Season 3 Episode 12: 2021 Franchise M&A Top 10 Questions Countdown



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Welcome to The Restaurant Boiler Room season three episode 12. I'm your host Rick Ormsby, managing director at Unbridled Capital. Today in the boiler room as our year ending episode, I will be answering 10 of the most commonly asked question from sellers, buyers, and investors who are fueling the surge in M&A activity in the franchise sector. These questions are wide in scope, so they should provide valuable insights for almost any listener. I hope you enjoy. The Restaurant Boiler Room is a one-stop shop for multi-million 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 franchisors on a monthly basis. Feel free to find our content at Unbridled Capital's website at Now, let's enter the boiler room.

Well, hey, I'm glad you're with us here today. This is the year end episode, it's hard to believe we're at the end of 2021. Man, how time has flown this year. I hope you guys have a great holiday season, guys and girls, have a great holiday season. I'll share with you a story, I love watching the Christmas Vacation movie with Chevy Chase and Randy Quaid, cousin Eddie I don't know if you guys watch that at all, but good old cousin Eddie. I could watch that cousin Eddie when he shows up as a surprise with the RV and stands in the front yard looking at the lights. I could watch that, I don't know, every day all year long and still keep laughing. Maybe it's because I'm originally from Kentucky and I got family like that. I don't know, but it's hilarious. I hope you enjoy the Christmas movies.

My dear wife, she's quite the light person over the Christmas season. I don't know if you have someone in your family who's this way or maybe you're this way. But I don't have to do any of the light stuff, she loves to do it. And I was looking outside and she was going to town on our front yard. I mean, every bush, she's got snowmen in the front yard, we got the joy sign. We've got trees that are getting wrapped. We've got Garland everywhere. We've got lights hung on the back fence. It's just basically like a Chevy Chase Christmas around here. Go picture that visual. That's the arms Ormsby family lighting scenario at our house. I hope you guys enjoy the Christmas season and many best.

It's hard to believe that we're going to be embarking on a new year soon. And boy, what a year it has been. For us at Unbridled and I'm hoping for anyone who's listening here, I hope that you can also say that it's been a great year professionally for you not without its difficulties. At Unbridled, we've grown our business by probably twofold over the last year. It hasn't come without long nights, sleepless weekends, et cetera, et cetera. But we feel blessed to be in a position to be so busy and really to be growing our business. And I hope you look on the year with reflection and positivity and feel the same way. Today, I have taken some time to write down 10 general questions that I commonly get throughout the year from, I mean, it could be buyers or sellers or private equity groups, family offices. Even lenders and real estate folks who support the M&A and the franchise business.

And I just get these questions, and so I tried to sit down and write down a review of these questions. I would say on average I get each one of these questions on a weekly basis, something like this or every other week. So I hear these questions a lot. Sometimes they're phrased a little bit differently, but I'll try to answer them generally so that you guys can hear this, wrap up the year, think about the M&A space and what we might think will happen going forward in 2022. And I hope regardless of what type of a person you are listening to this, whether you are a buyer or a seller or whether you're ... What stage or what you're looking to acquire, what you're looking to divest of. What brand that you support, whether you're a franchise or wherever you are in this cycle of this beautiful and wonderful industry that supports our American dream so strongly.

I hope that there's some questions in here that I'll answer that will give you some insight. And then we'll look forward to catching up again in 2022 afterwards. So the first question that I have here, and I get this a lot is as a buyer, how do I select a brand? So envision this question being something like a family office or a private equity company would call me and they would say, "Rick, I want to into franchising. I see all these people who have done it over the last couple of years and their names are all over these important magazines now and all the deals that they're doing and the money that they're making, how do I select a brand? How do I do this?"

My answer usually starts out something like this, I'll say, "Well, the first thing I would say is you've got to get a thesis on several brands." My comment is I have watched over almost 20 years financial groups call me by probably the thousands now over all this timeframe. And I do see one almost 100% link. These firms that call who are unsuccessful almost never have focus. So it's like anything in life, man, if you want to be successful, you got to have focus. I don't buy the strategy of, "Oh, I'm a family office or private equity guy, and I look at all kinds of deals from all kinds of different brands. And whether it would be a," blah, blah, blah, "tax franchise brand over here or a myriad group of different brands in the QSR side. And I'm also looking at casual dining, and I look at fitness. And I see every deal, we're interested in everything."

So when I hear that from someone who calls in and says, "Oh, we're interested in everything," the first thing I say to myself in my head is, and most of the time I tell it to the person too because that's just who I am. I say, "The chance of you ever acquiring anything with that kind of a strategy is zero." And then I think I'm not going to be talking with them much more. When someone calls me and they say, "I'm really interested in the pizza segment because of the following four reasons, and I think we would be interested in operating in the Southeastern United States." Then I say, "Oh, well, you have specificity in what you're looking to acquire." That's somebody who's likely to be some successful if they put some teeth behind their effort and they're patient enough to wait out a 6 to 12-month period to find the right acquisition. It's a way different type of response from me.

