Season 3 Episode 6. Bonus Episode - YTD Perspective on Restaurant M&A



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Rick shares his YTD perspectives on sales, profits, valuations, real estate, financing, and M&A in the restaurant industry.

The Restaurant Boiler Room, season three, episode six. I'm your host, Rick Ormsby, managing director at Unbridled Capital. Today in The Boiler Room, I'll be sharing my year-to-date perspectives on sales, profits, valuations, real estate, financing, and M&A in the restaurant industry. It is indeed a time of incredible change. And the goal of this podcast is to arm the listener with up-to-date M&A perspectives that have seemingly changed by the month as the effects and aftermath of the COVID pandemic have had a remarkable impact on a shifting trend in the restaurant consumer, investor, buyer, seller, lender, franchisor, and franchisee.

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.

Okay, well, thanks for listening in here. It's interesting. It's been a crazy year so far up to the middle part of 2021. And like I said, in the intro, I've been part of this industry a long time, for those of you who've listened, and it's been a pretty consistent industry. People typically don't come to the restaurant business, the franchise restaurant business looking for it to act like an internet stock from the late 1990s, up and down with crazy volatility and huge increases in sales and profits followed by uncertainty of crazy proportions. But that's seemingly what we have here in front of us now, and it's just historic and unprecedented. And I know a lot of industries are this way with COVID having impacted us greatly over the last almost year and a half now, but it just is a remarkable impact on QSR restaurants particularly, and also dine-in restaurants too, clearly, with the mask mandate and the capacity, indoor and outdoor seating capacity mandate limitations being taken away.

As an aside, before I start rambling, I guess I hope this finds everybody in good health and good spirits. I know I can tell you that I feel so much better returning to normal without masks and feeling safe doing it. And I think we're seeing the signs of it down here in Florida, of people just getting back to normal and vacationers and tourists alike coming back to the marketplaces, so I hope that's a good sign for everyone's businesses, whatever business you're in. But back to it, with restaurants, it's just been a crazy ride. And it seems like every month or so, there's something new that's happening that's causing sales and profits and interest in buying and selling businesses in this space to change.

I'll point out a couple of things that I've noticed that have changed since maybe the beginning of the year. Unbridled at this time has probably got 30 or so active assignments. So for us, we saw, like we normally do in this business. And for those of you who are new to the industry, typically, our business does work in cycles in this way. You're going to see more activity on the M&A side, typically in the first quarter and first part of the second quarter, call it from February to maybe April than you do probably for the rest of the year combined.

There's just natural reasons why people who might be franchisees or franchisors operating businesses may get their year-end P&L sometime at the latter part of January, they make their planning decisions for the next year. Oftentimes, they're looking at changes in personnel or changes in the political landscape, and they make decisions, strategic and long-term decisions usually in the January, February timeframe. So naturally, we see a good percentage of the deal flow happen at that time. So for us to have 30 assignments at this one point in time as we move into the second quarter and beyond is probably a little bit more than average for us, maybe not quite a doubling, but it's certainly a lot more than average.

And there's a couple of reasons for this. We've talked about this before. The first would be clearly that sales and profits are up. And so many who are selling their business or who are operating franchise businesses... We're just doing evaluation for franchisee today, I won't name the brand or the area of the country, but this franchisee had like $3.6 million of EBITDA in 2019, and he's got like $6 million in EBITDA in 2021 year-to-date I think through May. I feel he's up on, not quite double, but he's up like whatever the number is, 70 or 80% in EBITDA on a rolling year and a half period, which is pretty substantial, man.

And when you start applying multiples like that to that increase in EBITDA, let's say he was doing $3.6 million in EBITDA and now he's doing six, and let's say his business just, and this is after G&A, after maybe a three to 3.5% of sales G&A, let's just say his business was worth, it's in a system that worth six times EBITDA number. Certain franchise brands have higher multiples and others have lower multiples depending on the pace of M&A, the historical performance, the franchisor, the amount of consolidation room, the amount of competition amongst outside buyers of these brands. But let's just say in this brand it's six times, he's gone from basically, checking on my math, $21.6 million. Is that right? Is what his valuation would have been at the end of 2019, maybe January 1st of 2020. And now we're looking at a $36 million number.

Even if buyers might say, "Well, I'll pay you maybe not quite six times, five and a half times now, because your EBITDA's up so much and I don't know that I can keep it," you still are left with a business that's worth over $30 million now on this case. So the appreciation evaluation has been astounding, especially if, and we'll talk about this later today, the lenders are taking the approach which they are and certain brands, and it's really geography by geography and brand by brand, and it's buyer specific too, but whether the lenders are hopping on the train and believe that these increases are sustainable and are including them without hedges, hedging their loans at today's lease adjusted leverage calculation. So if they are doing that in some of these certain brands, they're seeing this appreciation, frankly, people who are operating businesses...

Let's be honest, you look around and while there has been a big trend of younger private equity based and family office based guys and gals getting into the space, it's still very fragmented with a lot of 65 and older franchisees. And so when someone is looking at that type of valuation increase and they're of that age and they may not have a son or a daughter who wants to be in the business, they may have 20 stores sitting in the middle of Kansas somewhere, they're forced to consider what it means to their legacy. These people are like you and me, they're good hardworking people who've started a business from scratch and have operated it for 30 or 35 years and they want an exit. They want to protect their employees certainly, but their family and their family legacy, and they want to be able to retire comfortably.

So these are natural considerations in times. And that's one of the reasons why the pace M&A has increased this year. Clearly, Biden has come out and said that he wants capital gains tax rates, I believe, to go back to, what, 43.2% or something in the low '40s? Whereas right now it's at 23.8%, which is not quite a doubling. Now, you have senators out there like Mancin who've basically stood up. He's a Democrat, but a conservative one, he's stood up and said, "Hey, I'm not going to vote for this and I'm the swing vote here." So it's likely that the capital gains tax rate gets negotiated downward somewhere or somehow. And it's difficult to note where, and under what timeline.

