Season 4 Episode 11: M&A Highlights from the Restaurant Finance and Development Conference



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Rick Ormsby:

Welcome to the Restaurant Boiler Room, season four, episode 11. I'm your host, Rick Ormsby, Managing Director at Unbridled Capital.

Today in the boiler room, I'll be giving an update on the recent Restaurant Finance & Development Conference in Las Vegas. I was a panelist out there, talking about the inflationary environment and its impact on valuations. So I'll share some of my responses from the panel as well. The Restaurant Boiler Room is a one stop shop for multimillion dollar merger and acquisition activity and financial complexities affecting the franchise restaurant industry. We talk money, deals, valuations, and risk, delivered to the front door of franchisees, private equity firms, family offices, large investors, and franchisors on a monthly basis. Feel free to find all of our content at Unbridled Capital's website at

Now, let's enter the boiler room. As I'm talking with you here, it's the week before Thanksgiving. You'll probably hear this after Thanksgiving. So a big happy Thanksgiving to everybody. I love this time of year, don't you? It's time we can take a little bit of time to be thankful, intentional about being thankful, and then also get to spend time with family and get a couple days off too. So hope you have enjoyed the break.

I just got back from the Restaurant Finance & Development Conference, every year in Las Vegas, around the second week of November. This year, there were about 3,000 people there, and it's kind of like this big mosh pit of franchisees and operators and franchisors and lenders and bankers and all these different people with a lot of good content about the current state of the restaurant franchise industry. And really, there are quite a few non-restaurant franchise concepts that come as well. So it's just a nice place to get a yearly update.

I was asked this year to be a panelist. There was a panel essentially entitled something like Inflationary Impact on Valuations this year and next year in doing M&A deals. And so, I happened to know a little bit about that. So I was on the panel with a couple lenders, Nick Cole and Armando Pedrosa. And also former lender, Robert Daniel, who now works for Franchise Equity Partners. He was kind of stepping in as a lender and we also had a evaluation expert there. And we just talked for about an hour about that. So after I give it just a general update on the conference, I'll kind of go through what I said on my part.

So first thing I would say is thank you so much for saying hi. For those of you who listen to the podcast, I bet I had a dozen people come up to me and say, "I love your podcast." So I feel honored and blessed that people listen. I kind of joke when I see you, and if you're listening now and I saw you out at the convention, or when I see you all at these different places, my answer's always the same, which is I'm humbled. I'm just some little old country boy who is sitting in a closet basically talking on a mic. It's been a blessing over all these years to be so narrowly focused on doing franchise M&A deals.

And gosh, when you do something for 20 years, it becomes one of these things where you just fall out of bed and it's what you do and it's who you are. So I'm just honored. You never know who's listening. You sit here just talking and rambling, and it's really cool to hear the people enjoy the content and use it as a temperature gauge for the market. So thank you for that. Thank you for listening and we're going to keep it rolling.

Let's see, one of the impressions I have was all the young people that are out there now. I'm 48 years old. I don't know how many, RFDC is what we call it, how many RFDC years I've been going to that convention. Maybe 15 years, I don't know.

But when I first started going, it was very much an older industry and franchisees were, and all the people supporting them were in their fifties and sixties. And now, goodness, I'm feeling like the old guy out there, man. So it's pretty cool to watch. It's pretty cool to watch the industry change. There's a lot of young, hungry, talented folks that have come into the franchise space in various support roles. Whether it be in real estate, and lending, franchisor. You've got a lot of young private equity groups that are really well-healed and smart and thoughtful people. And I think it's a healthy change. So I welcome that.

And it's funny, one guy came up to me and he... Because I was wearing a pair of shoes that matched my watch. And he's like, "Golly. You walk in the hallways here looking like what you're talking about." And I was kind of laughing because I was wearing a Swatch. And for those of you who are my age, maybe a little older or younger, you're probably familiar with a Swatch. It was this phenomenon back in the '80s. It was this clear, colorful watch, that you could see the components of it moving. You remember this? It was right around the time of parachute pants and Coca-Cola, like rugby shirts and jams. You remember all this stuff, man? I look back on this stuff and.