I would say the first thing I would do is don't be too broad, got to be specific. And so that's the first thing. So when you say how do I select a brand, I say, okay, well, before we start thinking about selecting a brand, let's make sure we first get really specific and let's pick two to three brands. And they're like, "What two to three brands am I looking to pick up?" My question then becomes, "Well, what size of an investment are you looking to acquire? How much EBITDA do you want? What brands do you absolutely not like? And what areas of the country do you not want to be in? And how big do you want to be?"

These kind of questions help me narrow in on a brand. If you want the most fluid M&A market, for example, if it's a family office or private equity buyer who ultimately wants to have 300 or 400 restaurants across two or three brands and they're looking for their first brand as a platform investment, they need like 40 or 50 restaurants or more to have the G&A and the structure to hire a big management team and then to build from there. If that's what they're looking to do, I would respond like this. You're typically then probably looking at a franchise brand that has 2 or 3000 units or more. And when we put that first screen on the brands that we see, I mean that cuts the brands pretty significantly.

The second question I ask is, okay, are we talking restaurants or non-restaurants? Although increasingly people are asking non restaurants, but most of the time people call in looking for QSR restaurants because so much of the franchise world of scale and size and longevity to this point has been in that realm. So if I find out that it's going to be QSR restaurants and then we find out that they want to buy a large platform acquisition, then my answer is you need to probably be at 2 to 3000 units or more in terms of the brand that you look at. And the question is, why? Well if you want a platform acquisition, some people have the strategy of buying the biggest franchisee in a smaller brand, which is a great possible idea to be a big kahuna in a small pond.

But the problem there is, I mean, the opportunity might be that you have a lot of greenfield development to grow the brand. But the downside might be that there's a lot of small franchisees that makes it difficult to acquire further add-on packages of scale or the sophistication in the brand may not be of the size that someone would be interested in. So that plays a little bit into the smaller brands. A question of the smaller brands might also be whether or not they have high growth characteristics. You think of a brand like Wingstop that's growing crazily. And then you think of some of the legacy brands that you see rotting on the corner in middle America that aren't growing. And you say, "Well, if it's a small brand that's not growing, is it the right brand for someone to get into if it has a low unit count?"

So that's the first place I go. If we have that initial discussion and they're looking for something that's going to have 2 or 3000 units or more because they want that initial platform acquisition and then they say, "Well, after that I want to grow this 40, 50 unit initial acquisition into 2 or 300 and then use it as a platform to buy another brand." Then it's easy to cut it down to like 15 different restaurant franchises in a hurry. You can just go online and Google and find the restaurant franchisees by size, by number of units. I mean, the information is public, it's out there consolidated in some places. At which point, then you look at it and you say, okay, well ... Then we pick apart within the 15, you say, "Okay, well, some of these don't really offer a free market system of buying and selling."

Some of the franchisors will only allow you to have one or two of these restaurants and not a whole portfolio. Some of these restaurant companies, and I'm not going to name any names, but some of them don't allow you to own real estate. They own the real estate and then control the buying and selling and they don't allow for a free market buying and selling process, which is usually not in the best interest of these family office and private equity groups that are buying. Then you look at it, put another filter on it and you say these brands that have the characteristics for further acquisitions are not good. So some of the brands might be, for example, let's say, most of the franchisees are one in two units. Well, if you're a larger firm and you're looking to acquire more after your first acquisition, you want an environment where you have some girth in the franchise system.

In other words, you have other franchisees of substantial size that you might be able to target for future acquisitions. And so that's maybe a filter that you'd want to place on it. You want to ask within these 15 brands what their recent performance has been, what the lenders feel about them. And that's another question I'm going to talk about here in a little bit, but how easy is it to borrow money? Most of the financial buyers of these businesses want to lever up these businesses as much as they can responsibly speaking. And what is the lending community looking at for some of these brands? I mean, you have these lease-adjusted leverage calculations that are different for each brand, and the risk departments of some of these banks just won't touch some of the brands that have some difficult performance.

Now, some people want to have a turnaround, and so that's another question within these 15 brands that have these certain size requirements in terms of number of units, do you want a high growth brand that you're willing to pay a huge price for and have a lower upfront return on investment but the chance to build more units and earn back your return on investment by building new units? And then also with the backdrop of having an asset that has a higher value if you ever have to sell it. Or do you want to go in to buy something that's tired or kicked around or in a brand that isn't trading as valuably where you might have a better opportunity to improve it? You're going to have better return on investment calculations because you've bought it at a lower price, but you may not have as strong of a business underpinning you if you ever decided to sell it or things went bad.

That's another filter like recent brand performance and then the price at which something must be acquired or is likely to be acquired. And so those kind of questions take the 15 brands really quickly. Once you just put the I can can't buy and sell it, I can't own the real estate, I can't own more than one or two or I can't be in any other business if I'm in this brand, that roughly 15 brand analysis drops you to like 10 brands or 9 brands really quickly. Then you ask the question, okay, within those remaining 9 or 10 brands, a couple of them are pizza brands, a couple of them are mostly chicken brands, a couple of them are burger brands. And so within those, you can't be owning both of those types of brands, you can't own two different pizza brands. You could only own one for non-compete reasons.