Some people say it could land in the 30 to 33% range, but even if it does, let's say it's 33% and that's a 10% increase in taxes that affects probably, depending on whether there's real estate in the transaction. Most of the time, a franchisee is going to pay primarily capital gains taxes if they've held the franchise a long time, because a lot of the value of a franchise deal is going to get allocated to goodwill and to real estate value and furniture, fixtures and in some of the areas that you can't depreciate as much. So you typically pay capital gains taxes on most of that portion of the proceeds on the sale. Some of it obviously on equipment, in some furniture, fixtures and equipment where you've had the ability to write it off.

And some of the favorable restaurant acts that are out there with Congress, they've enabled write-offs to really accelerate in the last few years. When you allocate a certain portion of that to the proceeds of a sale, you're going to be paying ordinary income tax on recapture there, but the blended... And every deal is different. CPAs make this stuff and we just track it and follow it, but primarily, on most deals, you are going to be paying more capital gains taxes than you do in ordinary income tax. And it's surprising to me because as I've started to talk with these first-generation franchisees who might have 15 stores, they oftentimes don't understand the impact of the taxes.

And they say, "Well, I pay ordinary income tax rates and I'm a pass through." And I'm saying, "Yeah, but most of your deal is going to be sold and taxed, not all of it, but a certain portion of it at capital gains rates." And that's what is at play here at such big increases. The ordinary income tax rate, they're talking about moving it up a little bit, but that's not going to be very substantial in the context of selling a bit of business, it's just a couple of percentage points of the top tax bracket is out there of increase. But if your business, 70% of it is going to be taxed at capital gains and you have a 10% increase in the tax rate, that means that your take-home proceeds are going to go down 70% of 10%, or 7%.

So if you're looking, and let's say you had no debt on your business in low basis, and you were going to walk away with $20 million, you could literally be looking at up to a million and a half to $2 million more in taxes if some of the measured tax increases on the capital gains side occur. I think after thinking about it, franchisees are looking at it and saying, "Okay, well, if this were to happen, how long do I have to operate just to pay off the increase in taxes?" And most of them are telling me two to three years. So the equation comes in, "Is my business going to stay at these levels with sales and EBITDA?" And many of them think most of it will.

And by the way, I was even one of them saying late last year, "I think once we hit this May timeframe, it's going to be like falling off a cliff." We'll talk about this in a little bit. But largely speaking, sales and profits are still really strong on a year-over-year basis in many brands. Now, some of it's geographic and some brands aren't doing as well and there has been a little bit of a slowdown, but we were all going to expect a slow down in same-store sales on a year-over-year basis. And once you get past March and April when everything was closed down in 2020... Any business would have a slowdown in comp sales, but we're still seeing flat to mildly positive, to sometimes very positive sales, even past the initial wave of the pandemic.

Of course, again, brand dependent, geography dependent, but this gives us maybe confidence that maybe this trend will continue. We won't have like a falling off of a cliff in the third quarter of the year, but it'll be just a soft landing.But even if we say that sales and profits are great and they'll maybe even continue flat from here or down just a little bit, what we still look at is if the tax policy is implemented, you're going to have to operate two or three years just to be able to pay off those increased taxes. And if you're 65 years old and you're looking at that, and you're looking at what's been a very difficult labor situation, as we all can attest to over the last three or four months, it's like a land grab for people.

I was just on another phone call incidentally with somebody saying, "Our sales right now are flat," they'd be up 5% on a comp sales basis if we could get enough people to keep our restaurants open longer, but right now we're running skeleton crews because we can't get people. That's essentially the norm out there in many areas as we open up past this pandemic. It just causes people who are maybe in their 60s or whatever age you are to look at it and say, "Unless I'm going to be in this business for seven to 10 years or more, sure, I'll hit another up cycle when sales and profits are huge, but goodness gracious, I don't know that I want to wait five years or six years to sell my business because it's not going to be net of taxes any better than it is now."

So you're basically getting two or three years of a blessing bestowed upon you when you look at what the future could hold. As it pertains to these tax increases, and we've talked a lot about this over prior podcasts and some of our webinars, which you should check out at, we we don't know when they'll happen. I suspect they'll become front and center this summer. And if they get past this fall, will it be passed retroactively to 2020, to January 1st, 2021? Unlikely, but who knows? Will they become effective immediately once passed? Maybe, who knows? Will they go into effect January 1st, 2022? Maybe, who knows? We just don't know.

But the assumption is that with limited information, we certainly shouldn't drag a sale and the closing of a sale of a business any past December 31st of 2021. And so that's why the pace of the acquisitions continues to increase. Now, as we go into the May-June timeframe, you typically do see a low of new restaurant activity. If you just take out all the incentives, all the economic things that are happening, all of the tax motivations that are out there, the pandemic and all the impact on a rollover basis of what sales and profits are doing just in a typical year in our good, old tried and true industry that doesn't change too much, except for now.

Typically, you see a low on M&A activity is starting in the summer. People do what people do, they go on vacations and they start doing other things with family. And typically, the summer, while we'll have transactions come to the marketplace, they just don't happen typically at the same pace as they do in the first and beginning of the second quarter. And then we get into the fall, and it stays quiet for a little bit. And then typically in the September, October, November timeframe, it starts to pick up again. We'll hopefully be going back to these restaurant conventions and things all over the country. I know I'll be going this year. I can't wait to get out there and do it and see everyone again. But that timeframe typically, it starts deal flow up. And then you see October, November, deal flow increases.
And then people start, we're always, it seems, negotiating purchase agreements on some deals that had just got launched in October, November timeframe. And we're also getting the deals closed around the holidays. So that's the normal pace and sequence. And I don't know what's going to happen this year. I just don't know. I can imagine, like if you were a car dealership and you put out a sign in your front yard, and you said, "10 years, 0% financing on these cars." What you're going to do is stimulate demand. But then when you run this promotion for 60 days or 90 days and you've stimulated demand you're saying big time, but then when you take this 10 years, 0% financing sign down in your front yard, you've already effectively pulled your demand forward and the supply of new car buyers is less than what it was prior to putting that sign on the market.