I feel so silly wearing some of it, but I came from a family that didn't have much money. And that's awesome, that's okay, and that's cool. And it formed who I was. And we didn't have enough money when I was a young kid to buy a Swatch. And so, Swatch was probably at that time $30 or $40. And all my friends had one and we couldn't afford one. I didn't have the money. So I bought a Swatch recently. And I'll wear a Swatch.

And one of the main reasons I do it was because when I look at the time on my hand, it reminds me of where I come from. It reminds me to stay humble and clearly to remember the path that I personally have forged. And so, I don't know if you have something in your life that kind of does that to you or for you, that can maybe remind you to stay grounded and remind you of the blessings that you have and where you came from. So that's the reason why I was wearing a Swatch out at the convention, instead of all these people wearing Rolex watches. And it was interesting that someone stopped me and thought it was stylish.

So there you go, my two cents. And my wife will tell you, I got no style. My two cents is wear a Swatch and people will think you're cool. All right, that's just a little rambling here.

A couple of high level items that I saw from RFTC. There were a lot more emerging concepts out there this year. Emerging concepts were in greater supply. When I say emerging concepts, I'm talking about small franchisors that are maybe somewhere between 10 and 50 units, that are looking to grow their businesses and have had some success. I think, it's a personal opinion, but this is going to become a bigger part of our industry going forward than it has been in the past. A lot of the legacy concepts and legacy franchise businesses there are...

If we talk about the 30 or 40 biggest brands in the franchise space, probably five to 10 of them are really struggling. And several of those big brands have high unit counts and are likely to probably close during this next phase of the next 18, 24 months, because of financial performance are likely to close 500, 750 stores. Maybe some of them 250 to 500 stores.

But if you went through the last recession and you know this, and we see brands kind of go through this cyclical change, where they do really well, they have great products, then they get a little hubris and they ask for big development requirements and they become arduous to work with. People jump into the space and over-leverage their deals. And they get fat and happy and lazy. And the marketing doesn't do well. And the operations slide. And then they become financially distressed. And then the banks get involved. And then some of the businesses unwind a little bit. And then they go through a little more humility. They start allowing store closures, they start rationalizing stores.

Then they come up with a new remodeling package that's more sensible and less cost prohibitive. And then they loosen the new development requirements. And then eventually, the store unit count is cut by 15% or 20% in some cases, sometimes 10%. At which point then, as you thin the herd and get rid of the losers and some of the distressed franchisees, the brand starts turning around. People jump back into it when they think it's at its bottom and then it kind of goes through the cycle again.

I've talked about this a little bit before, but I think this time through, especially with the pressures of commodities and with labor, you are going to see quite a bit of store rationalization, which is just a word for store closures. And I do think there is a positive trajectory for some of these emerging concepts going forward, especially because of demographics, support more interesting food and different delivery and digital ways and things that can move more quickly. And then our grandparents brands aren't necessarily our brands as much. So that was a big note to self when I was out there this time.

Another thing is the constant comments from the lenders, from all the people; investment bankers, advisors, everyone out there talking about the low deal flow in this environment and the tightening credit. I'll talk a little bit about this when I go through the panelist questions, but those are two items that were important to note, and I'll point it out again.

I had several meetings with distressed buyers of debt. And this is a new phenomenon. We've seen it before, in the last two cycles, but it just hasn't reared its head much. But there's several groups out at the conference whose interest is going to lenders, either through pre-bankruptcy or bankruptcy process, and buying or in putting debt into a company at maybe close to 10% interest rates or slightly less when there's no way to satisfy the debt requirements and the capitalization anymore of the business because of its performance, and if the current franchisee is not paying or is really behind on their covenants.

So I noted that. There's been several notable big transactions, where some of these more distressed investors have come in and bought the debt of some big franchisees businesses. And I think we're going to see a lot more of that going forward. It's not something that typically hits the market that everyone hears about. It's kind of done quietly, because there's only a few folks in this industry that really specialize in that area.

And as a side note, if you're listening to our podcast and you do specialize in that, make sure you drop me an email because it's probably once every three or four weeks now that we're directly hearing about an opportunity, where there might be a business that has $100 million in debt, but the business may only be worth $50 million. It's just an example. So what happens in that situation? It's not an easy situation to describe. And every lender and every creditor is different. But typically, a lender will make amendments to the loan covenants and then maybe go interest only and they'll try to work with the franchisee, especially if it's a systemic problem in a particular brand, or if it's something that's geographic, like huge minimum wage increases, or just in an area of the country that's not doing well.

