Welcome to the Restaurant Boiler Room, Season 8, Episode 2. I'm your host, Rick Ormsby, Managing Director at Unbridled Capital. Today in the Boiler Room, I'll be speaking with Tim Ring and Brad Cashman at MMB Law. These guys are very experienced franchise M&A attorneys, and they will help me tackle the top 10 legal issues affecting franchise M&A transactions in 2026. Some topics include tax considerations, franchisor issues, issues, due diligence, leases, guarantees, indemnifications, and yes, even AI. Hope you enjoy it. will be packed with applicable knowledge. The Restaurant Boiler Room is a one-stop shop for multi-million dollar merger and acquisition activity and financial complexities affecting the franchise industry. We talk money, deals, and 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 www..unbridledcapital.com. Now, let's enter the boiler room. Thank you who are watching. Thank you for tuning in. And also for listening as well. Those of you who are going to be listening on season 8, episode 2 of the Restaurant Boiler Room, we're very thankful that you're listening. And we're in year 8, man, so here we go. I was the only one doing this eight years ago. Now people are doing it all the time, but it's a blessing for those of you who kind of watch and listen. a little bit of information, we will send out a replay to everybody who signed up. There were a couple 100, I think, who signed up that I could tell, so we'll send out a replay. If you go to our website, unbridledcapital.com, there will be... all of the past podcast episodes and webinars, so you'll be able to hear these fine gentlemen today. And the last thing is, if you have a question of any kind, here's your chance during this webinar. Just raise your hand and ask it, and I'll try to eyeball it. Gentlemen, you do the same, and we'll try to answer it as we go through. What we're going to do today, and then usually I do one quick update, just a 30-second business update. It's been a bit of a slow start to the year for good assignments. We've got 11 assignments going now in six different brands. I think it's like Taco Bell, Wendy's, Wingstop, KFC, Freddy's, and Popeyes, if that equals 6. You know, so we're mostly working on high-quality assignments right now. There's a lot of assignments, unfortunately, that we've been talking to that just haven't been... able to come to the market because of either the performance of the business or the valuation expectations. And we hope that clears itself. Inflation's been a bit of a booger. And of course, same store sales in many brands has been struggling. So let's hope that comes back as we go into the spring and summer time this year. But let's pivot now to the webinar. I'll go ahead and start and introduce these two gentlemen. You have Tim Ring and Brad Cashman of MMB here. These are two friends and really remarkable attorneys with MMB up in Minneapolis. They have a long, outstanding reputation individually and as a firm of representing franchisees and franchisors and non-franchise businesses as well in all kinds of advisory capacities. And so we see them a lot at RFTC. We see them on a lot of our transactions and a lot of common clients that we have. We know the quality of their work is awesome. And so I'm honored to have them both here today to talk about 10 legal items that we feel like are going to have a lot to play in 2026. It'll be maybe a little technical, so it's probably best also kept as something you can refer to at a later date in a later time. But thank you, gentlemen, for joining. I'm excited to have you.
Brad Cashman
Thanks, Rick. Yeah, pleasure to be here. Always great to be doing something with unbridled. So we're both looking forward to it.
Rick Ormsby
Thank you both. And yeah, we didn't do this matching on purpose, but the MMB guys have got the light blue shirts, they got the jackets, and I got one too. So we all look like we're professional, but I bet we all don't have the same clothes on below the belt that we do above the belt.
Brad Cashman
Let's not find out.
Rick Ormsby
Well, guys, let's jump into it. And the first question that you guys wanted to talk about, and I'll let you guys speak with your expertise. Go for it. Structuring and entity choice was kind of our first comment that we're going to talk about when buying and setting up a franchise business. Go ahead. Tell me what you think.