So you're probably going to create a lack of business, that's just the nature of how it works. I expect that there'll be some of that happens in our industry too. I think because of the COVID pandemic putting such strong sales and profits on the top line and bottom line of these businesses and because of the threat of higher taxes and some of just the emotional and psychological bent of being part of this mess over the last year and a half, from just like not even at night perspective, huddled up in your house perspective, dealing with employees, and all the new rules and regulations and the PPP funding and all these things that have just made your business more difficult to operate if you're a franchisee and entrepreneur.

They may just make move forward with the sale of your company may end up in its place accelerate a normal steady state of restaurant M&A. So as I'm looking to maybe Q2 to Q3, we're in Q2, it'll be interesting to see if the normal pacing and sequencing and return to M&A in the early fall time will happen this year or not, because we probably can't... I've talked about this before, but you really need six months soup to nuts to sell a franchise company, when you have to deal with things like go into the marketplace, and find the best buyer, negotiating the right letter of intent, working on a purchase agreement, getting all the due diligence together, getting corporate to approve the transaction, getting the leases assigned. If there's any real estate in the sale, making sure that it's clean with environmentals and appraisals and surveys and all these things.

And then getting the financing in line for the buyer, getting the stores transferred. It becomes a bigger thorn in everyone's side every time with some of the credit card machines and store numbers and some of the technology that has to happen at the very end of the deal that delays it, usually a couple of weeks negotiating with the franchise over development agreements and all this stuff. It all takes about six months to do. So once we get into late Q2, early Q3, none of the sellers that are going to sell at that time are probably going to be able to realize their closing at the end of the year. Now, this past year, in 2020, we had one client in the Taco Bell space who, we were able to close his deal and somewhere 90 to 120 days in that range, and that was lightning fast.

I can remember back in 2008, we did a Pizza Hut deal that was just that fast. We did a deal in the Sonic system back in maybe 2010 or 11, that happened in 90 days soup to nuts. So that means of the hundreds and hundreds of deals that I've been a part of in my life, those are the only three that I can think of that were like 90 days-ish in soup to nuts to close. So it's very, very hard to do that. The only way you can really do that is if you have a buyer with no financing contingency and you have just like all the stars aligned perfectly, and that can happen, and it probably will happen in 2021. One thing I know about franchisees is they wait till the last minute always. So if you're hearing this, get on it. But you're trying to call me, I know, in September and say, "Can we close this by the end of the year?"

And with any type of liquid asset, the answer generally is yes, you can, but you take a discount to the price if you want to sell it quick because then you knock out some of the people who might pay the most money, may need to go through the traditional financing routes that just physically can't happen in three months to close. But I suspect we will see a bit of a slow down in Q3. And then in Q4, I don't know what's going to happen. I suspect that if the economy does well and we're continuing to do well, we're going to see sellers stay in the marketplace in the latter part of 2021 and into 2022.
There's a couple of concerns there. If we don't get a pronounced capital gains tax increase, if it's to 28 or 30%, which is, I think... I'm not a politician, I'm not an economist, but I would think that anybody would be smart enough not to jack the capital gains tax rates so high up to the 40s. If you do that, what you're going to do, whether you own stocks or businesses is you're likely not going to sell them because the taxes are too high. And if the whole point in raising the taxes is to produce more tax revenue, I think at least in our little narrow area of the world, what you're going to instead do to the opposite is raise taxes too high, and people aren't going to sell, and your tax base actually decreases.

So these politicians should be smart enough to understand that and come up with something that's marginally higher that doesn't stunt people from selling and liquidating, but also maybe brings more tax revenue into the door. So if that happens and maybe we get a 28% capital gains tax rate, maybe that's not enough, and I don't think it would be enough to stunt the activity of selling companies. And that would be good for buyers and sellers. And then maybe we don't have, again, a hard landing, we have just a soft landing in 2022, and people can continue to operate and sell them and buy and finance businesses on a normal basis. Although I do think even then we will have pulled forward enough selling clients so that it will leave a little bit in its wake for a couple of years.

What we haven't talked about though and what there essentially hasn't been, I was chatting with a major national franchise lender just the other day, and they're telling me like, "Rick, there's still essentially no financing for casual dining companies." And really, the same is for fast casual companies too, at this moment. So what we may see is that in Q3 and Q4, you start seeing a big return to normalcy for those types of brands that have weathered the pandemic and are still open and their sales are going to come back huge, because their comp sales will be rolling over some terrible numbers. And then maybe when we get into early 2022, that may produce the opportunity for these casual diners and fast casual companies to have a decent trailing 12 month P&L. And then when they have that, to consider selling their company at that point in time, if that makes sense.

So that may be the next leg of the stool if taxes don't kill things, is that you may see a slow down in some QSR sales and you may see a pickup and things like casual dining, fast casual, fitness, health, and wellbeing in some of these franchises that have really took a hit and COVID, but are going to really start showing great sales comps and a return to normalcy here this summer. Let's see. So right now, I would say it's interesting in the early days part of Q1-ish timeframe, we had way more demand than supply. I would have said because people still weren't putting their businesses up for sale and such quantity.

And so I felt like certainly in October, November, and then December, we had like a lot of buyers had come back to the marketplace, people wanting to put money in these franchises. They want the exposure to the retail space, they see that you can't COVID-explode a restaurant company, it's going to stay around, especially on the QSR side. And so the first thing you started seeing is the buyers casually coming back to the market, and these buyers are largely outside buyers, family, office, and private equity guys, but franchisees too getting interested and aggressive and wanting to put money to work and seeing the sales and profit increases, but not a lot of supply.

And so over the last couple of months, as we cruised into Q1, it was the same, but we started seeing a pickup in supply, and by supply, I mean people who are wanting to sell their franchise companies. And now as we sit in Q2, I think we're firmly in a really nice balance. I would say supply and demand are balanced. So still have a lot of competitive auction processes for deals that we're doing, still multiple offers from really good, high quality buyers. a lot of buyers in the marketplace still wanting to acquire, and so there's plenty of that. And then there's there's been an increase in amount of supply with this phenomenon of people wanting to sell their franchise companies.