But after a while, if the situation doesn't improve itself and the franchisee then stops paying the franchisor, or is delaying paying the franchisor, then usually it becomes a situation that cannot be recovered. And we will see some deal flow like that in 2023. Then the question becomes what's the best way to take $100 million of obligations off of a business that's only worth $50 million and may not ever be worth more than $50 million? So the question is bankruptcy's one way to do it. Another is where the major creditors, i.e. the bank. If there's no second lean, the bank and the landlords and the franchisor work together before a bankruptcy process, to cut their investment and then bring another investor in to take them out at a discount.

And so, that's kind of what I'm talking about. I'm talking about distressed buyers of debt out there. Typically, the lender of last resort, they will only lend a certain amount of money and they lend at a high interest rate. But they are there when no one else may be there. Just something to note.

Let's see, a couple of other comments from the convention. It seemed like there were fewer franchisee operators out there than normal. Again, going back to the comment of tightening credit, low deal flow, and maybe more attendance from emerging concepts. So again, watch that.

And then, I think while in general it was very well attended and a lot of folks were kind of sort of gloomy, and it's rightfully so to be a little gloomy after this year, it's been a tough year for all of us, I do think we reach a point hopefully soon where deal flow and everything does pick up.

So I'll go ahead and talk a little bit about the panel. And the panel again was with five of us and we were just chatting. Nick Cole was the operator and there were four of us on the panel. We were just talking about inflation and its impact on valuations.

And the first question that I was thrown was, "what's the level of transaction volume this year versus last year? And what are the factors impacting the transaction volume?" That was the first question. And so, let me share with you some of the results that you might find interesting.

Because I'm an independent company at Unbridled Capital, I can share some of these results, but some of the larger companies don't do this. For us, it was a banger year obviously in 2021. So any comparison of transaction volume year over year in terms of closing M&A deals is going to look really wacky and skewed, just because 2021 was such a big year. Unbridled took on about 40 assignments, I believe in 2021, and we closed 37 of them across about 10 brands roughly. So if you're a basketball player, and you probably know those statistics fairly well, because you've been sitting on the free throw line. "Oh man, when I'm 37 for 40, that means I'm 92.5%," so it's pretty high success rate.

In a normal year, you might see Unbridled doing maybe 25 deals. Sometimes a little more, sometimes a little less. And this year we project that our M&A volume will be down, probably be involved in maybe a little bit less or around 15 transactions. It's still hard to tell whether a couple of them will make it into the end of this year or not, or move into 2023. That means that our volume this year will be down 60% to 70%, versus 2021, and maybe 40% versus a normal year.

And I looked around in the crowd and looked around at some of my colleagues and the lenders, and most of them were just kind of nodding their heads. So I think we're kind of a microcosm, and I'm willing to put some numbers behind it, of what maybe the broad qualitative comments that you're hearing from other people in the industry. Not maybe a perfect microcosm, but a little bit of one. So 60% to 70% down versus 2021. 40% down versus a standard year. But I asked the question, "What's normal anymore?" Goodness gracious, I don't even know what's normal. And I doubt you do either.

In Q1 of 2022, so we were busy, Unbridled, and everybody else is busy finishing off deals that didn't close by year end. And if you remember back, it was a fury. We had just this enormous and probably once in a lifetime strain on everyone involved in the M&A food chain, trying to get deals closed at the end of 2021. And appraisers and lenders and surveyors and landlords and franchisors and IT people. And all these people were boots on the ground, as we like to say, working on deals, trying to get them closed.

I just kind of had this picture in my mind of these appraisers with their clipboard in hand and their work boots on and they're like, "Okay, I'm going to work today," and I get my sheet of how many restaurants they have to appraise and, the sheet's like 14 restaurants long, and I've got to do it in the next three hours, and I've got to drive to all the places and get it done, and everyone's pressuring me. So that's kind of my vision of what was going on at the end of last year. And certainly, we didn't sleep a whole lot either.