Tim Ring
Sure. Let's dive in. For the audience's benefit, Brad and I are both heavy on M&A as well as financing transactions. So we're going to talk with a group from different vantage points, given that my time is more financing, Brad's time is more emanate, but we do cross over. And we see these issues permeate blending facilities as well as emanate transactions. But right out of the gate, structuring your entity. That seems to be a buy-side focus, but I would encourage those potential sellers out there to embrace this caption, entity choice. We see the very well-advised sellers a couple of years in advance of a transaction restructuring their business. And when I say restructuring their business, they're changing entity formations, they're reincorporating or reorganizing their entities in different jurisdictions, getting ready to sell, first and foremost, trying to minimize those taxes, or clean up a very ugly entity structure. So for the sellers out there, I would encourage you to take a hard look at what you have and how you can potentially change it. We see a lot of our clients throughout the U.S. changing residents first, individually changing their residents, but in many cases also changing the state in which their entity is organized to minimize tax issues. Now to the buy side, historically, lawyers advise their clients one entity per franchise agreement. And over the years with a lot of mergers, buy, sell transactions, we're seeing at the lender table 60 to 70 different borrowers. And there's a cost benefit of doing that. There's an administrative burden of doing that. The sole goal to have one entity per franchise is to minimize liability, minimize landlord scooping. where you can't obtain a lease without a personal guarantee. So there are a number of different factors playing into that choice of how many entities do I have? Is it one per franchise? Or what we are seeing recently is more of a clustered approach. I'll have one entity for my units in North Carolina, another entity down in Florida, and I'll try to divide and conquer territories. That seems to be more of the winning strategy of late, with a keen eye, of course, on landlord guarantees. That might play the exception here. If you've got an obstreperous landlord, that's just wet to come hell or high water, you're guaranteeing that lease, maybe then that's deserving of a spin-off, split-off type of entity, 3rd or 4th entity, as the case may be. But also, as we talk about entities and cleaning up, sellers, sellers with real estate inside the entity, it's a great time to start divesting real estate and splitting apart your structure to an opco, propco, that's kind of the term du jour that we hear out there. Cleaning up your entities because in most cases you want to keep your real estate anyway. So it's a nice time to engage in that with your lawyers, your tax advisors, and others. A trend, and this is kind of interesting, a trend we're seeing on the buy side is the formation of C-corps in lieu of pass-through entities like LLCs and sub-asses. The marginal tax difference between those two structures is about 15 points, 15% taxation difference. C-corps are taxed much lower than the pass-through entities. And the guys, gals, and the entities listening to this webinar are, look, generally in the 37, 39% tax bracket. So that 21% tax bracket for a C-corp, that gets my attention. Now the consequence of a C-corp, look, everybody knows what it is. It's double taxation. But we do see the people choosing that C-corp route also forming management companies to help mitigate earnings build up inside the sea and getting cash out, getting cash out into a pass-through entity through management fees with residents of Florida, better yet on the tax. So saving state taxation.
Rick Ormsby
A lot of good points. And one, goodness, goodness, Tim. I mean, I hear like, because we see a lot of our clients are doing, I say a lot, but a decent amount of our clients before they sell a company, especially if they're an adjacent state to a state that has no state income tax, we'll consider that. Sounds like 2 years is kind of the number that they want to do. So you want to do some advanced planning if you're going to be selling a company and you want to relocate to take advantage of tax considerations. You talk a little bit about, you know, setting up your entities and opcos and propcos. That was interesting. I've seen this too. with the comment of how to put your entities, like you don't want 61 unit entities, that becomes such a laborious administrative burden and difficult to borrow money and keep up with. But you don't see everyone putting six, you know, sometimes you'll see 60 different locations in one company with a lot of umbrella insurance over top of it. But I agree, you do see a lot of entities that are like, oh, we'll split it into three or four or five different entities or three different entities to kind of mitigate a little bit of the risk by state or by type of asset maybe, but yet you don't see either all of it in one or one for every single store. And then, so all these things are like, my head's turning. And then the C corporation idea, right? Which is like 21% tax in the C corporation, retain the earnings, pull earnings out with the management agreement, and then manage the earnings within the C corporation, and then just keep the earnings in the C corporation for a long time and take advantage of the tax favorability there. Gosh, that's a lot for 5 minutes. What are we going to do now? Let's go play some basketball, Or watch. Or watch some basketball. Or watch some basketball.
Tim Ring
So the administrative burden for 60 entities and the cost to do a transaction versus the benefit when you have corporate insurance largely to mitigate risk, I think trumps that movement more towards clustering. The caveat being lease guarantees.
Rick Ormsby
Yeah, the lease guarantee comment. Yeah.
Tim Ring
Really should drive a lot of decisions. So we're going to move over to tax considerations now. And we'll talk about that in the second issue.
Rick Ormsby
Yeah, that's great. Brad, fire it up, buddy. You know, taxes. I don't want to talk about taxes. You moving to Puerto Rico, you know.
Brad Cashman
Maybe, yeah. So, you know, my perspective is tax considerations always have to be one of the top two or three issues that folks are focused on, particularly when they're going to sell exit business. What I always say is when you're considering selling, don't be focused on what that sales price is going to be. be focused on what the net takeaway is after expenses and taxes. That's the number that's really got to matter to the seller. And so generally speaking, you work with your tax advisors, your CPA, you can come up with a model, you can plug in purchase price, expenses, taxes. It really helps, from my perspective, guide decisions, right? Somebody may be really focused on that extra million or two of sales price. When they see where that actually translates into from net takeaway, maybe you can give on that issue and accept a little lower sales price because it's really not going to make as big of a difference as you maybe thought on the onset. So that's the first point is know the tax consequences, and then plan to try to maximize your after-tax proceeds. So there's a number of ways to do that. One good way is to structure the transaction for installment sale or some deferred purchase price. This can be done a number of ways. Obviously, there's some risk when you don't get all the purchase price upfront. But if you can spread that purchase price into multiple tax years, it can really save on the tax dollars you ultimately have to spend. Another great way to do it is to have a very favorable purchase price allocation between the different categories of assets. So if you are a seller, generally speaking, you want low value into tangible assets, high value into goodwill. And those tangible assets, which you have previously depreciated, you're going to have a bunch of recapture, which is in tax at ordinary rates. Goodwill would typically be treated as a capital gain. and you should get a more favorable capital gains rate on that piece of the purchase price. So that's always a give and take with the buyer. As a seller, get with your CPA early and really drive that as a negotiating point that you want a favorable purchase price allocation.
