According to the most recent and reliable data compiled by the market research and data analytics firm FRANdata, it’s estimated that between 500-600 franchise brands, representing approximately 12-13% of the sector, are backed by some form of private equity (PE) investment, if not outright ownership.
Among the most prolific PE groups is Roark Capital, a firm that either owns or maintains an equity stake in some of the most recognizable fast casual brands the franchising world has to offer, including Dunkin’ Donuts, Jimmy John’s, Buffalo Wild Wings, and Subway, to name a few. To that end, the franchising industry has taken note that interest from PE groups acquiring a stake – or outright ownership – of brands shows no signs of letting up anytime soon.
If anything, M&A activity continues to increase, as evidenced by Monomoy Capital Partners’ recent acquisition of Jiffy Lube International and its network of over 2,000 North American service centers in a blockbuster $1.3 billion deal. There seems to be a broad consensus among the investment community that franchisors have become an increasingly attractive bet for private equity, due to their potential for scalable growth and recurring revenue models that offer predictable cash flow and a reliable return on investment.
But advancing the conversation further, let’s consider this point: if private equity is here to stay, how will it impact the future of franchising as we know it? Long before we delve into the hypotheticals, let’s explore one particular area in which PE groups and franchisors share a common aim – a strikingly similar approach to strategic growth.
Are We Not the Same?
When it comes to strategic growth, private equity and franchisors may have a lot more in common than you think. As franchisors, surviving and thriving is wholly dependent on growing the brand at the unit level. But when it comes to recruiting ideal candidates and signing new deals, franchise sales and development teams will always favor (and push for) the larger, more profitable multi-unit agreements.
How does the sales and development sector attempt to persuade entrepreneurial candidates to choose the multi-unit option? By positioning the latter as the ultimate high-risk, high-reward scenario, citing the inherent value, scalability, and generous benefits of multi-unit franchise ownership. Go big, or go home, as the saying goes.
In our typical sales pitch, we explain to candidates that multi-unit ownership means multiple revenue streams – a force multiplier that allows new owners to scale income and build wealth much quicker than a single location can produce. In addition, we point out that multi-unit ownership allows them to share resources by spreading their fixed costs across several locations – an advantage that also gives them additional leverage to negotiate better terms with vendors and suppliers. Finally, we argue that multi-unit plays can double or triple your presence in the local marketplace, increasing your market share while diluting the operational risk across several locations.
This consolidated approach to strategic growth also applies to the end goal of all private equity firms. PE groups also seek deals to increase the number of revenue streams and diversify their portfolio’s holdings. They look for structured deals and attractive investments that allow them to share resources, scale income, and enhance overall market share by diluting fixed costs and operational risk across their portfolio. This is precisely where franchising and PE goals align when it comes to incremental growth and expansion.
Now that we’ve established this key point, let’s drill further, exploring how private equity investment might impact the future of franchising in three specific ways:
Tighter Financial Discipline
With widespread agreement that Item 19 of a brand’s FDD is perhaps the most significant benchmark of a franchisee’s earning potential, expect PE’s influence to improve financial discipline for brands. Private equity groups have developed a well-deserved reputation for only betting on sure things – investment opportunities that show real potential for return. When you’re looking at dozens of financial prospects at a time, you have that luxury. But PE firms do have the knowledge, insight, and expertise to help franchisors tighten their financial discipline in significant ways, with a stronger focus on EBITDA growth, same-store sales, average unit revenue/economics, and YoY comparisons for a much improved evaluation of a brand’s income-generating potential.
Accelerating Brand Growth
A large-scale capital infusion can be used in many different areas to accelerate brand growth and expansion. With more liquidity, franchisors can make significant investments in technology (especially anything AI-related), software platforms, systems and operations, recruiting, and many other proprietary initiatives. PE investment money can also be allocated to increase funding for existing co-op advertising, marketing, and promotional efforts designed to boost visibility and enhance brand awareness, especially in new and emerging markets. In terms of sheer scalability, the introduction of fresh capital can accelerate growth in a fraction of the time it may have taken a brand to accomplish on its own.
Early-Stage Adoptions
A noticeable trend is emerging in which private equity firms are increasingly taking ownership stakes in emerging and early-stage brands, typically defined as franchisors who haven’t yet reached the threshold of 50+ units. And why not? With approximately 300-400 concepts entering the marketplace each year, many are eager to be snapped up and backed by real capital. FRANdata has done some tremendous research in the area of early-stage adoption, likening private equity’s role as that of an “incubator.” They’re adopting many new and emerging brands that have an easily recognizable value proposition, enough key differentiators to separate them from the competition, and strong market demand from the consumer side.
Weighing the Risks
While many of the benefits derived from PE backing seem fairly obvious to the casual observer, that’s not to say there hasn’t been any pushback in the industry. While PE firms have the capital to drive meaningful change and accelerate growth, they can also be perceived in many negative ways. Painting them with a broad brush, they’ve been described as vultures, bottom feeders, cannibals, and ruthless corporate raiders, just to name a few. There is also a widespread, but perhaps somewhat misplaced, sentiment among consumers that everything private equity touches dies, a nod to several prominent examples in which a brand experienced a notable decline in quality and consumer sentiment.
While everyone seems to have their own opinion as to whether PE’s increasing influence in the franchising industry is a positive development or not, the real answer is much more nuanced and complex. But everyone can agree that the advent of private equity at franchising’s doorstep is no longer a prediction. It is here and it is already reshaping the industry. Because every PE partnership has the distinct possibility of being structured differently, franchise brands will have to weigh an important decision about their own future on a case-by-case basis, ultimately deciding for themselves whether the benefits outweigh the risks.
A Final Verdict That Remains to be Seen
The future will reveal the eventual answer everyone would like to have now. While private equity and franchising clearly share a common approach to scalable growth, whether their long-term objectives remain aligned is a question only time can answer.