So you form a viewpoint between the different types of the different segments. And then most people, I can just tell them here I'm going through the analysis of just, well, I like this brand better than this brand, this pizza brand better than that pizza brand or this burger brand better than that burger brand. And so then that strikes off 4 or 5 of the remaining 10 or so brands. And so you're only now left with four or five brands. And then the question then becomes, well, what area in the country are you wanting to operate? A lot of people say, "I don't want to be in the West Coast, and I don't want to be in the Northeast." Some people say, "Well, I want to be in those markets because I feel like if I get into those markets, they've already undergone a lot of the appreciation of labor in the P&Ls, and so I know what I'm buying."

You hear all kinds of views. But I'd say 75% of the people who want to buy anything don't want to buy on the West Coast or in the Northeast, unless they're already operating in those markets. So if someone's coming in from new, you probably look at some of the remaining brands and where their concentration is. And you may then skinny the brand list down to three or four brands. And then, bingo, you're at a remaining three or four brand list that you can delve and dive into. And then it's time to go to the franchisor. You can always ask Unbridled and we can introduce you to the franchisor. But it's time to have those conversations about the brand so you get to learn more. And then you listen to the management teams and you listen to the plans and strategies they have put forth.

And then from there, maybe you settle in on two or three brands and then that becomes your bucket that you're going after when you're looking at acquiring something. So there you go. I'm really largely catered in the answer to this question to the people who are coming out, they may have a billion dollar fund and they're looking at making a platform restaurant franchise investment. But if you're somebody who's calling in who might be a franchisee of a brand, let's say you own 50 of a sub shop brand and you want to get into a second brand. I mean, your discussion would be a lot different. There's not a lot of natural competition to sub franchises, so you're open to anything across the segment in the restaurant space if that's where you want to be for your second brand.

And then you look at where your units are geographically if you're an existing franchisee of any brand because then you want to see where there's complimentary areas that might overlap for your operations. And then you look at how diversified is your portfolio of restaurants versus what you want to buy. I mean, do you want to be concentrated and buy something in the same geography or of the same type of segment or do you want to go something totally separate? It is true that some of these segment don't move in concert with one another. So burgers may not be going up at the same time that pizza is going up and casual dining might not be going up at the same time that QSR is going up.

And sometimes certain drive-through types of QSR perform better, for example, like Sonic where you drive in. They just naturally had a contact list delivery model that may work better than other QSR concepts during the COVID crisis. And so there's all kinds of factors there. I hope that gives you all some idea. That's the first question. I hope the other ones are going to be a little shorter. Sorry for rambling. So another one is, Rick, what's your biggest concern for our industry for 2022, and specifically what's your concern from an M&A perspective as you see these deals going on? I get this question a lot.

I'm talking to you here in the middle of December. So in the last 60 to 90 days, I've been hearing a lot about food inflation. You'll be hearing the franchisors and the equity research analysts and the franchisees, everybody's talking about food inflation. And heck, it ain't just food inflation, it's inflation of everything in our country right now. I mean, look at gas prices and price of construction materials and cost to build new franchises right now. Just availability of materials, the whole thing. But pricing and particularly food inflation is a concern of mine for 2022. A lot of franchisors are getting in front of this as best they can and are recommending or mandating that their franchisees raise their prices to combat the near term food inflation situation.

I mean, I'm thinking particularly of the wing shortage and the cost of wings. I mean, gosh, you'd think chicken wings are like buying gold right now with the cost and how much it's gone up and down. It's just been very volatile in the pricing, but we should expect big food inflation in 2022, so that worries me. I think the brands will offset most of it with pricing. But I do also have a secondary concern about the ability of pricing to continue to stick. And when I say that, for those of you who are franchisees who listen, sticking pricing, it's like if I raise my price from $5 to $6, will I lose any customers in the process or will the increase in prices stick?

When I used to work at KFC corporate and we would assume that you would see 90% of pricing initiatives flow to the bottom line in terms of EBITDA, there would be no demand degradation from the clients. In other words, a customer is not going to not come and not buy because the cost went up from 5.25 to 5.50. And then you would say, okay, well, about 90% of that flows to the bottom line because the only thing you got to pay on every dollar of sales from pricing increases is really royalties and advertising. I mean, labor doesn't really change if you raise the price of a taco by 25 cents, food cost doesn't change. Your fixed costs, your utility costs in the back of the restaurant, all these things stay the same. But is a concern of mine when I now go to ... I mean, my kids love Chick-fil-A. They went to Chick-fil-A the other day here locally down the street and a number four or whatever the meal is. It's like $11 and 30 cents.

And I'm thinking to myself chicken sandwich, fries, and a small Sprite is like $11 and 30 cents. I had someone just the other day I was talking to, called me and he said, "Rick, I just got a 10-piece chicken McNugget, fries, and a water, and it was $11." And so the prices are coming up quite a bit. And I know I'm on the side of supporting the business owner. I mean, when your costs are being inflated, you have to raise your prices. But I think there is some price and at some point where I think you're going to see demand diminish if prices continue to rise. And I'm concerned about that for 2022.