Rick Ormsby
One of the ones, just to jump in there, we see this as you ask, talk to your CPA, get a perspective on if there's any equipment tax or FF&E tax. on the sale, because that could be an unseen double whammy. You have to recapture depreciation and then whatever allocation you have, like California is a good example, right? Where there's like a big tax on the value of the FF&E. That'll bite you in the tail if you're not looking for it.
Brad Cashman
Yeah, that's incredibly important. I think as you know, folks who do deals kind of nationwide, as you do, Rick, they become aware of which states you have to watch out for, right? So it's Colorado, it's California, it's New York, it's Tennessee. You just have to get that figured out. Because a lot of these franchisees, they do have units across multiple states. They may not know those different sales tax laws in different states. But it is a terrible surprise to close and realize in that purchase agreement, you agreed to pay for sales tax, and it's going to be 8% of what that tangible asset value was, which is going to be very significant. And again, if it's unexpected, a very awkward moment between the attorney and the client on Why did we agree to pay for that? Another point, and you guys touched on this earlier, but the state of residency of the owners can be super important, but it's something you have to think about well in advance. And so here in the state of Minnesota, there's an absolute exodus of folks who are moving to no income tax states prior to selling a business. So it can be done. There's reasons not to do it for a variety of reasons, but if you're able to move, if you want to move, a good time to do it is in advance of that sale. The last thing I want to touch on real quick is the The qualified small business stock exemptions, that is a very hot topic here in our office. Lots of clients call, want to know if they'll qualify. I think unfortunately, a lot of franchise businesses don't. Restaurants don't, but there are some that do. And just as a high level, what that means is if you do qualify, when you go and you sell your business, if you're selling stock, there's an exemption for capital gains, right? So it's a great tool. If your business qualifies, you have to be taxed as a C-Corp in order for this to work. But something you should certainly talk to your tax advisors, attorneys about in advance of starting a business to see, is this something we can take advantage of? So if you can, it's an absolute game changer on what your ultimate tax bill is going to be.
Rick Ormsby
That's great. A couple of comments I thought of in your remarks. One is we've seen this several times in transactions where someone would sell the business paying the real estate, but they would split them across two years. So that's something that we see, especially with smaller franchisees who don't have as big of a gain and can take advantage of the different marginal tax benefits of splitting them. You might sell the business in December, set up a lease, and then sell real estate to a REIT or on the 1031 market in January or February of the next year. We also see people timing tax situations a lot, where they want to sell it January 1st instead of December 31st, because if they sell it January 1st, they get until April 15th, 15th of the following year to file their taxes, and they can, this is more of a strategy for someone who's getting $50 million in a sale. And if you can invest that for 16 months versus pay it soon, like the deferral's worth a couple $1,000,000 to you, know what I mean? So those are a couple of things that we've seen. And the other item on taxes that's not legal at all, that I always tell people is if you're charitable by nature and you've never heard of a donor-advised fund, I encourage you to look into it. because the government will allow you to give up to, I could check the numbers with your CPA, but I think it's up to 25% of your AGI to charitable contributions in any one year. But the problem is most of us don't want to give that money away that quickly without having thought about it. So you set up a donor-advised fund, and I have one, and you put the money in that asset, and then you take the tax deduction in the year you place the funds, but then you don't have to give the money away right away. So it's kind of like a foundation, but way cheaper and way less administrative burden. And it allows you to kind of take advantage of a high tax rate that you're going to incur, but be generous with it over time if that's your inclination. So I always mention that because it's for a certain type of person, that's a big deal. But yeah, thank you, Brad. It's awesome.
Brad Cashman
Absolutely.
Rick Ormsby
And then, okay. And now we're talking personal liability and ways to mitigate. that's a booger.
Brad Cashman
Yeah, so this is one that I see all the time. So obviously franchising has been a very kind of hot place for folks to invest over the past several years, if not longer. And many of these folks are coming from private equity type backgrounds, not necessarily used to giving personal guarantees. and they decide they want to be a franchisee, and lo and behold, their franchisor is going to require a personal guarantee, their landlords are going to require personal guarantees, and oftentimes their lender is going to require a personal guarantee, which can be a very uncomfortable position to be in as you're starting this new business that while you're confident, nothing is certain. So, number one, I think folks should know going into this, unless you have a certain scale, you like they're going to have to give some form of personal guarantee, at least for some period of time. That's just kind of the reality of it. Ways to mitigate. This goes back to what Tim was talking about on structuring. If you do have a concentration of stores or units within a single entity, much easier to get a landlord or a lender to say, okay, given the scale of the borrower, the tenant, we may not need a personal guarantee. So That's a really important thing. Or having some sort of holding company or available corporate guarantor can also help. But absolutely, it's one of the most crucial things that any franchisee can consider along with tax is what is my personal liability in this business? As far as ways to mitigate, in addition to just structuring, we have seen where letters of credit can be used as a credit enhancement as opposed to a guarantee. So this can be landlords This can be franchisor on occasion. Another thing you absolutely want to do and should just always rely upon this, if you do give a personal guarantee, in particular on a lease, that there is language that when you assign that lease to the next tenant, franchisee, you're going to be released from your liability. I mean, it's one thing to be personally responsible when you're the one operating the store on that property. It's a whole other thing when you've now assigned it to somebody else and you're still responsible. I mean, that's the type of stuff that keeps people up at night, right? Where you sell your business, you think things are great, and then Five years later, seven years later, you get a call, you get a letter saying you're responsible for the obligations of that lease. And that happens, unfortunately, sometimes because people don't realize it, sometimes because they just can't get out of it because their lease didn't give them that option. But absolutely understand your personal liability, understand your guarantees, and have a plan to try and limit that risk as much as you can.
