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Key reasons why investing in franchising is attractive to private equity

November 4, 2014 Article 2 min read
Lisa Plonka Mark Fleischer
By all accounts, franchise companies are a hotbed of recent private equity (PE) activity. PE investors bring advanced expertise and a high level of sophistication to franchise systems. They also deliver knowledge of cost-cutting measures and improved efficiencies, along with the opportunity to build new relationships.

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PE investors are seeking out everything from restaurants (especially those with a greater number of franchised locations) to non-food areas such as wellness, children’s services, and home care, which have proven and lasting consumer appeal. What do PE companies look for when determining whether or not to invest? In many regards, they consider the same things a franchisee looks for when buying into a franchise concept. These include:

  1. Differentiated concepts.
    Like franchisees, PE companies are looking to invest in organizations that have a unique value proposition and sustainable competitive advantage.  Take a burger concept or sub shop, for example. A burger or sub restaurant that’s reminiscent of all the others is unlikely to be a prime target for investors. On the other hand, an organization that takes the fast casual burger concept and elevates it, offering a variety of unique fresh ingredients and a distinctive service model or environment, stands out. Another example of a unique concept is Massage Envy Spa, which took the tried-and-true monthly athletic membership model and applied it to spa services—something no one in that industry had done before.
  2. Attractive unit-level economics.
    PE companies want to invest in franchises with a solid bottom line. However your franchise system defines a “unit” (a store, a truck, a territory, and so forth), PE firms will want to clearly understand the strength and consistency of your unit performance. A common measure companies look at is year-over-year same-store sales.  While strong unit economics are important, other factors such as customer counts, average growth rates exclusive of price increases, number of troubled units, and number of closures and re-sales will be analyzed as well.
  3. Diversity of cash flows.
    While recurring monthly revenues from royalty fees provide a stable source of income, franchisors that have multiple revenue sources that can bolster the bottom line are attractive to investors. Both restaurant and service franchisors often generate revenue from the distribution of food and supplies in addition to royalties and franchise fees.
  4. Opportunity for growth.
    PE investors are looking for vibrant concepts devoid of market saturation or other geographic boundaries that inhibit future growth. Also, the existence of long-term area development agreements need to be considered.  Area developers should have a proven record of successful openings and create interest and excitement for the brand or concept.
  5. The existence of multiple brands.
    For example, consider the Dwyer Group out of Waco, TX. They focus on commercial and residential maintenance and repair with complementary companies like Mr. Rooter®, Mr. Electric®, and Mr. Appliance®. When evaluated as a whole, the portfolio is stronger than each individual brand. 

Other factors for consideration include a franchise’s international footprint (American concepts are very popular internationally), franchisee satisfaction, customer relationships and satisfaction, and an organization’s closure ratio.

For more information, or if you have specific questions about PE investment, give us a call.

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