And it feels to me like we are in pretty decent supply-demand. And I didn't mention this earlier, but just a 101 in economics, an interesting thing may occur for sellers who delay. If you get into Q3 and Q4, or maybe in 2022, you may not have so many brothers and sister franchisees of yours that are wanting to sell their companies and supply maybe in low quantity and demand will likely stay high, absent any crazy geopolitical or recessionary issues hitting our country. We may indeed be in a situation where sellers maybe able to command even higher prices if there's not as much supply. Again, I don't think it's going to overcome a huge tax increase in terms of net proceeds, but watch for that as we get through the pull forward of a lot of these QSR sellers.

So I think we have return to a normal M&A market. I'm going to chat a little bit in a minute about the lending landscape, but we talked about it last month in our webinar, but I'll take a little more detail to talk through it. We reached out to like 15 to 20 lenders, national restaurant lenders who all they do is lend to franchise. And they told us the way it looked last May and the way it looks this June, and it's interesting to see how the lending market has rebounded so robustly. And it's largely been a top heavy situation where people are wanting to flight to quality, lenders are wanting to finance reasonable, strong buyers in legacy brands with high unit counts and good comps.

So if you fall in that category, the lending space has really... It's probably at pre pandemic levels in many cases, and it was pretty frothy back then. And of course interest rates are remarkably low and expected to be in that range of nothing for quite, for quite a ways. So that's good news for people who are both buying and selling or just operating their businesses. We have seen big valuation increases. We've talked about that, just a couple of examples. One thing is, I mentioned it a little earlier, but sales may start to slow. And they have started to slow. A lot of it's labor related, some of it's roll over comp sales related. Let's see what happens as we move into the summertime.

I was talking with a good-sized franchisee and he felt like he was going to be flat or better in sales and profits for the back half of 2021 versus last year. It's just one franchisee of decent size in the Southeastern United States. He doesn't replicate everybody, obviously, but I've heard a lot more bullishness on comp sales as we go into Q3 Q4 than I expected, again, just to reiterate. So, as sales and profits naturally come back a little bit, as we open up the economy, maybe that will be a muted situation that will be a bit of a non-starter as it pertains to being in due diligence and having the ongoing business having changes in profits and sales in the ongoing business.

That would be nice. That would make deals easier to close and it would make sellers more confident to be able to close these deals at the price that they make at the outset with buyers. And I do think we've been spending, on a government level, like a drunken sailor over the last year. And so as that starts to taper off, who knows when it'll end, maybe it'll end in August, September, but when that starts to end and people have to go back to work, will there be less money in the marketplace and will there be less of a labor shortage? What's that going to look like? And how's that going to impact retail sales and restaurant sales? I don't know. We'll just have to see.

Hopefully, the economy's in a great place to be able to weather the lack of money that's being spit into the system. We'll have to see about that, but clearly, a lot of our clients and friends still don't have dining rooms open because they can't staff them, and so maybe at that point in time when people go back to work and people are in dining rooms and dining rooms are open, some of the lack of fiscal and monetary spending and its impact on same store sales can be muted by the fact that dining rooms are open and there's more people staffing the restaurants. We will see. But clearly, we're not going to be spending like a drunken sailor forever, it will have some impact.

And also, I just liken back to this gas situation. I got a Tesla a couple months ago, pretty sweet, man. I think, as an aside, if you've never driven in a Tesla now... I mean, the Tesla we have, its wheels may fall off tomorrow and I'm going to sing a different song. But right now driving the thing is like going from a flip phone to an Apple iPhone. It's shockingly different and awesome. It's made driving fun again for me. I got to think that people are going to hop into Teslas, and the prices aren't all that unreasonable now too, especially for the entry-level models, like the Model Y or the Tesla 3 or whatever it is. I got to think that the people are going to run away from these high gas prices.

I'm rambling a little bit, but we all know that high gas prices, they have a very big impact on restaurant sales. It's one of the first things I did as an analyst back in 2003, I think 2002, even, in the restaurant space is graph restaurant same store sales versus changes in gas prices. And you will see that it's highest correlation you can find because people, the discretionary money they have in their pocket decreases as gas prices increase, and of course that results in restaurant sales coming down a little bit. So we'll watch that happening as we have oil pipelines that are being hacked and everything else out there, if gas prices continue to decline and we see $4 gas at some point in time, I think you're going to see a massive impact on the QSR industry and the franchise industry as a whole, because of it.

And we're certainly worried about the inflation of our country either way. I'll just talk a little bit about QSR sales and profits, I have been talking about it, but I'll just make a couple more points. I think QSR is still winning big. They're still winning big in the second quarter of this year, but the entire industry is on the rebound. We're hearing some really, really positive trends from fast casual and casual diners who've really started to come back to pre-COVID levels. I'm really, really happy for those of you who are associated with that side of the industry. I'm really excited, hear that it's coming back.

I think the same thing is happening gradually in many places of the country, especially in the Southeast, places that have lifted all restrictions the fastest in other industries like fitness and in healthcare, but QSR is still winning, big sales and profits over last year. Profitability still at eye-popping levels. And it's really interesting to watch the comp sales vary by geography and brand. It's amazing, we've talking with a couple of KFC clients in different places of the country, sales are up huge, profits are huge, and they don't correlate quite with what's happening in other areas of the country.

And so these regional differences are going to continue to be something to watch. You used to be able to just with a blanket over the entire country and say, "As long as you're part of brand X, Y, Z, you're going to be seeing plus or minus one or 2% sales in profit differentials between these markets. And oh yeah, there's always reasonable things that happen, and it's snowing in New York and it's a drought in New Mexico, and there's an earthquake happening over in California, but essentially taking out the anomalies, it's pretty much a pretty steady thing." But right now, it's not that way even in brands. The same brand in different geographies are seeing 10-point swings and comps sales. So it's just really interesting to see.Now, we just have seen, of course, the Q1 just a little bit ago, we saw Q1 EPS releases and stock releases in a lot of these franchise businesses.