The big surge in year end closings was brought on earlier in the year by two factors. One, commodities were low, P&Ls look great, COVID had brought sales up to a remarkable level on a trailing 12 month basis. Trailing 12 month sales and profitability are a key way to define the value of a company. So that's not a surprise, number one.

And number two, you may have forgotten this, but there was a big fear that capital gains taxes were going to increase in 2022. So much so that around August, September timeframe, we started seeing research notes from investment banks and people on Wall Street and you started seeing all the news outlets talking about it.

And then, Congress basically couldn't get capital gains taxes passed, although they tried. And you'll remember that, I think it was Joe Manchin, the senator from West Virginia was kind of the cog in the wheel, allowing it to stay the same. And once we all felt like that was going to happen, then sellers were generally okay letting their deals slide into 2022. So the fear of capital gains tax increases dominated our thinking towards the early and mid part of last year.

In the first quarter of 2022, a couple things were happening. Number one, those deals, maybe 15% of the deals in the marketplace, that we're trying to close in November and December got shifted into 2022. So there was still a bunch of deals that were kind of in the closing phase in the first quarter.

Now at the same time, I don't have the exact dates, but right around the first of the year, we got the whack from Omicron. You all remember that? So Omicron kind of hit us hard and hit us quick for four to six to maybe eight weeks. And sales were under major pressure. And at that point in time, in our industry with all the people who support M&A, we had just come off of a really, really arduous 2021. We're blessed for it, but it was really busy. And we looked at Omicron for four to six weeks and we're like, "Oh, this is going to just make its way through the U.S. population and then we'll be fine once it's over with." But we all just took a little hiatus in January and February, waiting for all that situation to clear itself up. And then, sales performance was impacted pretty significantly in January and February of 2022. So that led to basically no new deal flow in the first quarter of the year of this year.

And another factor was that many franchisees had already decided to sell their business in 2021, and that caused this inevitable vacuum to start the year. So just 2021 kind of pulled forward sellers in 2022. It pulled them forward into 2021 when it was in 2021.

Once we hit March and beyond, we can all remember in the beginning of the second quarter we all started paying attention and noticing the surge in inflation. The labor market was already tight, so we're talking labor inflation for sure, but definitely it was a surge in commodity costs. And it started to get noticed pretty badly. And food cost inflation became enormous. Labor market, as I said, was continuing to be tight.

And during this timeframe, in Q2, there were very, very few new M&A deals out there, based on the first quarter having low sales and the second quarter having a surge in inflation. And then, during the second quarter of the year and even into the third quarter, but primarily in the second quarter, you had lots of deals die. Unbridled had a couple, not many. But I know across the industry, I'd say somewhere between 70% and 80% of the M&A deals on the marketplace that were set to close in the second quarter didn't close.

Lenders usually look in arrears, not in the current timeframe. So it took them until the second quarter to see what was happening negatively in the first quarter, so to speak, if that makes sense. And so, there was this little thawing that had to happen. And then, in the middle of the second quarter, that you would see the credit department starting to tighten, the risk department starting to tighten, a little bit of retrading going on, and then more retrading, and then buyers probably being too conservative, sellers probably thinking their valuation was getting impacted too much. And then a lot of deals, it just didn't happen.

Over the summertime, we started getting hit with interest rate increases. Sounds like a brutal year. And they picked up in the late summer and into the fall. And activity just remained low to nonexistent during this time. Franchisees continue to see impact to their P&L. And banks were starting to catch the wind again of these challenges and were starting to change the way they were looking and financing these deals.

In the past 45 days or so, now this probably stretch... When I say 45 days, I'm probably talking beginning to middle of October. We, being Unbridled, have seen a definite uptick in clients reaching out to us with interest in selling their companies after what I'd say is probably eight or nine months of crickets almost. And I think this will set us up for a fairly busy 2023. We just took maybe three new assignments in the last three to four weeks. A couple of these assignments are really nice in size and they're not distressed businesses. These are people who have strong businesses that want to sell in 2023. And we're pitching for some other deals, a handful or more of other deals that might come out in 2023.

So as I sit here in the middle of November, end of November, it feels somewhat normal amount of deal flow, not maybe back to a normal amount of deal flow in a normal year, but kind of getting going again. And so, I think that'll portend a fairly decent 2023 once we get into January and February, when people get their year in P&Ls and they make those final decisions in that late January, early February time, to potentially sell their companies.