Rick Ormsby
Give me an example, if you have one, Brad, like how much of your time is spent unwinding these things after the fact if there are problems? And what, like, could you give a broad example of someone who like had a personal guarantee or didn't and how it turned out that it gives some context?
Brad Cashman
Yeah, so we had one within the past several months where there was a personal guarantee and a lease. There was no language whatsoever that required the landlord to release the personal guarantee upon assignment. And so when we went to the landlord and say, we're going to assign, landlord said, great, we're excited about the new tenant, we'll approve. But when we asked for the release of the personal guarantee, the landlord said, no, we don't have to, and why would we? How does that benefit us? And so we were essentially stuck. So there's a couple options there. One is you get indemnification from the buyer, new tenant, which is great other than If they're defaulting on the lease, they're probably not going to be able to fulfill that indemnification. So it may not be worth much. What we ultimately did, which was painful, but worth it to the client, was we put down a 12-month deposit on that lease in exchange for landlord giving us the release of the personal guarantee. So that was, gosh, it was close to a six-figure payment to that landlord to get rid of that personal guarantee. And again, it was worth it in our estimation, but that is not cheap. And that's probably something if we had negotiated that up front, we could have gotten from the landlord. So, something to be aware of. And again, a little extra effort up front to know what that risk is and know what the plan is on the back end is really going to pay dividends.
Rick Ormsby
Yeah, well said. Very good. Well, that was interesting. Now we got financing, Tim, #4. So tell us about some legal stuff with regard to financing.
Tim Ring
So let's start with what's happening out there, just in a general sense. A lot of the audience, I would surmise, are in brands that are struggling. Pizza Hut, Wendy's, even Wingstop. You know, last year it had a real low, low tide, using words carefully, with consumers pulling back. Look, McDonald's. is struggling and was struggling last year. So this isn't new to any single brand or isn't unique to any single brand. Consumer spending has affected QSR, casual dining, generally more intensive impact, but it has affected virtually everybody in the audience, maybe other than some of the new coffee brands that are just ripping and roaring, that has not affected financing or availability of financing. A lot of struggled concepts are in existing portfolios. Those lenders are still active. That's the good news. They haven't taken a step back And where those portfolio struggles with several lenders are really focused on is typically leverage. It hasn't yet hit cash coverage ratios. So I think the state of the credit market, there's still credit available to do deals and grow deals. The caveat that I'm seeing, however, is leverage has come down maybe 1/4 turn. Rick, what are you seeing closing deals?
Rick Ormsby
That's right. I think that's pretty consistent. And underwriting's gotten tighter because like anything else, it's been, inflation's been high and sales have been down, you know?
Tim Ring
Yeah, and we'll talk about this a little later when it comes to franchise or approval, but it does carry up for into the state of the capital markets. Equities up. okay. Equity requirements are up. That's going to drive down typically leverage. But the way leverage is tested in this marketplace is, you know, lease adjusted EBITDAR to leverage as opposed to pure debt and equity. But that equity number still does play out and will carry tighter deals in the eyes of a lender. development lines of credit to re-image your business, to acquire new equipment, to grow locations, still seeing a very active marketplace in what we call deluxe, development lines of credit. A lot of companies miss an opportunity when they do take down a new credit facility, and that's building in accordions or incremental credit facilities so that you're poised and ready to grow even further with a development line once you near capacity. Generally, when you're in a lender deal for 18 months, two years, your deed lock is coming to an end. You still have many more units to develop under your DRR with your franchisor, your development agreement with your franchisor and building in those accordion facilities or incremental facilities to take advantage of what's already in the document really makes it a lot easier down the road. So something to think about as a borrower when you're getting a term sheet, asking for that flexibility from the lender up front. And when you're in facilities, generally a borrowing facility north of 10 million, 25 million, that's a lot easier to do. If you're in a facility that's under $10 million in size, the lender's not positioned to do that in most cases. And their response will be we'll revisit the subject 18 months out just to be realistic with everyone. Lender due diligence, I think, use the word underwriting. Yeah, it has tightened a little bit. I have yet to see any overwhelming burdensome requirements being layered on top of a borrower. Haven't seen it, but they have tightened. They're taking a harder look at some of the systems due to their already existing exposure in a particular franchise system. So they're taking a little closer look at their portfolio and how a new loan comes into their portfolio. yet, even in the, let's call it, or distressed QSR systems, other lenders are very active. So that kind of yin and yang are coming together and not creating a Sahara desert for anybody yet, for what it's worth. One of the big things borrowers should really focus on is closing fees for the their own facilities and capturing those costs up front, be it the fees, borrower council fees, but more importantly, lender council fees. There's a lot of surprise.