So keep an eye on the prices getting so high that the demand actually drops. I'm hoping that doesn't happen. Another concern of mine is obviously labor. I continue to hear the beating of the wardrobe of the franchisees who are like, "Rick, man, this circumstance is really hard to keep good people, it's harder than I've ever seen it." I'm hearing a little bit less worry about that than I did back in July, August, September, October. It's probably because the states have backed off some of the support of people who aren't working potentially depending on the state and where you are. I'm hearing a little bit less of it, but still it is an unprecedented time to find labor and to keep them employed. And I don't know that that's going to go away, although do I do feel like that is being become addressed over the last year. And while a big problem, maybe don't look at it as much of a surprise as the food inflation issue.

Another thing that concerns me is the sales rollovers. QSR especially has been on a, generally speaking, not every brand, but generally speaking has been on a nice sales tear over the last, call it 18 months. So most of the time now we've been lapping over big sales from last year for a while. I keep waiting to hear from franchisees with substantial sales declines. On a comp basis as we move forward and in some brands, sales are indeed dipping. And it is regional, and it is by brand too. But largely speaking, I think the environment from a comp sales perspective and QSR continues to be pretty strong. I was on the phone with a big pizza franchisee just yesterday who was feeling really good that comp sales and profits were looking good through the first half of 2022. And that was his individual situation in his markets.

But that nonetheless remains an issue. When you're going through a deal and sales on a comp basis are going down during due diligence, it becomes difficult to get the deal underwritten and for changing financials not to result in some re-trading between the buyer and seller at some level if the amount of comp sales declines and profit declines are substantial and continual. That's an issue. And then here we are sitting on this Omicron virus. I don't know what the heck that's going to do, how that's going to impact things. I have see, I think we all have that there have been some travel restrictions and things being put in place. Who knows how that'll play itself out over the wintertime when it's cold and everybody's indoors and probably more likely to be in contact with one another.

That is obviously an ongoing concern, although I would just say I think I've seen some CEOs say publicly in the last couple of weeks that people are just going to learn to deal with this, it's not going to go away. This virus situation is just going to be something that we'll all have to probably manage around for a longer period of time and get comfortable with the fact that people are going to get sick. So those are some of my big concerns, that's question number two. Another one would be comments on the franchisor acquisitions that you've seen this year. Yeah, this one's maybe a little quicker. I mean, just yesterday, I think it was, Jack in the Box announced that it was acquiring Del Taco. And my opinion on that is any of these acquisitions that you see are going to result in some positive synergies from a G&A and pricing perspective. That's probably not going to make the analysts feel good about the models that they're developing, that it's going to be a synergistic acquisition.

I think what you're seeing is these franchisors are buying more brands, and they're buying complimentary brands and brands that they can try to expand their franchise base in the brand they're acquiring to the franchisee of the existing brand. So for example, would it be a surprise to me to see more Jack in the Box for franchisees build Del Tacos in the coming years? No, not a bit, it wouldn't be. And you're seeing these clusters of groups form like you've got Inspire that's built up. A couple other brands like Jimmy John's and they just bought Dunkin', and they got Buffalo Wild Wings and Arby's and Sonic. And then I think they have a small taco brand as well.

They're trying to make these brands complimentary of one another so that franchisees who own in one brand could jump over and own in another. In that brand, who the heck knows, but you might start seeing Sonic franchisees build Dunkin' units as an example. You have Yum!, which has always been there, they added Habit this year. And Habit is a burger chain, a small burger chain in California. I'm sure Yum! was thinking we've got all these big and powerful KFC, Taco Bell and pizza franchisees with lots of capital and high unit counts in well capitalized businesses. And it would be nothing for them to sign on and expand this mostly California small burger concept and throw 10 of them in, I don't know, Oklahoma City or wherever in the heck it might be, Dallas as part of their relationship with Yum!.

And so I'm sure that's one. And then you've got RBI that has a litany of brands. And you've noticed over the years that the Burger King franchisees and RBI have started to build Popeyes locations. I mean, why? Because they like the unit economics of the Popeyes model. I mean, you build a Popeyes and it may do, the average AUV I believe is in the 1.7 to $1.8 million range, which gets buyers and operators excited about building into that space. It should because a lot of the other brands are showing 1.2, 1.3, $1.4 million AUVs, which just ain't cutting it for a new build when the cost of construction is going up by 25%. Just not financially viable if you can't deliver better AUVs than that to build new units, which all franchisors want to encourage their franchisees if not push their franchisees to build new units.

And then I think across those, you're seeing each one of those. And now you have Jack in the Box and Del Taco, they're a burger brand mostly right Jack in the Box, and they're adding a taco brand. So you see these complimentary brands forming in these conglomerate companies that enable the franchisor to get better distribution of the new brand among its franchisees without conflict or competition issues. It's almost like playing basketball in the playground, everyone's picking a teammate, you know what I'm saying and they're all building their team from the playground to play. And so it's become a little territorial. Also I think over time you're going to see a little bit more difficulty jumping between the brands.

