questions first was how an investment decision is made here, at the institutional level. And I think largely it would speak to what we focus on, and then every institution's going to be a little bit different. But really focus on, first and foremost, the management team. The background, who's going to be staying around? Understand sometimes there's going to be a seller that's stepping away, but has that person built a strong team that's going to go forward?

This is what I would put in the general bucket of how to attract institutional capital. Franchisee-to-franchisee deals would be different because management teams are there. And then category and performance. I think the stability of the category is key, longer-term performance, what do the tailwinds look in the business? Obviously, easier to invest in something with proven trends and a track record of success.

And then a few other things. The operating leverage of the business. And when I say the operating leverage, the easier way to describe that is maybe the margin profile of the business. So, for example, a business with a 15% corporate EBITDA margin is inherently going to be more attractive and trade at a higher multiple than a business with a 5% EBITDA margin. And the rationale there is if you look to an EBITDA to free cash flow conversion, a smaller percentage of your EBITDA is going to maintenance and remodel capex on the 15% business inherently than the 5% business.

So, I think you can see that multiples across the system, that's one thing that largely drives it, that all EBITDA is not created equal, and so all multiples won't be created equal as a result of that. And then I think the next two items is just the acquisition and development track record. I think this is very important for any institutional investor coming in because they're going to want to look at a way to drive value going forward. And so, how do you create a thesis is you're either going to develop units, you're going to acquire units.

If you can pencil out with a team that's got a successful track record of higher ROIs on new development or integrating acquisitions successfully. And even better than that, integrating acquisitions successfully and driving top-line and finding margin improvement. If you find those, I think those are what checks the box to be an investable business and what attracts institutional capital.

What about the opposite way? Give us an example, maybe not of a person or a business, but in your past, both of you guys maybe, when you saw someone unprepared. Sometimes the type and the anti-type give a better example. Someone who comes walking in the door and they're disheveled and they're grouchy, what makes them unattractive to you? What makes them unattractive to you?

We've passed on opportunities previously of someone comes in the door and maybe they're not even necessarily unprepared from the performance of their business today, but they're unprepared for a sale. And so, someone's come in the door before and they've had a phenomenal business. Trends have been good. They operate 300 basis points better than the system average does, but there's no succession plan and the plans to sell the business. There's no one that can step up. They've done a good job acquiring businesses. They've done a good job developing units, but all of that knowledge is leaving.

I think that's something that there's a disconnect. It's a very strong underlying business, but the pieces for that business to continue the success going forward are leaving. And so, that's caused us to walk away from transactions before of a good underlying business without a successful plan going forward.

Okay. Yeah, yeah. That's a helpful little tidbit there. Another thing I keep hearing you say is you look, to invest, for operators who are running their margins and you're using basis points. But for anybody out there who doesn't know basis points, if you're running margins that are 3% better than the average franchisee in your category or in your brand, that seems to be a very key component. These gentlemen here want to invest in operators who run good P&Ls, right? Because they're going to make the assumption that when they invest with you, that you're going to be growing in a way that their investment's going to grow and everyone's business is going to become more attractive is if you're able to operate the P&L very strongly.

So, reach out to us if you're on this phone or to CapitalSpring folks and get a perspective of how you do. How you're running against your brand franchisees. You could call me, let's say you're... I don't know a Popeyes franchisee or whoever you might be and say, "Hey, how do I run my margins compared to the average Popeyes franchisee." We have a perspective on that, and I know Richard and Wade do too. That's a critical component to whether someone is going to want to get into a marriage with you and help you grow your business beyond what you've been able to do yourself.

So, like anything else, your operation and your management teams are huge. Are a huge component of the success here. Anything you guys want to say in closing? Here's, obviously, their contact information. We'll send this out so if anyone doesn't have time to write it down, we'll get it otherwise. So, if Richard, you start getting a bunch of spam emails, you'll know it came from Unbridled. But-

There's a couple of questions that maybe if the people that posted the questions want to just email us directly, we'll just... Happy to jump on the phone and walk through those. I think some of the key components regardless of what type of capital you need is finding a partner that understands your business and understands it's not always going to be a perfect straight line that's going to take the bumps with you and be constructive in getting through the harder times or the headwinds as people maybe in conference rooms would say in New York City.

I think that's really important, and for us, we decided to pick one industry and just really focus on it. We look at three or 400 deals a year. We've got 30 people and all we do is look at restaurant deals. So, when we're having conversations with people, we get to the essence of it pretty quickly because we've seen a lot. Hopefully, we can be constructive and helpful and not [inaudible 00:46:21] on things that we just aren't a good fit for. And in situations that we think are good fits, I think can move as quickly or faster than most people because we already understand all the intermediary steps that a lot of people may ask questions about if they're looking at 10 different industries.

Yeah, there's no doubt that's right. There's no doubt that's right and we can do those. Thank you so much, and I hate to end with questions after that nice final hoorah, but since we have a couple of minutes left, let's answer these questions for these gentlemen and ladies, huh? Let's see, I see a lot of dual-flow and multiunit casual dining space that have solid pre-COVID operating histories. We have been thrashed by the pandemic and the owners are desperate since traditional bank financing has dried up. If you had to structure a deal to recapitalize, would it be a combination of debt and upside? Okay, specific comment there. We talked about it a little bit. This question came in before we touched [crosstalk 00:47:13].