Brad Cashman
Let me jump in here. So Tim had said that he hasn't seen any kind of overbearing underwriting requirements of lenders. Tim also represents a lot of lenders, so he tends to favor lenders.
Tim Ring
I've you're not you wouldn't speak ill.
Rick Ormsby
I love it. I love it.
Brad Cashman
So here's what I'll say, Rick. I actually had the opportunity to work on three different financing closings in the past two or three weeks, all on the borrower side. Two of the three, I think the borrower walked away saying, holy smokes, I did not have any idea what lenders counsel was going to cost. I had no idea how over the top their requirements were going to be relative to leases and collateral assignments and just the franchisor or tri-parties, legal opinions. And then the third one, Borrow walked away saying, boy, that was pretty painless. The costs were reasonable. And it totally skews, I think, how folks view those transactions. So what I always advise people is, when they're doing the beauty contest and trying to pick the lender they're going to go with, especially if you are somebody who's highly desirable, super strong financially, great brands, that should absolutely be one of the components that you're having that lender pitch you on is who's their counsel, what are the requirements, are they going to require all kinds of legal opinions, what type of landlord agreements, tri-party agreements, and what's an expected cost for their counsel? Because it is really important. If you just go with who's got the lowest interest rate, that may not be the best economic deal for you when you layer in some of this other stuff, setting aside the aggravation and the time it takes to get through that process. And so fully understand it's what lenders have to do, but I think there is some room there to make it more efficient and more cost effective if you push for those things on the front end.
Rick Ormsby
Yeah, it's really well said. I'd say make 2 comments. First is, Running a process is actually probably a pretty good idea, right? So not trying to be self-serving. We do that service on occasion, but like it's like anything, get three quotes, you know what I mean? And ask all the right questions so you can line up all the different, you know, kind of fees, the administrative burden of it. Like there's a lot of covenant reporting requirements that become a big deal that people forget about when they sign up for a loan. That's #1. And the second is, and we're running a little short on time here with this question, but are you guys working with distress situations much right now where you have like a borrower who's like interest only or not able to, he's busted through the covenants and not able and, you know, to pay per the schedule? I mean, how much of your work is related to that at the moment?
Tim Ring
So great question. Given our exposure in the industry, we've got numerous clients who have busted leverage covenants and, you know, they're either exercising pre-negotiated equity cures or they've gone into kind of a semi-IO interest only period or they've re-amortized with an equity infusion into the business. So it's catch as catch can. Great news is the lenders aren't bringing out the mallets. They're, in most cases, pretty reasonable and cooperative, being more relationship oriented versus transactional. And that's a key upfront decision for borrowers. To really embrace, in addition to the cost, what kind of group am I really working with? How long have they been in the industry and what's their reputation? Look, it plays a big deal and you try to negotiate as much of that up front or as we're advocating here today, be informed up front so you're not shocked or surprised.
Rick Ormsby
Yeah, and if you aren't in a bad situation and you're blowing your covenants, I mean, hey, look, it's happening to a lot of people. You're probably amongst half of the restaurant community as your peers right now. Know that there are several options. Don't put your head in the sand, you know, be communicative with your lender and seek out some counsel and advice. You know, these gentlemen know how to step through it. Let's keep rolling. We're on question #5. So franchisors, we got to speed it up a little bit though, gentlemen, so go for it.
Tim Ring
So franchisor issues, I think we can capture pretty quickly. And three key considerations on the buy-sell side of your business. And the three questions are, what kind of franchisor am I dealing with? Is it distressed? Is it opportunistic or is it a traditional model? Distressed franchisors or systems are really focused on good operators. Now, we see some systems like McDonald's really squeezing out the weaker operators in favor of stronger operators. That's not a capital equity decision that they're making. It's pure operational. So what type of system are you buying into or are you selling in? Or is it a system like some of the new coffee shop brands? They're looking at balance sheets. less focused on operator quality, they're looking at pedal to the metal to grow that business as fast as possible. Taco Bell five years ago, seven years ago, and even very much true today, still focused on how many more units can we develop. So they're looking at balance sheets, to a lesser extent, operators. The traditional model combination of equity net worth, which tends to be pretty low, all things considered, and operational experience. So what are you selling into rather than beating your head against the wall? It's, you know, okay, who should I sell to given a dynamics that I'm currently plagued with, good or bad, as the case may be? Who's the better buyer? Who's more likely to get approved? Good advisors like Rick will help navigate that, of course. and align you with the better buyer. But if you're not using a broker or using a broker other than Rick, those are questions you should be thinking about rather than beating your head against the wall trying to get someone approved who's just not going to happen.