In other words, it's going to be maybe more difficult tomorrow than it is today to be an Inspire Brands franchisee and then a franchisee of another brand in one of those other buckets like Yum!, RBI or maybe this combined Jack in the Back Del Taco situation. And it might work like this. If you are a Yum! franchisee and you own Pizza Huts and you want to buy Popeyes, well, both RBI and Yum! may have a problem with KFC being the competing brand even though you don't own KFCs within the Yum! family. Does that makes sense? There are FDDs, and most of the FDDs clearly lay out which brands are non-compete brands. So I don't want to try to jump in front of that and say what is and what isn't, you can read that for yourself and request that from the franchisor.

Just keep remembering this analogy of the schoolyard divvying up a bunch of kids to form a bunch to basketball teams. You pick your team that you're going to play for, you pick your brand, your conglomerate that you're going to develop stores and own stores and operate stores in. And then you stay in that bucket a little more than maybe you used to in years past. As a result of all the acquisition of the brands that have been happening to form these conglomerate companies. Another one is number four here, franchisor temperature. Tell us about the franchisor, what's changed this year in the franchisor. I guess I would say the franchisors in large part I think did a fantastic job of rolling out their plans during COVID, their cleanliness plan, their operational plans, their sales and marketing plans, their advertising plans to keep these businesses on the QSR side, especially really humming along and doing well.

And I would say in large measure they used virtual tools and they rallied the franchise bases well. In many cases, they delayed some development. And so I think that was also intentional and probably a good idea because hard to borrow money when we hit the pandemic. And you couldn't get people to build anything, and the whole world shut down for probably a period of six months. So I applaud the franchisors in that way. But that comes with a price, doesn't it? Because the franchisors ultimately, the ones that are public are answering to the street on earnings per share growth and new unit development. And the ones that aren't public may even have more aggressive goals for new unit development. I think that is now what I'm seeing coming forward with a fury.

And the franchisors I think whether they're saying it or not, I bet they're thinking this or like, "Your alls businesses have been kicking butt, you can now start building restaurants. You can start doing what we want to do. We've helped you out now, now you're flushed with cash. It's time to open your pocketbook and build." So I am seeing definitely a turn towards development in a rampant way, especially on our new acquisitions where we're helping someone sell a business and someone buys it, and the buyer takes it to corporate and says, "Hey, I'm going to buy this business." And corporate says, "Sure, but you're going to build 20 new restaurants over the next four years. And if you don't build them, we're going to penalize you with pretty stiff penalties until you do."

And so that is becoming a bigger part of the conversation. The development ask I think is getting more and more tough, difficult. And there's a lot of pushback at that level with buyers who are getting hit with franchisors asking for huge development obligations. Another thing I would say is in my first, heck, I don't know, 15, 18, 19 years in the business, I probably saw across the brands that I was doing deals, I probably saw the franchisor exercise the right of first refusal less than a handful of times. It wasn't a common thing. The asset light model that we've been reading about for years was the vogue thing to do, which is the franchisors wanted to sell all their corporate stores and only operate somewhere between 0 and 5% for marketing purpose says and for brand relevancy purposes. And then they wanted to sell the rest of the stores to franchisees because there's a better return on investment to be a brand manager not a restaurant manager, if that makes sense.

But now we're seeing right of first refusals being invoked. I've seen this on three or four occasions in the last three months. So it's something that's happening more. In one case, it was corporate going to buy and operate the restaurants. And then in three other cases that we've seen it, it is for the purpose of corporate exercising the right of first refusal and then either owning temporarily and giving it to another franchisee or selling it to another franchisee that they want to bring into the system for whatever reason it might be. Or they would invoke the right of first refusal but pass it to another existing franchisee and not buy it themselves. So I don't know that that's a major trend. If we're going to do 40 or 50 deals in a year and we see four of them that are like that, that's a pretty big increase, especially in the hundreds of deals before where they're a thousand, I don't know how many but lots and lots of deals over the past 20 years where we've very rarely seen it.

So I'd expect to see a more hands-on franchisor in the transfer approval process and more exercising of right of first refusals and definitely more push for development. And buyers are going to have to be wary of it and are going to have to negotiate as they're able. Number five, M&A outlook for 2022. QSR, I think the deals are going to continue to flow as mid-December we signed up six new assignments in the last four weeks after a period between August, September, and October where it was very quiet. Which was expected because with the proposed tax changes and with people's fear that taxes were going up in 2022, heck they still might, but we don't know. People who were wanting to sell in 2021 because of that and they wanted to get their businesses on the market in the spring and the summertime. And so that just created a vacuum in the fall where it was quiet.

But I think we've seen QSR guys come back to the market pretty strongly in December. And I think it's just because of, there's a couple of reasons, they might be thinking, "Well, these franchisees, well, prices are still really high. I missed the initial window, but I'm not going to miss it again. The operational environment might be difficult now, and I can't see myself owning this thing for another 5 to 10 years, I'm kind of tired." Taxes don't look like they're going to be going up meaningfully. And as such, I should do it as soon as I can." Those might be the reasons, but whatever the reasons, I think we're going to see QSR probably pick up again once you probably hit mid-January to the middle of April, I think there's going to be maybe as much activity as there was in 2021. So strep up man and get ready be because I expect it'll be a busy time.