Yeah, I think that's right. I think it would be a combination. I think there would be an upside component in there, and I think the way that we would look at it is when we talked about previously of looking at the pre-COVID performance, factoring in what's the burn rate look like until things normalize to establish the ultimate capital need and liquidity horizon for the business.

What are some of the snags of a deal getting closed once you get in the trenches with the potential... I mean, that is an open-ended question I could speak for weeks about, but you've got leases that go crazy, you've got franchise owners that go crazy, you've got financials that aren't what you thought they were, you've got management teams that don't stick around, you've got... I mean, there's all kinds of things, but any comments there?

I think financing sources, surety of close can be one of the more important things. You may have the cheapest price, but if they're going to not get to your finish line, the timeframe that you need it to, that may jeopardize the whole deal. So, I think surety of close is key and understanding upfront how comfortable are you that the counterparties you're talking to on the financing side can get there and on your timeline. I think that's where we see hurdles all the time when there are multiple parties at the table and somebody's on a different timeline and holds the entire process up.

I think brands. Obviously, making sure there's a lot of brand approvals that are needed anytime a franchisee deal is done. Making sure you understand those upfront and are tracking the timelines that are needed to get to those approvals. Obviously, lease transfers. We see that oftentimes holding up deals where you have a variety of landlords and to get those lease transfers, that may take a different period of time for each type of landlord. So, making sure you start those processes early in your own process to make sure that they're going to be done and transferred before you're ready to close. That can always hang things up. [crosstalk 00:48:57].

I always tell people in our line of business that if you have a business that we're selling for you and your business is tracking negative, comping negative. I very rarely see businesses close at the same price you start at if the business is comping negative in a pretty dramatic direction during due diligence.

Sure.

If your margin... Some sellers or people who are doing any kind of a transaction take their eye off the ball and stop operating well during the middle of a transaction because it gets overwhelming, and that's a bad thing to do. You have to operate your business well, you have to continue to produce year-over-year sales increases or flat sales, and you need to be positive in what you do. And I also say the other thing that I see where deals get hung up is when clients have a misappropriation and misunderstanding of the risk associated with the transaction, whatever that would be.

A lot of that relates to when our experience is selling a company. You'll see franchisees not understand that there are reps and warranties and there's all kinds of language that affects the decisions they make to either sell or finance their business or find equity partners. And so, an understanding of that risk is something that we'll do on the front end to make sure that people are going through a process that they understand. Because once you get into those due diligence periods and people have not understood the risk appropriately, a lot of deals can fall apart during that phase if you're not careful.

So, I see we had another question. Did we have one more question? So, let's see if we can get it again. Do you facilitate international acquisitions and sell-offs? I mean, at Unbridled, yes. We've worked internationally in quite a few markets. It's not something we do for smaller transactions, but sure, we've done work in Canada. We're bringing a big group from the South Pacific area into the United States on an acquisition right now. A big acquisition, actually, almost nine figures. Several other deals in the Caribbean area, so yes. And I know, Richard, you guys do as well don't you? I mean, at one point, I know you were looking at the UK for franchise brands, the?

We do. So, we've done work in Canada, Mexico, Puerto Rico, and looked at stuff in the Caribbean certainly. We look at stuff in Europe, Eastern Europe, and certainly have considered deals. We haven't done a specific deal in Europe yet, but we've got flexibility and a mandate to look at some opportunities there. We would typically... Most of what we've looked at have been US brands that have good franchisees over there looking to consolidate or need a capital partner.

And so, we certainly are able to do that. It's not certainly our expertise sitting in the US. Most of what we do is in the US, but we certainly have and will continue to look at opportunities overseas.

Those international deals are really difficult to do because there's usually not any [inaudible 00:51:38], right? [crosstalk 00:51:40].

Yeah, there's a lot of local jurisdictions and lending laws that it takes a lot of extra work to make sure you've got your arms around the risk and the return potential.

And that's for you and it is for us too. It's a big piece of it. Every country has a different law, has different complexities. So, just the deal cost of Richard and Wade's time, and the professionals used to make the decisions is higher. So, the opportunity probably has to be larger, I would say, for you guys, right? Same with us.

I think so. We've looked at things where we've actually looked at financing US operations and made a loan to a US operation. They've used the proceeds to go build something internationally. So, our collateral is in the US, but the use of proceeds may not necessarily be US-based. So, we can get creative in those respects as well.

Thank you, guys, man. Thank you for joining. What an excellent-

Thank you. Thanks for your time.

... webinar. Really enjoyed it [crosstalk 00:52:32].

Yeah, you can see us face-to-face sometime soon.

Yeah, man. And for everyone who's watching, let's go get them. I think the message is a positive one despite what you're seeing on TV. I'm really proud of our industry as a whole and everyone who's attached to it that we're hanging in there. I just hope and pray that everyone listening, that you guys are safe, and that your business really is improving. There's a sunnier day that's coming for sure, so thank you all so much.

Let us know if we can be helpful regardless of whether it's a fit for us. We're happy to be helpful to answer questions or connect dots to the extent we can, we're here.

Awesome.

Thank you.

Thanks, Richard and Wade. Thank you, everyone, for watching.

Great day.

Y'all too.

Thanks, Rick.

Bye.

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