Franchises

When and Why Franchises Seek Investors

When and Why Franchises Seek Investors

Scott Svenson, cofounder and CEO of MOD Pizza.

Image credit: Michael Clinard
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This story appears in the March 2016 issue of Startups. Subscribe »
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Imagine going into a bank and insisting that a loan officer read a manifesto before investing in your business. Chances are you’d be escorted out the door by security. But when Chuck Runyon and Dave Mortensen, founders of the Minnesota-based Anytime Fitness franchise, began looking for investment capital in 2013, they wrote out a manifesto and required investors read it. They claim it’s one of the smartest moves they’ve ever made.

Their seven-page manifesto tells their personal stories, talks about their logo tattoos, employee appreciation and the company’s four p’s: people, purpose, profit and play. Runyon and Mortensen see it as an invitation to a relationship. “If you like what you read,” the manifesto says, “let’s continue to explore a partnership to benefit all the various parties involved. If you don’t like what you read, that’s perfectly fine. It doesn’t say anything bad about you or us, it just means we don’t have the required chemistry to go forward.”

For Anytime Fitness, a brand that has more than 3,100 units, the founders were looking for an equity partner who understood franchising and could help with expansion overseas. The manifesto ensured they found the right fit. 

When they began their search, Runyon and Mortensen discovered an entire ecosystem of investment capital. There are firms that invest only in ailing brands. Some work only with companies with less than $10 million in revenue. Some deal only with brands worth more than $50 million. There are private equity investors who invest solely in personal-care companies. Some simply want to buy a stake in a company, while some want to advise and help a company grow.

The firm Runyon and Mortensen found, Roark Capital Group -- which bought a minority stake -- specializes in franchise brands, and has invested in more than 30 other franchise businesses.

Cash Infusions

For almost every franchise brand, there comes a moment when the founder needs to think about bringing in large-scale outside investors. The reasons are many: The company may need more capital to take it to the next level -- to go from a regional brand to a national name or from a small player to a major competitor.

In some cases, franchises bring in private equity and institutional investors to save a failing brand. Sometimes they want to tap an investment firm with experience expanding large systems. And in some cases, founders who have worked long hours for years or decades with minimal compensation want to finally cash in and enjoy the fruits of their labor.

But securing investor money is not as simple as finding someone willing to pay for a slice of the pie. The franchise brand needs to get itself in shipshape to be attractive to capital investors. Then it has to find the right investor, a firm that will bring something more to the table than just a check.

Before any of this happens, a company needs to tidy up its books and get them ready for institutional investors to pore over. Anytime Fitness brought in an investment banker to assess the books, help collect and consolidate franchise agreements, develop better financial reporting and forecasting and make sure everything was buttoned up.

“When you go through a sale like that, it makes you scrutinize your business. It’s not fun, but it’s healthy,” Runyon says. “It’s good to get an outside lens on things. The process will expose vulnerabilities in your business you might not have seen.”

Selling her Camp Bow Wow franchise system never crossed Heidi Ganahl’s mind when she began the dog boarding and daycare business 15 years ago outside Denver. “You set smaller goals, like I have 10 units, now I want 25. Then you want 50,” she says. “Then as you start to see and go through challenges, you begin to realize there’s a limit to how far you can go with bootstrapping. You start to think how far you could go with more capital.”

For Ganahl, that meant selling 100 percent of her company to an outside investor in 2014 for an undisclosed sum. Not only did that bring her a nice payday -- and more time to spend with her children -- it also meant that the brand could get the resources to expand. 

She knew she couldn’t pay for growth with her limited resources. So Ganahl hired Arlington Capital to help find a buyer for her brand. Starting with 85 potential investors, Ganahl and Arlington got down to 10 firms that might fit. Eventually, she decided to go with VCA, a Los Angeles–based company with experience caring for animals and the potential to partner Camp Bow Wow with its veterinary clinics.

At MOD Pizza, a Seattle-based fast-casual brand, looking for private equity was a change in strategy. Since its launch in 2008, the brand had relied on individual investors for funding. 

“Private individuals will invest in businesses based on passion and emotion,” says cofounder and CEO Scott Svenson. “Private equity -- not so much. They only invest in those businesses that have proven themselves.”

For MOD’s founders, who sold a minority stake in their company to PWP Growth Equity in 2015, the idea was to find a partner who could help expand the business. Even more important, they wanted a partner who understood MOD’s unique purpose and culture. They inked a $40 million deal with PWP after talking with 10 investment firms. 

“We make decisions differently and make trade-offs between purpose and profit,” Svenson explains. “We think we found people who understand that. And now we have a few more people around with experience who now have skin in the game, giving us independent perspective and input.”

New People, New Ideas

The founders of Newk’s Eatery, a Mississippi-based fast-casual franchise with 70 units primarily in the South, had several reasons for seeking out private equity. First, cofounders Don Newcomb and his son, Chris, the CEO, wanted a cash infusion to help the brand expand.

“We were looking for an investment to give my dad some liquidity, bring stability and good counsel to the brand and help us grow faster,” Chris says. “It got to the point where if I wanted to do this brand justice, I had to bring other people in.”

To get his brand ready for investment, Chris began building an experienced management team, pulling executives from other successful franchises. He also put tighter controls on financial reporting and procedures. The hard work paid off: Sentinel Capital Partners bought majority ownership in 2014. Sentinel has infused Newk’s with more resources and ideas, and bolstered its leadership team by bringing in experienced franchise executive Jim Greco as COO. While the new blood is great for Newk’s, Greco says keeping the founders and management team onboard is often a smart move for PE firms.

“Generally, these firms are not just buying a concept,” he says. “They are purchasing a management team. They want to make sure there’s some continuity there, and that those people who built up the brand don’t just leave once they cash the checks.”

Value of Intangibles

When the Flip Flop Shops franchise was acquired by Cherokee Global Brands in 2015, cofounder Darin Kraetsch did take the money and run, though he still consults with the brand. His partner Brian Curin, the company’s enthusiastic president, remains onboard. Kraetsch -- who is now developing a new franchise, OfficeZilla, and helped grow and sell Moe’s Southwest Grill -- has a practical perspective on how franchises develop.

 “There just comes a time in a brand’s evolution when it needs different leadership,” he says. “It needs X, Y and Z to grow and doing it takes a serious financial commitment.”

And Kraetsch says that the most important thing when trying to attract private equity is to always keep value in mind. Equity firms are not just investing in past performance. They are looking at the future, and the people who know how to take the brand there.

“You need to be able to explain the value of the whitespace in your business,” he says. “They see metrics and financials, but you need to articulate what they don’t see: the potential for innovation and expansion. Most places want to keep the management team onboard, and they want to know what else they can do. Frankly, that was one of the things buyers found exciting about Flip Flop Shops. They liked how we planned to grow the business with out-of-the-box ideas.”

Edition: December 2016

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