Let me talk about a couple of other places for M&A outlook. Casual dining and fast casual, they largely have not been able to sell because their comp sales have been poor. It took them a while to get back from COVID. A lot of casual dining folks are calling me and I'm asking the questions and they're answering mostly in the same way like business is almost back to where it was in 2019 would be the way that I would generally describe it. But we've only been showing that for four or five months. To which point I say you need to wait a little bit more. And all the lenders and everybody are focused on closing all these deals by the end of 2021.

The lenders are not focused on casual dining, and they're going to look back into the trailing 12 months and they're going to still see some poor performance in four or five or six of those months because of COVID. And so you need to prove the case a little bit more, we can't just perform the last four months of good sales and say that this is what it's going to look like going forward. That may work as an explanation to some buyers, but it won't with a lot of the lenders. I think we're probably going to see at Q2, you'll start seeing the casual diners as long as the economic environment don't change substantially and we're not in some crazy recession, I think you'll see casual and fast casual start coming out because there's a lot of pent up demand, man. You couldn't sell any casual dining or fast casual company really in 2020, in 2021.

And then here we'll get to Q2 of 2022 and that's two and a half years. I think you're going to see that the supply will increase pretty quickly as soon as the trailing 12-month financial statement looks decent and more predictive of what it's been in the past. And when we start getting some positive lender comments coming out saying hey more than just, we'll look at anything. But actually they'll actually fund casual dining deals that aren't distressed deals. Small franchisors are calling us a lot, something that we're starting to see that has been quite a big uptick from last few years and even the few years before that. So maybe the same emotions are going on with these owners of small franchisors. And I'm talking people who might have a brand that has 25 units in Whereverville, USA. And they've owned it for 35 years and they and their family operate it. And they may have some franchisees or they may not, but we seem to be getting a big influx of those types of phone calls.

So I think those types of deals will probably go the route of the casual and fast casual process here where once the comp sales looks strong and the market rebounds for financing those deals, I think you'll see a big uptick in supply. I'm hoping that that'll happen as QSR maybe settles down. And so those small franchisees and the franchisees of casual and fast casual will have less supply from the QSR side to compete with their deals. And then I think you have the fourth bucket for M&A outlook, which is the non-restaurant deals. We're starting to hear about fitness deals, health and beauty deals coming back into the market. So it's a similar thing. I would put all of these deals about a year behind what QSR was, which if you listen to this podcast I was saying, man, this time last year, November of 2020, October, December 2020, I was like, "The rush is coming, the rush is coming. We're starting to see some of these businesses now come out on the market, the performance is good. We're going to see it grow substantially in 2021."

I was saying that before anyone else was if you listened and watched. And sure enough, I was right. In 2021, it blew up. And we had the same thing going with casual, fast casual, small franchisors, and non-restaurant franchisee that were in that same cycle. And so I expect 2022 to a big rebound. But I think it will be a little more delayed than it was on QSR just because of the comp sales issue. So that's my outlook. But I think 2022 could as a whole barring any unforeseen circumstances like massive recession or terrible virus returns in some incredibly unpredictable way or what have you. I think 2022 M&A could look almost as robust as 2021, which just a few months ago I would've said, "No way, 2021 is going to be the highest it's ever been." But I think 2022 could be similar, so hold on, could be another busy year for all of us.

Okay, there's a comment here about lender updates, I get this question a lot. And I've talked about it in the last comment about M&A outlook. So what's your update with lenders and cap rates? And I would just say cap rates continue to be strong. There was some fear that the new tax policy, whatever it would be would restrict or maybe even eliminate the 1031 exchange market, which would crash our economy because so many things are dependent upon 1031s in the commercial real estate space. But I haven't seen any legislation that really addresses that concern in any way. So let's just assume for the moment until we know otherwise that the 1031 market stays now what it is and won't change.

The cap rate environment continues to be very attractive. The EBIDA market, the multiples on some of these businesses that are selling are continuing to be strong if not record prices. So prices are very high, historically high. Cap rates are historically strong on real estate. I mean, look around at any piece of real estate that you're looking to acquire, whether it's a house, a trailer park, a restaurant or a bowling alley. Whatever it is, the real estate is really expensive, it's probably at an all time high. So there's been incredible appreciation as interest rates have stayed low. In 2022, we must expect from both a lender and say a lease back perspective that with inflation zooming upwards and comments from the fed, people in the fed saying we might need six to eight interest rate hikes in the near term. I mean, you're hearing that.

Anytime you see the interest rates come up, tightens the cash flow, restricts borrowing a little bit and the euphoria of borrowing. Hopefully it's done in a planful way. But that kind of meaningful change in interest rates is likely to turn the EBITDA multiples down a little bit, and it's likely to worsen the cap rates a little bit above their historical highs. You might see some gradual but meaningful lowering in valuations that may accompany successive and continued changes in interest rates. Be mindful of that. And the last comment I would make about lenders is I think the credit departments at these lenders are tightening up a little bit because of the previously mentioned comments on pricing and labor and food inflation and some of the sales role overs on a comp sales basis.

