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Do you hope to someday bring on a private equity (PE) partner to accelerate your franchise business? If you're a franchisor, this simple list should be at the root of every decision you make going forward as you build your enterprise, from now until you're ready to sell or bring on a PE partner:
1. Private equity buyers want proof of franchise model quality, specifically strong unit-level economics and positive franchisee validation
This means to get top dollar, it's not enough to have a strong franchise value proposition for franchisees. You must track system metrics and show positive trends over time. Collect franchisee profit and loss statements from the beginning. Standardized point-of-sales systems can help collect unit-level performance information that buyers will want to see. Franchisee satisfaction surveys should be implemented. If franchisee feedback isn't strong, move quickly to address issues and communication gaps.
Related: Thinking of Selling Your Franchise to a Private Equity Firm? Here Are 9 Ways to Build a Valuable Reputation
2. There must be additional evidence of brand momentum through new unit openings, same-store sales growth, significant open whitespace and other growth opportunities yet available
The operating model must be replicable, and there must be proof. For example, can you demonstrate that you open 100% of the units you sell? Are franchisees ramping to profitability within 18 months or fewer? That is much more valuable and important than selling a bunch of multi-unit licenses that never open. Do franchisees experience a solid cash-on-cash return? Buyers especially get excited when they see existing franchisees returning to buy new expansion units.
Private equity sponsors want to see strong growth potential within their own planned hold period. But they also want a terrific growth story for the next sponsor as well to command a good exit price. Franchise businesses can trade between private equity (PE) sponsors multiple times. Technically, this is called a "secondary buyout" (whether it's the second PE-to-PE transaction or the tenth). I prefer to think of it as the PE Profit Ladder. At each step, new sponsors need to see a compelling long-term growth story for the business to command premium enterprise value.
3. If No. 1 and No. 2 are missing or weak and if the evidence doesn't match the hype, PE quickly moves on
While you may be selling franchise licenses, that in and of itself doesn't make your business attractive. It validates that you're good at selling franchises, not that PE will find your company attractive. You may have even received (or paid for) flattering press coverage. Are you starting to believe your own press? Buyers may be calling you with effusive, "We'd love to talk about your business," messages. After basking in the warmth of some positive market attention and getting these phone calls, the transition to engaging seriously with a seasoned PE buyer who assesses your business with a swift, clinical eye can feel like suddenly walking into a freezer. Where did the love go?
Related: Is This the Right Time to Sell your Franchise to a Private Equity Firm?
4. This is where your franchisee-franchisor relationship karma will finally catch up to you
Your franchisees have tremendous power over your sale outcome. If that idea strikes fear into your heart, you know where your work begins. Call it "turnabout is fair play," "revenge of the franchisees" or whatever you like.
If you're a franchisor, your ability to sell your company to private equity at a high price with great terms depends on the quality of your relationship with your franchisees, strong return on investment for franchisees and the quality of operators you attract to your system. I've seen this collapse of the hype-machine dawn on sellers far too late. PE's brutally cool, fact-based assessment and the importance PE attaches to franchisee satisfaction, profitability and positive references about their franchise experiences can be jarring to some sellers. If you're used to acting independently as a founder, it can feel like turning in your high school math test and getting it back with a bunch of red pen mark-ups. Whatever attention you are, or are not, currently investing to ensure strong franchisee profitability, the market will one day hold you accountable.
Most PE sponsors want growth stories, not turnaround projects ripe with risk and headaches. Turnaround projects in franchising carry significant extra risks and uncertainties because of franchising's distributed ownership model. For many private equity investors, franchise turnarounds just aren't worth the effort within the available time or will only be considered at a steeply discounted price by specialist firms.
If you or your banker diligently advertise that your business is for sale and months pass with no deal, this well-meaning effort effectively spreads the word to the buyer community that you tried to sell the business but have no takers. This creates a negative impression that you will have to walk back if you decide to wait and go to market again later. It's like that house that didn't sell and is finally taken off the market. Two years later, prospective buyers watching the neighborhood see it listed again and remember that it didn't sell the first time around. They wonder, "What's wrong with that house? What's changed since the last time it was on the market?" If you land here, you need to hear the market feedback and make meaningful changes to improve the value proposition for franchisees.
You are much better off fixing your franchise model first and only going to market when you have something truly valuable to sell. Franchising is a brilliant wealth creation model that performs optimally when franchisees can create a rock-solid return on their investment. If you remain focused on promoting and growing unit-level profitability, you will build a truly valuable system that will stand up to PE buyer scrutiny.