And you saw what happened in Q1 and mostly, almost all of the brands, you've seen some pretty huge amount of increase in sales. So we'll just watch how that happens by brand angiography. We see food and labor inflation are on a big uptick. And it's almost impossible to get people right now at a decent wage. So people are paying the wage, whatever the wage is. I had one franchisees like smaller, 15 unit operators, small town saying, "Hey, I'm going to buy you a truck if you'll come to the restaurant manager, if you'll come in and work for the next nine months and not quit." So there's crazy stuff going on out there in the system, but it's causing labor inflation. And I was just yesterday on a boat down here in Florida and pulled off and moored up at a little restaurant. And they said that they're no longer serving chicken wings because of the chicken wing shortage and the high cost of chicken wings.
So there's food inflation here too, and difficulty with delivery drivers because there's not enough of them. And just supply chains are still messy. I'm sure that'll work itself out soon, but right now, it's still crazy. That's what we see in sales and profit outlook. And like I said, stimulus spending might lighten up through the summer. And so we'll hopefully have a soft landing there. Now, on the valuation side, it's interesting, there's a couple of things that make a price to restaurant business, or any franchise business or any business, it's usually the multiple of EBITDA, and it's the EBITDA itself. Now, there's all kinds of little factors and proformas and adjustments, you have to think about what the actual versus the implied GNA is and make adjustment, do some of your locations, had they been closed for remodel?

How many stores have to be re remodeled, relocated, scraped, and rebuilt over the next three or four years? What is your development obligations look like? And yada, yada, yada. Do your leases expire? Do you have any egregious leases? There's all kinds of things that go into the qualitative assessment of value of a business. Do you have a master lease that impairs the value of your business? There's all kinds of things. Are you in a bad area of the country that people don't like to operate in? But if we comb all that out for a minute, we say that EBITDA and EBITDA multiple are the two things that drive prices, 90% they driver prices, we're seeing multiples at or near historic.

If you are in a queue, pardon me in a tier one brand, you're seeing your multiples basically at where they have historically been. And that is fantastic because we all know your EBITDA in most brands is way up. So if you're going to apply the same multiple, if it was worth six times EBITDA or six and a half times EBITDA back in 2019, and it's worth six to six and a half times EBITDA now, but your EBITDA is up 60%, guess what, your business is up 60% in value. So usually multiples have been staying relatively normal to a three-year trend and near a 15-year high, and that's really cool.

In some cases with tier one brands that aren't the premium deals that are on the market, people will pay less of a multiple to a little bit of a less multiple, not one for one, but a little bit of less than multiple to account for the fact that they're paying based on an EBITDA that's so large. What's happening though, is that in tier two and tier three brands, and I've mentioned this in prior podcasts, they're just not seeing multiples staying at the same level, either that or conversely people are taking the EBITDA on some of these tier two and tier three brands. There's not as much competition and not as much of a robust M&A market and they're hedging the EBITDA.

In our prior example of $3.6 million in EBITDA that became 6 million in EBITDA, they may say, they may do one of two things, but effectively it will do the same thing, which is lower the price versus what you might think. They may say, "I'll pay you based on that four and a half million dollar revised EBITDA. And I'll pay you six times multiple. Or, "I will pay you based on your $6 million in EBITDA, but I'm only going to pay you at four and a half times multiple," or some iteration of that, if you don't have like the demand and you're not at the top of this rank and stack order of the most desirable brands that have the most interest.

And that's really a case by case basis and a geography by geography basis to me, and we've seen it in, I can just think right now, two different brands that we're working in. We're in one area of the country that was a really hot area to be in. The deals are priced on trailing 12 month current EBITDA at a really high multiple. And then in another area of the country that isn't as desirable to be in, in the Northeast, the thing trades at trailing 12 month EBITDA multiple, but the multiple is like 20%, 25% lower. And those wild swings are difficult to conceptualize in a space that typically hasn't had that much variation by brand. So some of these things are interesting, but multiples are near historic highs, especially if you're in high quality brands.

And so in some brands and geographies, we are still seeing multiple expansion. And I think it's interesting, either brands that are really kicking butt and taking names, people might be wanting to pay more than they were before. We also have another phenomenon of, "Gee, oh, well, I thought I'd get a deal at this stage in the cycle because of the pandemic. And it might be able to slide into one of these brands like Taco Bell, where they're really expensive, but oh, by the way, I can't, because people are still paying high prices. So therefore, I will move into a brand that's a little more attractive on a price standpoint because all I'm buying is EBITDA anyway." And so those deals may be secondarily getting some lift and getting some EBITDA multiple expansion that previously wasn't maybe thought of.

And so I'm seeing that in across several brands. And oh, by the way, in some of these brands that aren't the top tier brands, but just one iota below, most of the franchisees who are existing, especially if they're not like Uber capitalized, these guys aren't paying the prices. It's almost exclusively people coming in from outside the system who are wanting their first restaurant deal. And that's another reason the size in addition to the geography make a difference in the pricing because if you're down in... These new guys who are coming into the system need to have a certain critical mass of stores, A. And B, they ain't going to be going into areas in the Northeast or West Coast that they can avoid it. So those are just some of the other factors that play into the multiple expansion discussion.
We know, like I've I talked about EBITDA, big EBITDA increasing overall valuations, and we just talked a little bit about how buyers are treating EBITDA differently by brand. They're either accepting all the EBITDA increases at the same multiple if it's a great brand, or if it's an upcoming brand, it's maybe seeing a multiple expansion, you could see EBITDA multiple increases on increased EBITDA. Sometimes you're seeing in brands that aren't doing as well, or that it just been cruising along and getting C-pluses in school, you know what I mean? For the last 10 years, you might see like a little bit of an EBITDA multiple drop on little bit of an EBITDA multiple increase, and you may see year over year valuations relatively the same.

You have a lot of these tier two and tier three brands that have seen big EBITDA increases, but they're just not getting the EBITDA multiple that they used to because lenders don't want to finance tier two and tier three deals as aggressively and buyers don't want to therefore pay the prices. So you're seeing maybe a situation where the valuation is up, but less than you might expect. And so it really creates a really an interesting thing. So that's a little bit of a valuation update. Last month on the webinar, we talked a little bit about the lender survey that we did, and I want to take a little bit more time to talk about this, just because I think it's a really meaningful piece of information that you don't see in the marketplace too often.