You talk to the sales guy at the bank, and he's all positive and things are great. But behind him or her is a risk department, and the underwriters are much more conservative. It would behoove you to ask those questions if you're looking to borrow money. Don't just talk with the sales guy, ask to talk with the credit people too. And also be Frank with them upfront about which brands are they aggressive with and which ones aren't they. There's a big dichotomy, everyone wants to finance a Taco Bell deal, but not everybody wants to finance, for example, a Pizza Hut deal. So there's just way different grouping of lenders based on the brand that you're interested in acquiring. So that's something to be mindful of.

Number seven, what complications have you seen in due diligence in your deals this year? Well, this is the monster question. So I'm going to pull up just a couple of the deals, not mention any of them, but I'm just going to talk about real quickly and fire away at some of the things that we saw in due diligence. On one deal we saw issues with the franchisor trying to push huge development obligations and a huge relationship agreement on the buyer who's coming into a new system. Eventually got worked out, required a lot of time to negotiate. This one here, we saw a buyer went into due diligence with a seller and the assets weren't very strong. So the buyer did their third party inspections, sent people around to look at all the buildings and came back with a huge price deduction probably more than they should have and were warranted. And it had to be negotiated through some difficulty.

Another one we saw, property taxes on real estate transfers were unexpected by the buyer and required a negotiation. The next one, oh, here's one, a big deal that we worked on where the seller's attorney had no experience even though it was a big franchisee, had very little experience doing M&A deals. And that's something that I would just say, we always on our clients recommend third party attorneys that have dedicated experience doing franchise to franchise M&A work. Because if you have a good trusted attorney that you've worked with over the years that's helped you from everything from lease assignments to your divorce or whatever it is, that person doesn't spend every day negotiating M&A deals with sophisticated buyers.

And so this particular deal had a surprisingly large franchisee and an attorney that wasn't mostly familiar, and it made the negotiations tough. This next couple of deals fell into the same category where we had an international franchisee come in to buy the businesses. And then they went to corporate, and they didn't like the terms of the relationship agreement to get approved in the brand. And so they walked away from the deal, and it forced us to re-market the deal to somebody else. I've had two deals this year, believe it or not that were on Indian reservations in different areas of the country. So getting those leases assigned, you have to be very careful about the lease language there. And so those have been maybe more arduous because of some of the specif lease assignment language with these Indian tribes.

So in these two cases particularly, and I'm just looking at deals that we're doing here. You have to look at the brand, we were in a new brand this year that has a reputation for when you submit the buyer and seller's asset purchase agreement, they will look at it and shop it among their franchisees to try to find someone who will pay for it at the same price or a higher price, which is a surprise to us and quite frankly questionable business practice. But that caused an extra 90-day delay in the transfer approval process because of the franchisor's process that they go through to ultimately approve of someone to buy the business. In some areas of the country, we have major weather problems like hurricanes and snow storms that can change deals or change the closing on deals or change the utility transfers and the sales and all those sort of things and opening and closing.

We had another deal that had a really difficult attorney that was pretty tough on the escrows and the indemnification provisions that really made it difficult. So that just maybe gives you a few, I'm just going to scan through here. We had one here where, another one where a new franchisee was coming into a new brand. They were a big franchisee of another brand. The approval process took longer than expected to work out in this case, again, the development agreements going forward. You have another deal that the buyer was a little bit disorganized and the purchase agreement took an extra 30 days to negotiate than what we expected. We had another deal here that we had to break up into two chunks because the buyer wouldn't buy all of it and only wanted some of it. That's not common for us to see.

I had a deal here where franchisor invoked the right of first refusal and then is trying to sell it to somebody else. And so the deal had to get broken up into two separate deals. And then we had one that got re-traded a couple of times in due diligence because the EBIDA was dropping fairly substantially during the closing process. Wow, that's a big mess. So I hope there's something in there that might be helpful to you. Question number eight, what are the main items a seller forgets to consider? Most people who sell things, especially the less sophisticated ones ... And it's amazing, you can be a big franchisee and be unsophisticated, t's not really totally a matter of size. But if you're a first generation franchisee, whether you're big or small, you probably unfamiliar with some of this.

You probably think that an advisor's main role is to find the highest price. And so you're thinking, okay, the most important thing is the highest price and then everything else will work itself out as if I was selling my house or something, and that's just not the case here. I would say a seller forgets to think about their legacy, they forget to think about tax planning. They forget to think about the importance of a good dedicated attorney who has specific deal experience negotiating with purchase agreements with a family office and private equity buyers because those guys are tough and those girls are tough. So that's something that they don't think about. Sellers almost always who are less sophisticated or unfamiliar don't think about the APA terms.

For example, if I tell you it's customary to see 5 to 7% of the purchase price held back in an escrow agreement for 12 to 18 months and held in a bucket for any unforeseen liabilities and then it's given out if there are no claims against that bucket. And you might say, I was selling a 50 million company, you're telling me 3 million, 4 million is going into that bucket, I'm only seeing 46 to 47 million at closing. And the rest of it is sitting in a contingent bucket in escrow for 12 to 18 months as an example. Most people are not familiar with that, they're also usually not familiar with the consequences and the contingent liability of the indemnification clauses that these buyers are trying to push on the sellers. Most of the unsophisticated sellers will say, "Oh, it's an as is, where is sale. I'm selling them, and I'm walking away." And that's absolutely not the way most of the professional buying community thinks of it. So there's usually a major disconnect there that requires a lot of education to get over the hurdle.