Related: A Beginner's Guide to Private Equity
FAQs
But conversely, private equity loves franchising because franchising is a straightforward, proven business model with predictable value creation levers. Franchise growth curves are also predictable, as are common inflection points as brands grow.
Why private equity firms like investing in franchises? ›
But conversely, private equity loves franchising because franchising is a straightforward, proven business model with predictable value creation levers. Franchise growth curves are also predictable, as are common inflection points as brands grow.
What are two main drivers of financial success for private equity investors? ›
Private equity firms generate returns through a combination of making operational improvements, implementing financial engineering strategies, and leveraging their own capital.
What do I need to know before investing in private equity? ›
However, private equity investing is not without risk. Private equity firms typically invest a lot of money in a relatively small number of companies, so their performance is often more volatile than the overall stock market. In addition, private equity firms typically charge high fees, which can eat into returns.
What are the four typical private equity comprises? ›
Equity can be further subdivided into four components: shareholder loans, preferred shares, CCPPO shares, and ordinary shares. Typically, the equity proportion accounts for 30% to 40% of funding in a buyout. Private equity firms tend to invest in the equity stake with an exit plan of 4 to 7 years.
Why do investors invest in private equity? ›
The underlying reason for private equity investing is to achieve returns on investment that may not be achievable in the public market. Partners at PE firms raise and manage funds to yield favorable returns for shareholders, typically with an investment horizon of four to seven years.
Do private equity firms buy franchises? ›
Furthermore, a substantial 87,488 franchised businesses were part of PE-led M&A (Mergers and Acquisitions) deals, and approximately 64% of brands that had been franchising for a decade or longer were acquired by PE firms. Importantly, these trends have persisted over the past several years.
Who typically invests in private equity? ›
Who can invest? A private equity fund is typically open only to accredited investors and qualified clients. Accredited investors and qualified clients include institutional investors, such as insurance companies, university endowments and pension funds, and high income and net worth individuals.
What are the three ways to make money in private equity? ›
Private equity firms make money through carried interest, management fees, and dividend recaps. Carried interest: This is the profit paid to a fund's general partners (GPs).
What are the drivers of value in private equity? ›
What are some main drivers of value in private equity? Though sometimes classified differently, value creation strategies in private equity typically fall within one of three main categories: operational improvement, multiple expansion, or leverage.
Private equity firms buy companies and overhaul them to earn a profit when the business is sold again. Capital for the acquisitions comes from outside investors in the private equity funds the firms establish and manage, usually supplemented by debt.
What knowledge is required for private equity? ›
Private equity firms usually look for entry-level associates with at least two years of experience within the banking industry. Investment bankers usually follow the PE firm career path as their next job and typically have a bachelor's degree in finance, accounting, economics, and other related fields.
What is the average return on private equity? ›
According toCambridge Associates' U.S. Private Equity Index, PE had an average annual return of 14.65% in the 20 years ended December 31,2021.
What is the most common private equity deal? ›
Common types of private equity deals
- Take private – A take private involves buying out a company that is publicly listed on a stock exchange. ...
- Private company buyout – In a private company buyout, a private equity firm purchases a controlling stake in a privately owned company.
This is also known as the “2 and 20” fee structure and it's a common fee arrangement in private equity funds. It means that the GP's management fee is 2% of the investment and the incentive fee is 20% of the profits. Both components of the GPs fees are clearly detailed in the partnership's investment agreement.
What is the 2 and 20 model private equity? ›
"Two" means 2% of assets under management (AUM), and refers to the annual management fee charged by the hedge fund for managing assets. "Twenty" refers to the standard performance or incentive fee of 20% of profits made by the fund above a certain predefined benchmark.
Why would a company choose to franchise? ›
Franchising your business can be a cost-effective way to grow your business. You will not have to cover the cost of investing in new premises or staff. Additional sales lead to additional profit and if you retain this in the business, in the long-term, you should have a saleable asset for your future.
Why do firms use franchising as an entrepreneurial strategy? ›
Access to New Markets: Franchising allows companies to enter new markets they might not be able to reach otherwise. Enhanced Brand Reputation: The brand gets a boost in reputation and visibility, building a loyal customer base across different locations.
What are private equity firms investing in? ›
A private equity firm is an investment management company that provides financial backing and makes investments in the private equity of startup or operating companies through a variety of loosely affiliated investment strategies including leveraged buyout, venture capital, and growth capital.
Why do venture capitalists prefer investing in startups? ›
VCs are willing to risk investing in such companies because they can earn a massive return on their investments if they are successful. However, VCs experience high rates of failure due to the uncertainty involved with new and unproven companies.