So I got a lot of buddies who lend money to this space, as you might imagine, and they seem to find us out when they know we're doing a lot of deals, but the overall comments I would make is number one, the lending market from all I'm hearing has rebounded with a fury. Many lenders are looking to take share from their competitors. And there is a massive, massive good deals out there in terms of rate and amortization and fixed charge coverage, at least adjusted leverage, straight leverage. It's just really, you have a lot of optimism, and a lot of options, which frankly, it did not exist three and six months ago. It was dry, it was dry. And now it's really out there.

The question that we've talked about before is what are lenders going to do when they underwrite, run rate EBITDA? They are not sure. I can tell you that lots of them and they all have a different convention. It's like if you have a CPAs, someone wants told me if you hired 10 CPAs and you gave them your tax return, they come up with 10 different answers. They would all be technically, but they would just be a little bit different because of the way they approach a tax return. And so in this way, I think the lenders are the same way. I think I've talked with all these lenders and they all have a slightly different approach to how they're going to lend money to a business in the franchise space.
First of all, you have the variability of their management and the risk and their credit departments, but then you have the variability of how they look at run rate increases, how they like, or don't like different brands, what they think of the buyer. And so it's created... I'm not trying to make a pitch from Unbridled Capital Services, but it creates a less of a well-known commoditized lending situation because there's so much misinformation and so many different approaches to him handling a restaurant loan in this marketplace. It makes the case to speak with multiple lenders to find the right opportunity because they may not are all going to sing from the same sheet of music like they used to 18 months ago. It's a little bit of the Wild West right now.

You do see on the lending side, like I said, there's a flight to quality and size as deal flows increase. It's hard to find a small deal to finance. If you've got less than a $10 million business that you want to finance, you pretty much got to go to a regional or an SBA loan now, it's amazing how much that market has gone away. There are lenders who do it and we know them, but that's just not a primary area of our business anymore surprisingly. So obviously, the rates and terms are very favorable. 90-day LIBORs are at a historic low, heck it's close to zero. So I think it's 25 basis points. Well, I guess we're going to be eventually moving off of the LIBOR metric as the main metric to lend, going forward at some point, at least many lenders will.

I would say that rates are still just unbelievably favorable. If you have a tier one brand you're getting like LIBOR plus 200, LIBOR plus 175, LIBOR plus even 300, you're looking at a two to 3% loan. And if you are able to get that loan fixed with a little bit of hedging, goodness gracious, you've got a situation that's really, almost unheard of historically. And how long it'll stay here, the lenders we'll talk about in a minute, have a perspective on that, but for buyers, it's pretty remarkable. I just bought a house in Florida. It's pretty nice to be able to get a low interest rate. And it enables me, maybe I don't think this way really, but it enables me to buy a house with a little bit of a higher price because the monthly payment is more reasonable than I figured it would be.

And again, lenders are telling me there's no fluid financing market for casual dining as of now. So as we just chat through some of this, from a year ago, most lenders didn't have a lot of deal flow, now we're seeing more deal flow. I do see some of the lenders out there who are reporting that they are looking at over 11 deals. It's just one or two of them, but overall, I think that we would... Because I don't have a perfect insight, of course I do franchise M&A, and I know what the deal market's like, and I know what our book of business is like, so I can infer what the overall M&A market's like in the franchise space, not including the deals that we're doing, but I don't know for sure. I don't know everything.

And so as I look at this lender survey, what it tells me is that there has been a modest pickup in their loan activity since June of 2020 to May of 2021. And that's the timeframe we're talking about like one year, one year, year ago to today, there's been a modest increase in the number of deals that they're looking at, which frankly surprises me because we're about twice as busy and these numbers don't seem to indicate that lenders feel that way. So that must be we're over indexing, which is good for us. So next slide that I'm just looking through from this lender survey, it's interesting, back in 2020, it was like... man, in June of 2020, most of them were saying cautiously lending, and that was like three quarters of the lender respondents.

And then there's a bunch that say unlikely to lend or not lending. And that was like another 25%. There's basically, you're either not lending or you're cautiously lending. That was it. And now, open like 60% of 65% of the pie is saying, "We're open, we're lending, and we're looking to take market share." And 30 and maybe 33% are cautiously lending for the right circumstance. And nobody responded saying that they're not lending or that they are unlikely lending. So that is a massive, massive shift, a massive shift. And who the heck knows what will happen later on this year. But right now what that means is man, over two-thirds of the lenders in the space that responded to the survey are looking to take market share.

That is a big, big statement and it's really good for the health of the M&A market and what we do. Another question was when do you think franchise lending will get back to pre-COVID levels? It's interesting, whereas before it was a majority of people said 12 to 24 months, now you see a lot of people saying three to six months, and less people saying 12 to 24 months, which makes sense because it's a year ago that we did the first survey, and so it's been 12 months. But you just see that probably almost close to half of the people who responded are thinking that the market's going to get back to normalcy within the next three to six months, which would be towards the end of the year.
But based on the prior, I might say it already feels like we're back to the way it used to be. I've always found it interesting because lenders all think about this the way I do. I asked them in both instances a year ago and today what type of operator they want to make a loan to? And pretty much 60% of them say they want to make a loan to anybody, whether you're family, office, private equity, whether you're a 10 to 50 unit operator or whether you're a one to 10 unit operator. And so I'm like, "Oh, that's cool." And that's like 60% of them say that. And 40% of them go straight to the 10 to 50 unit operator only. And that's how I feel too, man.

I think at the end of the day, I think we would all casually say this. I love the family office and private equity groups. A lot of them are good friends of mine, but I would say that the 10 to 50 unit operator who knows his markets, knows the GM's names, goes by each individual restaurant, the knows the band and the local high school and their little small town in USA, that type of operator has tried and true proven to be the one that typically can garner the attention of lenders just because they liked that type of a profile. Now, there might be some risks to that type of an operator not being as solvent as a large family office, private equity group. But then again, some of these financial buyers aren't willing to part with their money either, whereas a small operator owns 25 restaurants in the middle of New Mexico might be the one who lives with everything on his sleeve.