Rick Ormsby
Thank you. Really well said. We spend a lot of our time in this realm and it does depend on what brand you're in and what the state of the union in that brand is. And they change too, don't they? I'm not gonna be naming names, but there's a burger brand out there that used to really court the private equity buyers and family office buyers who weren't necessarily good operators, but had a lot of capital. And now they've switched the other way around and are wanting like people in pickup trucks driving in their markets, operating restaurants who aren't well capitalized, but have good growth, have good operations chops. So these corporate edicts change all the time. And if you're not aware of those changes, either as a buyer or as a seller, it can be a pretty tough transition. So really well said. Any other comments you want to make about the franchisor process?
Tim Ring
No, I think that captures that help keep us on track here. And we can move over to purchase agreements and market trends.
Rick Ormsby
Okay, and of course we got reps and warranties down the list and diligence, all these nasty things attorneys think about all the time. So stay awake, it's coming. All right, here we go.
Brad Cashman
I'll start off here. I think before we get to some of that fun stuff, kind of the guts of these purchase agreements, if you are somebody considering selling, I think one of the main considerations you should make is who do I want to sell to Right, there's a whole universe of different types of buyers out there for your business, but to kind of make it into two broad categories, you've got strategic buyers, which are essentially folks. already in the brand, have familiarity with your business. And then there's more private equity type groups who may be coming in as more of a financial buyer, probably need to absorb your operating team because they don't have the operating experience themselves. And those are very different types of buyers and various positives and negatives that go along with it. What I would say for a strategic buyer, and this kind of goes back to the franchisor discussions, that unnamed burger concept, they like that type of buyer. Ideally, the one who is in the territory next to yours, who knows the market, and it's oftentimes pretty seamless from a purchase and sale perspective because they already understand your business. The diligence is usually a little bit lighter, and they're a little more reasonable on what the expectations are because they know the business. On the flip side, with what's called a private equity financial type buyer, this may be new to them. may be new to the franchisor, so that makes it more difficult. And the level of diligence that probably got to undertake to understand your business and make sure the people are right. You may be a little bit more, at least by reputation, cutthroat and hard-edged as far as what they're going to do on facilities inspections, who's paying for remodels, things of that nature. But they may come with a bigger purchase price. They may have more access to capital. So certainty of clothes from having the capital available, maybe better with that type of buyer. But really something to consider. And again, that's where Rick and Unbridled are absolutely able to kind of probably introduce you to both and you can make that decision on what's the best route for you. And Rick, you can speak to this, but purchase price is only one of the considerations on who you've picked to be your buyer. There's a whole host. So I mean, you go through that with your folks to decide which one to go with.
Rick Ormsby
Typically, it's a great question, Brad. Yeah, we're typically, you know, like, you know, have like a seven or eight point checklist of things that a buyer or a seller should consider if they get an offer from a buyer and price is just one of them. I could offer you a billion dollars for that little gnome in the back of your, you see that little gnome there? You know, yeah, I could offer you a billion dollars for that gnome. I don't have a billion dollars. So you know what I mean? So do you have the money? Can you get approved? What's your operational history? You know, what are the terms of the offer that you're making? You know, who are the principles that are involved? Like, there's just, there's a litany of questions that you have to ask to get to which offer is the best. I mean, it's really well said for sure.
Tim Ring
Are you seeing a gap out there right now on the sell and buy in terms of expectancy of the seller and willingness of the purchaser to pay the seller's price?
Rick Ormsby
Yeah, you know, that's traditionally, you know, it's been there for the last three or four years in most brands, except for the ones like you say, Taco Bell, that have been performing really well, continued A consistent path over the last few years. A lot of the brands and a lot of the franchisees, unfortunately, because of no fault of their own, just because of the economic times and some of the trends in the business, find themselves kind of in a position where they have to have a certain price to clear the debt and to make a return. And that price is just not there relative to what the business might be worth. So it's a, we probably, for every 10 assignments we take, we probably do 30 or 35, who knows, valuations. And we have to say, no, we don't think it's worth what you want, you know, probably 70% of the time, unfortunately, at the moment. That does change. And the pendulum has swung with your strategic and your financial buyer discussion, you know, Brad. Like, It was financial buyers only, but primarily in 2017, 18, 19, 20, 21. And then as we've swung into 24, 25, and 26, the financial buyers have really kind of put the brakes on their acquisitions. And you see a lot of businesses that are selling go to strategic buyers. and so that pendulum will probably come back in the middle at some point. It's probably not today or tomorrow, but who knows when exactly. But for the time being, if you're a buyer of a business and you are a strategic buyer, you're a 30 unit operator sitting in Omaha, Nebraska, you know, and you've lost out on growing opportunities, I'd say hang in there and be attentive because you probably have a better chance to get them right now.
Tim Ring
So to that point, Brad and I are seeing sub debt. kind of come back into some deals to kind of stop gap, lower leverage from lenders, bridging the gap on price, rollover equity deals, very common with private equity financial buyer. They want the seller to keep some skin in the game, especially if they intend to be active. But earnouts, We haven't seen a big use of earn-outs except for newly developed units or units under development pending inking a deal and closing a deal. But those 3 tools remain out there for sellers to embrace to help bridge those gaps somewhat or expect potentially on the sub debt side in terms of to Brad's point, which buyer?
