How to Make Your Franchise Attractive to Private Equity Firms

A female business woman discusses how to make a franchise attractive to private equity firms.

Many franchise owners do not consider seeking funds from private equity (PE) firms, but PE firms can be a valuable source of funding. And partnering with a PE firm could offer a franchise a capital boost to fund expansion, execute on a strategic transaction (such as an acquisition), provide an exit strategy, or meet other needs for business growth.

To benefit from such deals, franchisees must understand what it takes to create a successful partnership with a PE firm, as well as how to attract PE investment in their businesses.

Understand the PE Firm's Point of View

Franchisees who need extra capital already understand why private equity investment could be valuable for their businesses. But a partnership must go both ways, so it’s vital to consider why a PE firm might be interested in a franchise. Understanding the viewpoint of the PE firm can help a franchise owner position his or her business and a potential deal in a way that meets the needs of both stakeholders.

First, private equity seeks to earn a return on the capital it invests. The most common measures are the internal rate of return (IRR) or multiple of invested capital (MOIC). Successful franchisee businesses can be an attractive investment for a PE firm because franchises have tested systems that have worked over and over again, which can make the IRR/MOIC reasonably predictable. In addition, because each franchisee must provide specific reports to the franchisor on a regular basis, they also have a detailed paper trail of disclosure documents that makes it easy for the PE firm to do its homework on the firm to validate its thesis.

Private equity leaders understand that franchising has been established as a proven business model in various market segments such as restaurants, fitness and healthcare. And successful franchisees often have territorial rights for a specific geographic area, which can provide a clear route to continued growth.

Determine Goals

The partnership between a PE firm and franchisee can produce increased revenue and attractive returns for both. But before a franchisee approaches PE firms for investment, it’s important to refine the objectives for such a deal.

In most cases, franchise owners have one or more of the following goals in partnering with PE firms:

  1. Create liquidity for one or more of the owners
  2. Access new capital for growth or acquisition
  3. Build an exit strategy

Whether a franchisee's goals align with those, or they have other objectives for partnering with a PE firm, the business owner must be able to articulate that future vision. Taking time to clarify goals will affect how a franchisee approaches PE firms.

In addition to understanding what they hope to gain from a PE firm’s investment, franchisees must also consider the level of control they are willing to relinquish. The most common transaction involves a recapitalization that sells economic control of the business, meaning ownership of more than 50 percent to the PE firm, with the owners retaining a minority position. Other PE firms will provide capital for non-control transactions. In either case, whether the PE firm has a seat on the board of directors or effective control of the board, but they will almost certainly not expect control of day-to-day management.

Target The Right PE Firms

When they've developed clear expectations, franchisees can carefully vet PE firms to find the ones that might be a good fit. If the franchisee seeks capital only, they will look for different PE firms than if they were seeking a managerial partner along with a capital investment. Each PE firm has its own preferences for how to partner, so it's important to find one that matches the franchisee's objectives.

Also, the size of the investment needed will determine the size of the firms to approach. If a company owns just a few franchises but has explosive growth potential, they might target boutique firms. Larger PE firms will be more interested in more significant investments, such as franchises that have $10 million or more of EBITDA.

Franchisees should also talk to their franchisors about plans to pursue PE investment. Not only might franchisors want to give input on the materials provided to PE firms, but they may also be able to recommend PE firms to contact.

Prepare for PE Meetings

Before approaching private equity firms to ask for investments, franchisees should spend a significant amount of time preparing. If franchisees don’t have the appropriate information available to answer the PE firms’ questions, it's unlikely they will give the business owner a second chance.

Franchisees should start by developing a solid valuation and assessment of their businesses. This should include the size of the business, number of operating units, expectations of future growth, territory, capacity of leadership team, debt load, and other important details.

It can be valuable to enlist the help of an outside auditor to audit the franchisee firm and assemble detailed financial information, including upcoming capital expenses.

When all the legwork is completed, franchisees need to create marketing materials to present all this information. The most important piece is to develop a confidential information presentation (CIP), a benchmark document that explains the business, who runs it, key operational dynamics, key investment considerations and summary financial information. Also, franchisees might consider building a virtual data room that includes supplementary documents such as leases and marketing studies to make it easy for potential partners to conduct additional research on the firm.

Articulate Vision and Style

Not only should franchisees arm themselves with all the necessary data about their companies, but they should also be ready to share information about themselves and their management teams. Franchisees should not hesitate to display their unique personality, passion and leadership style; in fact, doing so can be a key to success.

PE firms are interested in investing in a management team as much as a business, so franchisee leaders must be prepared to demonstrate their commitment, ability, culture and vision. The franchise owner should think of his or her conversations with potential investors like job interviews.

With the onset of the Coronavirus pandemic—and its impact on the market—PE firms will certainly have tough questions before they’ll commit to funding, and franchise owners will need to prepare to be responsive to those requests.

In some cases, business owners may need to explain how their business performed during the shutdown, if relevant, and they may face questions on any long-term implications and plans for going forward, generally. A business owner's willingness and ability to respond promptly, professionally and adequately will reflect on his or her ability as a leader.

The views expressed by the author are not necessarily those of Fifth Third Bank, National Association and are solely the opinions of the author. This article is for informational purposes only. It does not constitute the rendering of legal, accounting, or other professional services by Fifth Third Bank or any of their subsidiaries or affiliates, and are provided without any warranty whatsoever. Deposit and credit products provided by Fifth Third Bank, National Association.