And that's ultimately what a lender wants to lend to. So that wasn't a surprise to me, 60% of the correspondence is pretty much stayed consistent throughout, want to lend to anybody for the right deal. And then 40% want to loan just to the 10 to 50 unit operator, because they like the characteristics of that type of client. The next slide I was asking for lenders, what do you think is the most the type of business you want to be lending to? And really no change there. I would say the 60% are saying mid-leverage legacy QSR brands, and 40% are saying mid leverage QSR brands that have really been resurging like in pizza and chicken, like a Pizza Hut, or KFC, or Popeye's, or a Papa John's.

One of these companies they're sonic, one of these companies that's historically been at a large unit count on a legacy basis, but it's just through the last year, just really started cranking it beyond what maybe we would all have expected. So we have a contingent of people who want to go into those types of brands and it must be on the lending side that they see a bigger future looking forward there than just the COVID pandemic with a sensible amount and a majority amount wanting to just stay in general in the mid-leverage legacy QSR brands. No one wants to do distress, and no one now wants to do the high-leverage top tier QSR deals, which is interesting. That's a little bit of a change from back in May.

Here's an interesting thing to comment that the next question was just, how likely would you be into a casual dining brand? And so back in 2020 in June, it's like you saw maybe a third of the pie saying somewhat likely, and then a quarter of the pie, over 50% were saying somewhat likely or likely, which has actually dropped in the most recent survey. So fewer respondents, fewer lenders are likely, or somewhat likely to lend to a casual time brand. And then you have the unlikely component has taken the brand of the increase while the other two have decreased. My feedback there is just basically, I think that again, we don't really have a fluid M&A market. As a matter of fact, this indicates to me that even though we're seeing the resurgence of casual, as COVID opens up, we don't see the corresponding response from lenders with interest in pursuing those deals, which is a shame.

Hopefully that'll get there in the next couple of quarters. It may be part of a longer business trend for those of you who are listening, you're casual dining and fast casual folks, who've been impacted massively by COVID, it's another shot, and you're dying hard, you've taken enough of them, but hopefully, let's hang in there and see what happens. Maybe the temperature in the lending market will change as the deal flow, may be lessons on the QSR side as we get into the Q3 and Q4 timeframe of this year, who knows, we'll see what happens to comp sales and profits. I think it's interesting to see that the biggest increases and scrutiny and the rest department of these lenders, interest rate was an issue last year and no one said it was this year.

So what that tells me is that lenders are willing to give on interest rate because interest rate is so low. And so it's not the determining factor in making a loan anymore, instead, there has been a big increase in amortization in term. So people are watching amortization and term much more. There's had the same concern on leases and lease-adjusted leverage. And personal guarantees are obviously still a consideration, especially if you have a smaller franchise business, that's a consideration lenders are going to make, but the amortization and term is getting more scrutiny and the interest rate conversation and the risk departments of these lenders is definitely the opposite, getting less scrutiny.

And looking here, lease-adjusted leverage remains one of three metrics that people use, it's the most popular. Most lenders are using all of those metrics, lease-adjusted leverage, fixed-charge coverage, and straight leverage in order to do a restaurant loan. We'll say that-lease adjusted leverage has gotten more, what would the word be? It's gotten more interest. Lenders are using that metric more and fixed charge coverage perhaps less as the primary means of pricing a restaurant loan. If you don't know how lease-adjusted leverage works, then give me a holler, I'm glad to talk with you about it. But essentially, it takes eight times rent and takes total funded debt divided by some level of EBITDA.
And so most banks are lending based five and half to six times, 5.7 times, maybe some brands five and a half, five and a quarter, five times lease-adjusted leverage. And if you plug in all of the variables in your good old algebra calculation, you can usually in an M&A transaction calculate what amount of total funded debt a deal will likely receive from the lending community. And of course, we do this for all of our clients, but this gives you a feel for if you know how much debt someone's going to be able to place against your business if you were to sell it, then you can also look at how much is a reasonable amount of equity.

Some people may say, "Okay, I'll put in 25 to 30% equity, or I'll put in 35, or maybe I'll put in 40% equity on some of these deals that are highly levered," but it's just another way to get a context for what the upward pricing on a restaurant business or any other franchise business might be other than just a pedal the EBITDA multiples, which factor that in any way in a roundabout way. Let's see. So as lease-adjusted leverage continues to be one of the main criteria people are using to make loans, one of their questions we hear is, "Hey, are you going to be varying this?" And back in 2020, a lot of them were saying, "Yeah, we're expecting, it's going to go, going to go down. It's going to reduce."
The majority, probably 75 of the respondents were saying 30 to 45, between 30 and 60 basis points, it was going to drop, which is pretty significant that would represent like all things equal and eight to 9% drop in the amount of total loan proceeds that a bank would give someone on an acquisition, which is not good. And of course, it was indicative at the beginning of the pandemic. Here we are in the second quarter of 2021, and like almost three quarters of the respondents are saying zero to 15 or 15 to 30 basis points. So maybe the middle point is 15 basis points, which 15 basis points, if I'm doing my math right here is like 3% less. So the loan proceeds may be just marginally less going forward than what they'd been pre-pandemic, but not much change.

And of course that's what, that's what we want to hear. And so also that might include the impact of increased EBITDA, depending on how they're looking, the lenders are underwriting EBITDA increases and how massive, and drastic those EBITDA increases are. And then I asked the question, just where do you see rates settling? And most people say, small contingent says lower, about half says flat, about another half says basically zero to 50 basis points higher, which a year ago, these lenders, that half of them said 50 to 100 basis points higher, and some said over 100 basis points. And oh, by the way, they weren't wrong. So the whole group was duped, although half of the...