But I think deals will be challenging to complete because of interest rates. I think people probably have not accurately realized how far tight the market has gotten for financing deals. So that's going to be a bit of a challenge.

The good news in the opposite direction being that there's really still a lot of buyers in the marketplace. Obviously, if you're at RFDC, you saw all of them. There's tons of companies out there wanting to buy more businesses and there's just not a lot of sellers out there right now. So that's the good news, is that the supply demand is there big time for people who want to sell their companies, even if the valuations are lower and the credit markets aren't as strong.

And I'll talk a little bit in a minute about the EBITDA multiple front, but one of my colleagues who was just sharing. He was a evaluation expert and he went through his discussion about the discounted cash flow evaluation models that he does for clients.

And his clients are a little bit different than ours. And he's usually valuing people's interest, it seemed like. Like majority or minority interest in a company, and he was using a lot of DCF modeling and discount cash flow modeling. And I think he kind of shared that the valuations... If EBITDA is holding the same, the valuations might be down 10% to 15%, which to me felt like it was pretty good. We don't have a whole lot of empirical data here. There just hasn't been enough deal flow to see what the impact evaluations is on restaurant companies and in franchise businesses. I'll be able to answer that question a lot more accurately probably in March, April of 2023.

But I will say, my gut tells me that maybe we've seen concepts drop a half turn of EBITDA, maybe a half turn. Some concepts less, some concepts that are really struggling, more. Half turn of EBITDA on a six and a half times business that's now worth six times. That's about a 9% drop in value. So a 75 basis points drop in EBITDA multiple. That's a 13% drop in value.

If I'm just kind of spit-balling it, it seems pretty close to what Scott Fear, or whatever his name was, the valuation expert guy had to say. And he seemed pretty astute about the issue too.

And that's our initial kind of read. But I'll also back up and say if you have a killer brand, and I'll talk about this a little bit more, if you have a killer business, it's like having Florida real estate and owning a beautiful brand new house on the water that sits at 15 foot elevation. That kind of a situation, where it won't get knocked down by the hurricane, it won't get flooded in bad weather, that type of a house, it really doesn't matter what the interest rates are. There's going to be massive demand for it and the price isn't going to change too much, because it's not trying to compete against people who are borrowing every last dollar and don't have the money to buy the house. They're just going to say, "It's awesome, it's irreplaceable and I want it."

And I still think the same thing holds for the right brands and the right geographies and the right store counts. If the right deal comes up, because the supply demand situation is so favorable right now, if you have that type of a business, you shouldn't see much of an impact, other than the impact of your EBITDA actually dropping. But not maybe the multiple dropping too much, if that makes sense.

On the other hand, if you are in a brand that has been performing poorly and has rough performance and is in distress and has lower sales and has had kind of a bad go of it during COVID, you could be getting hit with a pretty massive multi-prong attack on your valuation. Your EBITDA might be down 20% in 2022 versus 2021, and it may not look like it's going to get any better in 2023, and because your brands may be not as strong and not as desirable, your multiple may have dropped half a turn to three quarters of a turn. And if you own real estate, I can tell you that the cap rates have changed about 150 basis points, 100 to 150 basis points on the REIT side. That's just what's happened. The REITs are in a major mess right now.

If you're like a midsize franchisee who in a struggling brand and you own real estate, if you start multiplying these factors together, you could see some massive difference in valuation. Maybe as much as 30%, 40%, 50% drop, and that's significant, but it's not a blanket approach to all brands. And some brands, where they're really doing well, EBITDA is mostly the same, the brand is really in high demand and the business is really good, you could see almost no impact. We have a business on the market right now and really very little impact from what it would've been last year, other than the change in cap rates potentially. Okay, that was question number one.

Question number two are, "What are the motivations you're most commonly seen for business owners trying to sell today and what is causing others to hesitate? And what is the emotional state of sellers today? And does it take some creativity to get a transaction across the finish line?" And that's a lot. That's four questions in one question. So I had trouble getting this in time. I had three to five minutes to answer it. Are you kidding me? I can't answer that in three to five minutes, but you all get a little bit more time. But I'll try to be quick.