You have lease assignments. Almost everybody you talk to says, "Oh, if I have 20 restaurants, it'll be no problem to get the lease assignment." You Some will say, "I've got a couple of booger landlords." But mostly it's like, "Oh, this will be no problem." And then we get into due diligence and there's always 4 or 5 or 3 or 4 out of a group of 20 that are totally unreasonable. I can think of a deal right now where a couple landlords are trying to double the rent upon assignment. Some others that are not approving the assignment because the form of the company buying the business is an LLC not an S corporation. I mean, just crazy stuff that seems nonsensical. A lot of these buyers aren't going to offer personal guarantees, that's part of their deal.

If they're a private equity group, they're not going to offer in many cases a personal guarantee on the leases. And the landlords may have had a personal guarantee in the past even if that personal guarantee was from the operator who's not all that well capitalized. So that process always in many cases requires some work and some patience. And then I think the other thing you hear a seller always thinks that all of their real estate environmentals are clean when they're almost never completely clean in their entirety. For every 10 stores that have real estate that transfer, there's always going to be a couple. I mean, not always, but usually there's going to be a couple. Even in many cases if the franchisee has had a phase one environmental study done on the assets, they can even be surprised when it comes back through another environmental company that there's a laundromat down the road and there are issues. So those are almost always surprises. Just a few things there to consider.

Question number nine, who are the buyers for your businesses? Let's see. It depends on the brand, but I would say if we talk about a small deal, we're typically talking about usually existing franchisees who are nearby who can bring in their operations and can operate the stores and fold them into their operating envelope. If it's a mid-size or larger deal where you can put someone remote from your existing operations, mid-size deals you typically see a lot of existing franchisees of the brand or of similar non-competing brands in different geographies and similar geographies tend to be the ones who are the likely buyers.

So the first group is like 5 units, 5 to 10 units or less typically is going to be a, not always, but it's typically going to be a surrounding or nearby franchisee who wants to grow and pay a good price. If it's like 10 to 20 units or so, it's typically going to be too small for most family office and all private equity people typically. And it's instead going to be mostly a market of franchisees of scale who may or may not be contiguous to the market and may or may not operate in the brand currently or may be private equity or family office people who are already in the brand and are looking to expand. And then you've got 30 plus unit acquisitions. And then in those deals, if you have 10 offers on a business like this, you typically have 3 or 4 of them, maybe more who are outside of the system. And then the remaining are split between existing franchisees and then other franchisees non-contiguous of dissimilar brands.

So you've got maybe much more of a diverse group of buyers in the larger deals because they see these as platform investments that can be there on a standalone basis. Final question of the day, dah, dah, dah, dah, number 10, what's the biggest value add-on of an advisor? I get this question a lot actually. It's like why should we hire you kind of question. So I'm not trying to speak for Unbridled, but when I think about an advisor, I would say that advisor's job is probably 40% to find you buyers, 40% to manage the process and to get it closed. And then 20% of it is to have your back and to think about your legacy.

Most people misappropriate the value of an advisor and they say, "Oh, they're going to open up the market and find me buyers I couldn't find myself." Yes, that's true but that's not 100% of it. That's obviously a big component. But man, when you make deals with these big groups to buy and sell things at high prices in this marketplace, it ain't easy. It isn't easy like signing the back of a napkin and just saying here's the stores and then walk away it with a big fat check. Someone will do that with you if you're willing to sell it at four times EBIDA. But if you want to sell it at seven times EBIDA, these deals are difficult. And the buyers are going to have quality of earning studies, and they're going to come and physically inspect your assets and point out all the things that are wrong and try to negotiate a price reduction for it. And they're not going to accept your lease assignments if there's big rent increases without talking about it. And the agreements and the asset purchase agreements are going to be difficult to negotiate.

And the discussions with the franchisors are going to be hard and contingent. And the borrowing at these high prices is going to be difficult to attain all the way through if there are changes in the financial situation with the company while the deal is going on. So I would say half of the deal or 40% of the deal is managing that process, managing that process, which is a bear. All the due diligence, all of the things to get a deal closed. And then I think a good advisor thinks about your legacy, thinks about your intention and has your trust. And those are very important things to consider. It's not just somebody who has an email address, it's someone who you trust, who has your back. And I think that's important thing to consider with anyone who you trust as an advisor.

So thanks so much, happy new year everybody. Thanks for listening to this rambling podcast, I hope it was helpful to you. Take care and talk to you in 2022. Thanks so much for entering The Boiler Room today. You can find our podcast on iTunes, Google Play, Stitch or TuneIn and Spotify. If you like these podcasts, please listen, rate, and review. I also encourage you to visit our website for the best franchise M&A and financial resources in the industry. Our website includes webinars, podcasts, videos, white papers, and a list of our past M&A transactions. Please note that neither Rick Ormsby nor Unbridled Capital Advisors LLC give legal, financial or tax advice. These podcasts represent opinions that have prepared for informational purposes only. We expressly disclaim any and all liabilities that may be based on such information, errors there in or omissions there by.