I'd say probably 35% of the respondents last year said flat. And that actually would have been wrong too, because they've actually come down a little bit. So it just goes to show that even when you have really good industry professionals put together in mass quantities asking questions, usually they're right or directionally right, but in this case, they weren't. And it's because we've had so much incredible change. Jump to real estate financing and stay at least back updates, I'll just make a couple of comments. Cap rates are really strong, same reason. Part of the Biden proposal that's out there now has been floated is that if you're going to have a gain greater than $250,000, you can't do a 1031 on it now without paying your cap gains tax.

Who knows if that's going to make it through, I hope it doesn't because if it does, it's going to have a massively negative impact on the future of real estate transactions, massively negative. And I can't believe they would do that to the industry. So let's watch that. But right now what that's doing is if of course causing people to want to sell their real estate right now and do 1031. So there's a lot of fluidity and the market, cap rates are continuing to be strong because interest rates are low. There's a healthy amount of buyers and sellers. I would say from our perspective real estate, cap rate, 1031, financing is probably similar to selling these businesses. There's basically a steady supply of buyers and sellers, we're at pretty good equilibrium right now.

And there's a maybe a little bit of a lack of inventory, actually, still the supply may be a little lower than demand. The 1031 market obviously is strong, the REIT market, and I'd say it was previously very wobbly, but now it's starting to show strength again for tier one deals. We've had a couple of big REIT deals on the marketplace where massive amounts of real estate needed to be bought at one time. And we've seen clients doing that and the pricing has come back. The market is there. The market really wasn't there six months ago. It was really wobbly because of all of the losses and all of the write downs that were happening in the retail sector because of no customers in stores.

But for the right deals, with the right brands in QSR, especially where we spend most of our time, we are seeing that market really come back quite strongly, which is a really great and positive sign. So that's a positive. And for those of you we've listened to the podcast for a long time, that's a method of financing and acquisition, is to sell real estate. Sometimes the seller sells the business and the real estate and the buyer buys a business in the real estate and keeps the real estate and finances, sometimes they sell the real estate as a condition of the sale, and they sell it all at once to one buyer, usually a REIT.

If there's a lot of real estate in that, usually it takes care of all the real estate in one fell swoop. And for that convenience, you typically don't get quite an attractive cap rate as you would if you wanted to sell the real estate individually on a 1031 basis to buyers across the country who were looking to do 1031s to avoid capital gains taxes. But that involves multiple sales, multiple negotiations, broker fees across the country, and all these other things that have to happen. So in terms of using real estate as a motivator are to make a transaction happen, there are a lot of considerations to go through as you think through that, whether you're a seller or buyer. Of course, we do this all day long, so again, if you ever want to talk about it, call us.

But as I look into Q4 of 2020 and beyond, or 2020, 2021 and beyond, I guess I would just say, we would expect a flattened... This is just a guess, I've got a crystal ball on it, I'm probably wrong about half of this, but I guess I could just talk about it. If you put a gun to my head, I would say that probably once we get past Q2 of 2021, we're going to see the EBITDA increases probably flatten. Hopefully they'll stay positive, maybe they'll dip negative a little bit, but hopefully the entire year of 2021 will look strong. If we don't have any geopolitical or crazy political nonsense going on, maybe we will be entering 2022 at a time when our economy could be feeling strong, and a sales and profits in the restaurants could be good as long as you have the labor and you can afford the labor.

What will supply and demand look like? To reiterate, I think you're seeing a pull forward of supply, supply and demand are in balance, probably both on the restaurant and on the real estate side. We're probably going to see a dry up, a little bit of a drop in supply, and we'll see demand stay strong. So what will that mean? It depends on how much the taxes increase and what happens to sales and profits after we hit Q3 and beyond. But if we have a soft landing, I think we'll have a seller's market a little bit, but maybe equilibrium. But if we have a really hard landing, you're going to have demand and not very much supply, which may at some point, increase prices, and it probably will have to increase prices to get sellers to sell given that they'd have to pay whatever the rate will be, a higher amount of tax on the sale of their companies.

We continue to expect it to be busy in the first half for the year. And Unbridled is going to be putting big book or press. We're all stressed and working hard to get these deals done before the end of the year. That's what I think will happen. I think you'll see stragglers continue to come in and say they want to sell all the way up to the last minute underestimating and not listening to me and underestimating how long it takes to get a deal done. So that'll last probably until the middle of Q3, I would say. And so we could start seeing a natural slow down, but maybe it's a healthy place. I hope M&A activity selfishly stays strong. I know we've got a lot of good groups that are in the market that want to buy these assets. That has not changed.

And if you're listening to this and you own a franchise business, I would encourage you to look and answer the question of whether you want to be in this business for the next seven to 10 years. And if the answer is, heck yes, baby, then stay in the business and keep cranking, figure out how to staff your restaurants, take advantage of what you can, do great, keep your head down, earn EBITDA, do what you got to do, grow your business during that time. But if not, if not, if you can't look at yourself in the mirror and look at your family in the mirror and your partners and say, "I want to be in this in the next seven to 10 years," if you're hearing me now, you ought to be looking to lock in your gains and get your agreements going soon.

Whoever your advisor is, or whether you're going to use one, you ought to be considering evaluation and sale of your business, and you should be getting on top of it quickly because again, we'll probably have a cliff at the end of this year. And plus, we have a really good look P&L across most brands. And if you're not in the QSR business and your business is just now returning to some normalcy, I want to tell you, congratulations, it's been a long road, really rooting for you. Hang in there for the next few quarters, you may find yourself in a situation where you have less competition from other sellers on the marketplace, and eventually, this too shall pass.

And you may become in vogue again with both lenders and buyers, pulling socks up to your knees on a basketball court, may become cool again, if you'll just wait long enough. So thanks so much for listening today. And let's keep rocking and rolling, and I have this awesome belief that our business is really and our industry is the best thing going. Thanks so much.

Thanks so much for entering the Boiler Room today. You can find our podcasts on iTunes, Google Play, Stitcher Tune, and Spotify. If you like these podcasts, please listen, rate and review. I also encourage you to visit our website at for the best franchise M&A and financial resources in the industry. Our website includes 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.

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