First of all, I think that like 25% to 35% of people, it's just a rough number, sell things for various reasons that are not related to timing. There's always going to be people selling things involving death, divorce, health considerations and life circumstances. I expect that to happen in 2023. I expect that to happen in 3033 if we're not gone. So there's that constant stream business that really kind of happens regardless of timing. That's number one. That's why someone would want to sell.

Number two, franchisees, some of them have awesome businesses. And like I talked about earlier, if you have a really good business, you're not really worried about it as much. You might have some timing considerations, but an awesome business is an awesome business. And it'll sell at any time.

Number three, franchisees, some of them are really just plain tired. It hadn't been easy, and operating these businesses has been a drain. Not just physically, but emotionally and spiritually too. And we see a bunch of fatigue among our clients. And I hear people saying they're tired. And this should be no surprise to anybody because it's been a long road and a hard go. And I think it's caused people, especially as they age, and I'm aging too, so are you, listening to this, it causes you to reexamine your priorities and ask tough questions about what your legacy needs to look like and what you want to do with the rest of your life and whether this investment of your time, talents, and treasure is worth it. So I think that's something that is weighing on people's mind. They're tired.

Another reason people sell things in a market this is some people think things will get worse. Over a seven to 10 year period, there will be another up-cycle, but maybe a lot of people don't want to wait that long or their plan never was to wait that long. They couldn't hit at the timing when it was 2021, they missed it. It's difficult to know if things will be any better in the next few years. Heck, it could go lower or be worse, we don't know. Valuations are still higher than they were five years ago. Maybe you have a $50 million company in 2021, it's worth $40 million now, but it was worth $30 million in 2017. And even though most people think their baby is always cuter than it really is, and most operators have a problem looking objectively at their business, some people will indeed take the approach that, "Okay, it was 50, it was 30 five years ago, 40 right now is right in between. I'll sell." So that's another reason.

There's an ever increasing amount of private equity ownership in the franchising space, as you all know. And some funds are expiring and this is causing a sale. The investors want their money back. I've seen this in a couple circumstances, not in a distressed way, but a lot of these private equity funds and a lot of these investors have dedicated fund lives. And they have to sell in these fund lives or maybe an extension of the fund lives. So that's causing some deals to come to the market when you wouldn't expect it.

We are seeing an uptick in distressed sellers, and I think this is going to increase in 2023. We've already taken one or two assignments that have some element of distress in them this year, but certainly, that's going to be a bigger part of what we do and the whole industry does in 2023, I believe.

And then, I think lastly, and it's a kind of a lesser comment, but some franchisees are getting development pressure from franchisors for deals that they made four or five years ago. And as everyone knows, development is a very difficult time to develop right now. It's really hard because prices are so high and now interest rates are higher. And it's kind of frozen the development pipeline a little bit for people and forcing them to reconsider their investment. And then also, if they're getting penalized or they're getting pressure from their franchisor, it makes them maybe consider selling their business.

All that to be said, there's other reasons not to sell. And the primary reason not to sell is monetary. Prices are just lower. That's the main reason to wait, lower prices.

But also, let me again restate, and don't miss this, lower prices and the belief that things will be better in the future than the present. And again, going back to people can't really objectively look at their business. Bitcoin was at 60,000 and now it's 16,000. If you hold Bitcoin and bought it at $40,000, are you objective in thinking it's going back up to $30,000? Or could it go down to $10,000? It's the question. So in order to wait to sell something, you have to be a midterm seller anyway, and you have to not like the lower prices, and you have to believe that things will get better in the near term. So that philosophy could be wrong. So that's one thing.

Like I talked about earlier, EBITDA has dropped considerably for some operators, and that's the main culprit. Interest rates have risen. Almost doubled in the last maybe four months. And to see a seven or 8% interest rate when it was 3% to 4%, that's a significant impact. And it's affecting cap rates, like I said, by 100 to 150 basis points. And that's basically a 15% to 20% lower real estate valuation with that kind of an impact to cap rates. Wow. So if your piece of real estate was worth 10 million and now it's worth 8.5 million, that's significant. Interest rates are likely affecting EBITDA multiples, like we talked about, in some way, but we need more deal flow to be sure. Again, a half turn could be worth 8% or 9%, 10% lower in price. In some brands, we are not going to see that much or any impact. In some brands, it might be more.