Rick Ormsby
Yeah, and the earn-out piece is in there a lot with new units because the businesses that are selling right now are typically the ones that have been performing well in brands that are growing, that have a certain percentage of their portfolio that are new or they're, golly, gee, I'm just opening the door tomorrow, but I'm selling this business. And so how do I value an asset that the door hasn't yet opened, but it's only one of 50 stores that I'm selling. So this is something that we talk about a lot in that context. But I want to get into the diligence and the representations and award. So let's make sure to do that. What do you got on diligence issues? We've got about 10 more minutes.
Brad Cashman
Yeah, so I can make this relatively simple. So diligence to me is do you understand the business that you're buying? So if you are a buyer of a business, of a franchise business, there's some core components you have to understand. So first one is you have to understand the financials, right? So a lot of times you will do a quality of earnings to kind of prove out what Is that true EBITDA or profitability of that businesses? That's incredibly important. That's basically what you're buying is that ongoing revenue stream. Number 2, you have to understand where that seller is with their franchisor and their franchise obligations around CapEx and remodels. So it's incredibly important you understand that, you understand kind of what you're stepping into, what your cash outlay is going to be to get those stores up to standard once they take over. Next piece is always a condition of facilities, right? So sometimes, internal teams that takes a look, other times you can use a third party inspector that goes in and figures out. What's the parking lot look like? Is the roof leaking? Are the tiles cracking? All those things add up, right? And maybe the purchase price is such that that's your expectation, that it's relatively rough shape. But if you're paying top dollar, you want top dollar condition for those units. Another piece is taxes of the seller, right? You want to make sure they're current on their taxes. Sales tax, employer taxes. If they're not, as a buyer, you could be stepping into their shoes for that liability as the successor to the business. So incredibly important, you understand that. And the last piece to me is always the real estate in the leases, right? This can be done through estoppels, landlord agreements, but you really have to understand what those leases say You have to understand that you're not in default when you take over on day one, right? The most important part of any franchise business is the lease since the franchise agreement. So do your diligence there. So that's on the buy side. On the sell side, Will tell you, and Rick would probably hopefully echo this, get organized before you sell, right? You know that the buyer's going to want all this diligence. Once you actually sign a purchase agreement and you start the process, you're essentially taking on a second full-time job, right? Not only are you running your business, but now you're trying to sell your business. And if you're trying to track down all these lease documents and franchise documents and everything else, it can be overwhelming and it can slow the process down. So as part of this process of let's get ready to sell, you know, get your diligence files in order and be ready to go for those questions that you know the buyer's going to ask.
Rick Ormsby
Yeah, it's a big deal. It's a big deal. People underestimate it. They look at costs. And they look at timeline and they look at taxes and all this stuff, but they don't factor in how much time it takes to actually pull all of this together. And the benefit of that by hiring a good advisor, but also a good attorney is enormous, really.
Brad Cashman
The tutorial there is a lot of times if you're a principal who's running this business and you want to keep things quiet, you're kind of doing it on your own, right? All these people have helped you run this business for years. You may not tell them right away. So you're the one digging through, try and get that. So it is a pretty extensive process to undertake.
Rick Ormsby
I mean, like your tax bill for store XYZ from 2017 in the state of Utah. Like, oh my gosh, really? Like, and that's one of like 1000 things. You know what I mean? So it can be a little overwhelming. Okay, fantastic. Reps and warranties. Tim, give us a few minutes.
Tim Ring
Really quickly, kind of the big three areas, buyer or seller, and the most common thought over area, indemnity. What is the seller indemnifying for? What does the risk allocation model look like? Is it reasonable? As A seller or a buyer, that is really the focal point next to price. You know, I'm not glossing over Assume liabilities or price, but the most contested issue in the document is indemnity as it relates to covenants and reps and warranties. And that's where a good lawyer can really help mitigate liability for both buyer or a seller. That should be your focal point, I would submit, other than purchase price excluded liabilities. You can use rip and warranty insurance to mitigate those liabilities further, but those are typically structures in private equity-led sponsored deals, but something to look at as a seller if you're really concerned about lingering liability post-sale. Five, seven years ago, sellers could get away with, here are the keys. Here's the price. take it or leave it. It's no longer realistic. It's a buyer market out there. Prices have come down. Buyer expectations of sellers taking on responsibility for their actions, running the business are not only reasonable, but it is the reality of doing these deals. Now, how do you slice that, mitigate that? That's the art of lawyering, kind of the art of closing a deal. Let's move over quickly to Brad and talk about state-specific issues, because this is a rude awakening to a lot of buyers.
Rick Ormsby
Yeah, for sure. Go for it, Brad. This is state-specific considerations and employment issues.
