Multi-Unit Franchisee Magazine Issue II, 2015 | Page 96
ExitStrategies
BY DEAN ZUCCARELLO
Small Is Still Beautiful
Single-unit franchisees will survive
I
t seems we read about more and
more franchise acquisitions every
day, where one franchisee becomes
larger by purchasing another. Franchisees seem to be growing ever greater
in size, with fewer small franchisees in the
marketplace. Is this really what’s happening? And if so, why?
1) The franchise model. Franchising, created as a way for capital-intensive,
multi-unit businesses to rapidly expand
their reach, has been a common business
practice for more than 50 years now. In
that time it has provided a great opportunity for entrepreneurs seeking to operate
an independent business, but not the risk
associated with creating their own concept. The franchise model was perfect:
operators were equipped with a formulated
method to successfully operate and market
their business and were able to own and
run their own companies. Initially, most
franchises were sold to individuals on a
location-by-location basis. Larger territories were granted in some instances, but
most franchisors elected to expand their
concepts with single-location franchisees.
2) Evolution of the franchise model.
As franchise concepts demonstrated success and became increasingly accepted as
mainstream, it created a greater demand
for more locations. Not only did this mean
more franchisees were needed to maintain
a growing franchise system, it also meant
existing franchisees wanted to expand
their own companies by operating more
locations. While the replicable nature of
most franchise concepts benefited franchisees by making it simpler to develop
and manage additional locations, and the
development of better managerial practices allowed operators to focus on more
locations, financing remained a limiting
factor. Through the early 1980s, many
franchisees still relied heavily on personal
financial resources and some form of very
conservative bank financing to fund their
growth. In the mid-1980s, we began to
see an evolution of specialty franchise
lenders that understood the franchise
model and were willing to extend more
aggressive levels of financing to facilitate
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rapid expansion. This was the start of the
multi-unit franchise revolution.
3) Franchisee life cycle. Over the past
few decades, many early stage franchisees
began contemplating retirement. Many
elected to cash in on their years of hard
work and enjoy a profitable liquidity event.
Others continued to grow, consolidate,
and transition to future family generations, but this was not the norm. While
the restaurant industry has been growing
at an annual rate of 1 to 2 percent, the
top 200 restaurant franchisees are growing by close to 20 to 30 percent annually,
primarily through acquisitions. Unit-level
economics and overall industry dynamics
have also created an environment where
efficiency through size is a must, making
it more challenging for small and midsized franchisees to compete with their
larger colleagues.
4) Who is becoming larger—and
why. The franchisee groups that are
growing dramatically have been able to
attract outside equity capital to expand
the base of their holdings. Historically,
franchisees seeking to expand through
acquisition resisted outside investors,
instead using their own balance sheet
equity, along with higher levels of leverage, to finance their acquisition activity.
In many instances, they were “one and
done,” without enough capital to sustain any meaningful acquisition growth
plan. Franchise companies that have seen
success with a consistent growth model
through acquisition have raised outside
equity in sufficient amounts to facilitate
their plans without relying solely on the
limitations of their own equity and the
availability of high leverage.
Why has the franchise segment become
attractive to financial investors? For years,
professional and institutional financial investors (private equity, family offices, and
wealthy investors) were more interested
in investing in franchisors rather than
franchisees. They sought investments that
provided total brand control and offered
the possibility of high returns if they selected the right brand. This thinking still
exists today, and brand-level investments
are still highly sought after.
However, over the past 15 years we
have seen a change in the way investors
think about franchisees. At first, it was a
small minority of private equity and institutional investors that embraced the notion of a franchisee investment. As interest
rates declined and risk tolerance became
more of a factor, many early stage professional investors recognized that they could
achieve a nice, stable return by investing
in a franchisee of a successful brand. With
investors starting to desire the premiums
of safety and stability from franchisees’
consistent cash flows, it became less important to achieve a 30 percent return
from every investment. Additionally, the
risks were far less than trying to pick the
right franchisor, which carried a much
higher price of entry. Today we see larger
private equity firms participating in the
space with names like Apollo, Sentinel,
and others investing at the franchisee
level. With no shortage of investment
capital, we see the trend of investing in
franchisee businesses as bright.
5) The future. So what does this mean
for the future of small franchisees? They
won’t completely disappear from the
landscape, but the scenery will change.
Many brands, such as service concepts,
lend themselves to smaller, independent
franchise ownership. These brands will
provide the opportunities for future generations to own a small franchi se business.
Mature concepts and those requiring
greater levels of capital and operational
sophistication will continue to experience
consolidation, with a reduced presence of
the smaller franchisee. However, owning
your own business remains the dream of
many, one that will never cease to exist.
As long as the demand is there, franchise
opportunities will continue to be available
for those looking for independence.
Dean Zuccarello is CEO
and founder of The Cypress
Group, a privately owned investment bank and advisory
services firm focused exclusively on the multi-unit and
franchise business for 24 years.
He has more than 30 years of financial and
transactional experience in mergers, acquisitions, divestitures, strategic planning, and
financing in the restaurant industry. Contact
him at 303-680-4141 or [email protected].
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