Valuations are based on the confluence of EBITDA, EBITDA multiples, and if there's real estate involved, cap rates. And so, the multiplying effect, like I said, can be significant.

And there is some optimism that there will be a Goldilocks situation in the next 12 to 24 months. I read this term recently. Goldilocks in this regard means higher prices. The operators have taken prices, and you all know that, right? You go to your local XYZ brand and go order a cheeseburger and see how much that thing is when you walk out the door. It's way more than it has been. But the higher prices could eventually be met with much lower commodity costs and easing inflation, if not deflation, by the time we get to the end of 2023 and into 2024. And that could produce some seriously powerful EBITDA.

Now, I'm not saying that's going to happen, I'm not sure it's going to happen. But you could certainly see a cheeseburger that was $2.89, that's now 3.99, and then commodity costs go back to where they were. And then the profitability look ridiculously good for a time. And I hope that's what happens. And then we'll have the inevitable, brands and operators will take that money and grab it like they should, because they went through the hard time and then they repopulate their silos. And then, brands typically start competing on price with promotion. So that's kind of the cycle. So we're waiting to see if this makes sense.

The question about the emotional state of sellers, it's definitely true that sellers are fatigued. Deals have been taking this year maybe 25% longer because of financial performance and tightening credit markets and just a general inertia in the space this year, just made it a little bit longer. But equally fatigued I think are sellers with the prospect of operating their businesses, like I said earlier. So you've got to be set up and buyers do too for patience throughout an M&A process these days, but also know that the sellers are fatigued with their businesses that they're operating.

And creativity needed to get a deal closed, let me give you a few examples of some of the things. Number one, operators are going to increasingly hold onto their real estate because cap rates have changed so much that they can't stomach the recent price decreases. I think that makes sense. We've seen that in a couple of our deals. Sellers are just selling the business and they're not selling the real estate. They were interested in selling the real estate previously. Now they're not. They sell the business, keep the real estate, and then they hold onto it, pay lower taxes, and kind of collect the income from it. So you have to be careful about the credit quality of the buyer you're selling the businesses to when you do that because you have a heavy percentage of your net worth tied up in your real estate. If you do, then that's a significant factor, and it could be even a bigger factor than the actual sale of the business. But that's one thing we're seeing in terms of creativity.

Seller financing has already gotten more popular. I hadn't heard the word seller financing since 2013, but we have it going on in at least one of our deals now and one deal that ended in 2021. And I think it's going to be something we're going to see continually. Devil's in the details here, make sure that you are protected if you're someone who's going to accept seller financing, and get legal help.

We have seen buyers too. I'm looking into mezz financing and minority equity operators as well. These types of products are coming back, I think, as we try to figure out how to make the capital structure work when the amount of debt that is out there has been reduced. The amount of equity has to be increased. The purchase price maybe has to come down a little bit and there's still a sliver of financing that's needed. Mezz and minority equity are things that are going to jump back in. And they're going to be a higher interest rate, kind of junior capital structure things that sit underneath equity, but on top of debt in some way, in terms of the terms and in the way they're paid back.

And then from an advisory standpoint, man, I got to tell you, an advisor's work triples in terms of creativity because when the deals become a little bit more arduous, they just don't become arduous on price. Landlords don't cooperate. Franchisors are unreasonable. Lending is more difficult. All the way around, creativity is needed when the market kind of shifts to be a little more chilly.

The last question I was asked was a four part question. And it was, "For the next 12 months, give us your view on transaction activity, inflation, capital, lending markets and real estate."

So number one, transaction activity, I think it'll increase by maybe 30% to 50% above current levels. Maybe not quite back to a normal year, but meaningfully different than 2022, just because there's a full year of pent up demand. And I just think that the pent up demand plus the FOMO of missing in 2021 and kind of the fallout of the tired, drained nature of some of the franchisees will lead to more M&A. Some deals won't close though. I don't think people yet fully realize how hard the banks are tightening their belts. There are a bunch of buyers though, I reiterate that. So demand is plentiful and I do think that part of this uptick will be due to distress deals. That's number one.