Brad Cashman
So I think we touched on this earlier, but the franchise model is really interesting in that it allows somebody to own businesses across a lot of different states and geographic areas in the United States. And so by doing that, you end up in some places that are very different from other places you may be more familiar with. And it's important you understand the landscape, the regulatory landscape, the legal landscape, the employer landscape of these different locations. So just kind of speaking broadly, there are certain states States I think most franchisees would consider friendlier than others, right? So it's kind of your typical New York, California, Washington. I'll even lump in my home state of Minnesota in there are at times a little tougher places to run a business based on wage and hour and liability from litigation type issues, regulatory concerns. So I'll give you an example of there are certain states, and it's the ones I just mentioned, where if you are a large franchisee, with a high number of businesses, you are an absolute target for class action lawsuits. It's not a matter of if, it's a matter of when, one of these is going to be coming at you. And there are so many regulations in these locations that make you susceptible to something that really caused no practical harm to an employee or customer, but does set you up for these. So it's just essentially a cost of doing business. in those locations. So that I think is the downside. The upside is if you say, hey, I know how to run restaurants in California, you've got less competition, right? There's a lot of money that says, I'm not going to California, that concerns me, too many regulations, too much to deal with, too expensive. So if you've got it figured out, you really do have a strategic advantage of less competition for those restaurants to thrive.
Rick Ormsby
That's definitely true. Let me ask you, the top three or four on the list of states, if you had to say, what are the hot ones that you don't get any lawsuits and problems from, what jumps in your head?
Brad Cashman
Well, I just look out your window, Rick, at Florida is obviously a normal place to run a business. You know, Florida, Texas, you know, all the southern states are generally great places to run these franchise businesses from, you know, employer favorable laws. relatively low cost, easier real estate, right? We do all these transactions where if you're dealing with New York landlords versus Mississippi landlords, you take the Mississippi landlords all day long. It's just different, right? And folks have to understand that and know what they're getting involved with before they decide to buy restaurants in one place versus another.
Rick Ormsby
You remember that Joe Pesci movie? It was on the other day. I was flipping through it. He's like this New York attorney goes down to Alabama to try to get his, My cousin Vinny. My cousin Vinny. My cousin Vinny. I mean, I was chuckling. The dude who was the guy on the Addams family was the judge. You know what I mean? And you're just like, there's some truth to the stereotype in some cases. All right, quick 30 seconds or 60 seconds on AI, because I promised we'd say something about AI. What are we going to do? Are the robots going to fly over and kill us all, Tim?
Tim Ring
You know, yeah, yes. Arnold Schwarzenegger in the background, right? Totally, totally. AI, there are some pretty cool things happening with AI, AI kitchens, the back room, the modeling that's occurring with respect to staffing, inventory, hours, customer counts. And I talked with a lot of operators in the business, in the industry about what's happening in the kitchen, what's happening with the franchisors. There's some really slick programs being rolled out that are helping improve margins. 100 basis points to 300 basis points, really improving profitability, AI driven largely. So I would expect further development of those systems and maybe a little broader impact into other franchisees. But if you look at Japan and the robotic use in the back kitchen, even servers for casual dining, The US is just scratching at the surface right now. McDonald's menu boards, largely electronic driven. Wendy's other systems have, McDunkin' Donuts, have started to roll out those electronic boards. It's a capital cost. but hopefully recaptured within some reasonable payback period for less cash shares. I haven't seen those numbers yet in terms of the payback period for an electronic menu board, ordering kiosk. Rick, have you seen any of those ROIs?
Rick Ormsby
Sometimes they're a little bit arduous right now. You know, I would just say as a general blanket statement, but we're all, you know, like we're building data farms, not because it makes economic sense to build data farms, but because we are waiting for the, we're allowing for the technology to catch up and to bring the productivity for the future. And I think that's some of what you have to do. This industry only needs 100 or 200 basis points. of improvement to really make a meaningful impact on one store's P&L. And so this has been a singles and maybe slide into second base with a double type of a business. It's not a home run business. And so we're eking out small gains as we can get them. And technology is going to be a big force for the future. There's no doubt about it. And with that, gentlemen, I want to just wrap up and say thank you so much for your time. It's been a really insightful webinar. This is one of these, and podcast too, as you hear this, that you just earmark and listen to again. So gentlemen, thank you both to Tim and Brad. I think you know how to find them. If you don't know how to find them, MMB is a law firm in Minneapolis. And of course, you know how to find me and you can always ask me to get in touch with them. I'm glad to do so. And thank you all. I hope you all have a blessed day and week and appreciate your time on today's webinar.
Tim Ring
Thanks, Rick.
Brad Cashman
Yeah, thank you, Rick. Privilege to do it.
Rick Ormsby
All right, y'all too. Thanks again. Take care. Thanks so much for entering the boiler room today. You can find our podcasts on iTunes, Google Play, Stitcher, TuneIn, and Spotify. If you like these podcasts, please listen, rate, and review. I also encourage you to visit our website at www..unbridledcapital.com for the best franchise M&A and financial resources in the industry. Our website includes webinars, podcasts, videos, white papers, and a list of our past M&A transactions. Please note that neither Rick Ormsby nor Unbridled Capital Advisors LLC give legal, financial, or tax advice. These podcasts represent opinions that have been prepared for informational purposes only. We expressly disclaim any and all liabilities that may be based on such information, errors therein, or omissions therefrom. This podcast was edited by Resonate Recordings.