So inflation, what's going to happen to inflation in the next 12 months? What the heck do I know? Who the heck knows? If we knew we'd be rich. I'm hopeful the expected December interest rate hikes will be the last for a while. I think we need to sit and see how it'll affect the economy and just sit back and sit on our hands. My gut tells me that the consumer's going to tighten up significantly in 2023. I think we're already seeing it. I live in and I hang out with middle America and you can kind of feel people tightening their belts. That's not a very scientific answer, but I think you're going to see people tightening up their belts. Consumer spending is going to really tighten up in 2023. And that inflation will drop significantly in the back half of 2023.

Now, a lot of franchise brands are in year long contracts with their purchasing decisions. If you're going to buy 500 million pounds of hot dogs in 2023, you can't very well buy them at a spot price and negotiate them three days in advance of buying them. You have to get a contract a year in advance in many cases. In those instances, a lot of people are going to be locked into full year 2023 commodity, difficult commodity circumstances with high prices. But I think in the cases where that's not true and in our general economy, I think we may see deflation in the back of 2023, watch me be totally wrong about that. But I think we're going to see deflation.

The issue's going to be those commodity costs which are going to begin to turn really favorable in 2023 and 2024 for sure, it's going to take a operator's P&L a full year to be able to benefit from that. Because when you sell a company, you have to have at least 12 months or some amount of time of trailing financials that show the revised or better conditions before you're going to be able to convince a buyer and a bank and everybody else that the price should be higher. I think everyone acknowledges that today's commodity costs built into today's trailing 12 month P&L are not realistic of a 20 year business. So there's some explaining that buyers and sellers can do with one another in order to come to terms with some negotiation of what the going forward food cost or commodity cost would be. But proof's in the pudding, and it's always easier to sell actual results than it is to talk about something that hasn't yet happened. So that's my comment on that.

And it may mean therefore that M&A kind of slows down, but it really is on fire in mid-year 2024. So that could be a year and a half from now, but by then the hope would be that if the Goldilocks scenario does happen, we have strong consumer demand and we have lower commodity costs again, and maybe a moderate interest rate environment. It could be pent up M&A demand could just explode. That's maybe a thought.

Lending in the capital markets, I think for next year it'll be really chilly. I think lenders look in arrears again and the trailing 12 month P&L likely won't look significantly better until 2024, like I just said. So in the last cycle, some lenders jumped out there aggressively and took a bunch of market share before the turnaround. This was in the great recession, and I think you'll be seeing this same thing happen too. When that happens, I'm not sure, maybe it'll happen towards the end of 2023, just an idea. You'll just need to know who these lenders are, which brands they finance, and what type of deals that they want.

And I sent out a lender study that I've talked about before, and it showed that there is a trend in lenders moving away from highly priced tier one deals and brands to more moderately priced value brands. So I think in a time like this, you're going to see lenders retreat to value and retreat to stability and retreat to lower leverage. No surprise. Lease adjusted leverage may be running at 5.5 To 5.75 times, might now be 5 to 5.25, and that change is just indicative of what I just said.

The last thing would be real estate. So cap rates in the sale-leaseback market, I was asked. And so, like I said earlier in the podcast, REITs are coming out with bad news these days, as cap rates have worsened sizeably. The 1031 sale-leaseback market is maybe the tallest pygmy of the financing bunch right now. And I said in there, I said never underestimate what individuals in California, for example, will do to defer their taxes. So people are still selling things in California and having to pay huge tax burdens and they want to do 1031s to defer those tax burdens. Heck, I have a couple people here in Florida who I've met who are from California who are looking to buy their houses that they've flipped in the same situation.

So that's a very powerful phenomenon and that powerful phenomenon is more powerful than interest rate increases in the short term. So I do think the 1031 sale-leaseback market, although I'm not advocating for it, I do think that becomes kind of the tallest pygmy in the room, as a way to maybe finance a deal, because the interest rates haven't affected the cap rates as much or as quickly. Eventually, they will. But right now, that's an area of relative strength.

That's my story for this time. And again, I thank you guys for listening. Stay tuned for the year end. I think we're going to do a nice year end podcast here next month and kind of wrap up the year. Deal flows increasings, keep the faith, and let's stay strong out there. And I just hope you guys had a great Thanksgiving. Merry Christmas. Feliz Navidad. And talk to you soon.

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