Thinking of Selling Your Franchise to a Private Equity Firm? Here Are 9 Ways to Build a Valuable Reputation
Private equity (PE) firms are watching your franchise business — right now. If you want to eventually exit via a private equity buy-out, you must build a valuable reputation.
Private equity (PE) firms are watching your franchise business right now — and so are a few potential strategic acquirers. Many franchise founders, especially within emerging brands, carry common misconceptions about how they get on private equity's radar in the first place. You're not an unknown starlet who is suddenly "discovered" while waiting tables at a Hollywood diner. Private equity investors, especially those who understand franchising very well, watch the sector constantly (as do strategic acquirers on the hunt for opportunities within your vertical). Your brand may already be listed internally on their watch list, marked with notes like: "approach now, watch, likely to trade, weak/not a fit." This is happening even if you're already private-equity owned, since PE also tracks competition and follow-on acquisition opportunities.
Think of it from private equity's perspective. According to FRANdata, there are more than 4,000 active franchise brands in the U.S. alone, with around 200-300 new brands launching per year. But many already have partnerships of some kind with institutional capital, are publicly traded or are already part of a platform — which itself could be PE-backed. Another subset of brands isn't attractive due to their size or doesn't fit within the PE firm's particular thesis or sector focus. So the available pool of attractive but still unaffiliated franchise options (or likely re-trade opportunities) isn't huge if you want to acquire an entire system (there are many more roll-up opportunities at the franchisee level, which is why private equity investors are so active in that space).
Related: A Beginner's Guide to Private Equity
Are you being watched?
Through this constant evaluation and weeding-out process, each PE firm active in franchising ends up watching a subset of opportunities that look interesting. They still keep tabs on the remaining field for valuation data, competitive activities, trends and so on. Some also keep an eye on emerging brands. There are a few firms that specifically target emerging brands. But most prefer to wait until a concept is more proven and profitable before investing — or their required check size only permits larger acquisitions.
This entire exercise can be outsourced. Data can be inexpensively and automatically collected and curated. So, it costs the private equity firm very little effort to stay on top of industry trends and your activities. Feel like you're being watched? You are.
How PE investors operate
All this data is great. Information is like grease in the machine. But at its core, private equity is a people-driven business. PE firms have relationships everywhere, especially if they are deeply committed to a sector. It doesn't matter if that sector is consumer goods, energy, cybersecurity or franchising. PE investors proactively build deep relationships in their focus sectors and are constantly educating themselves about the unique dynamics of that sector. They attend sector conferences, read industry reports and keep abreast of trends.
They also have a huge network of attorneys, accountants, consultants, intermediaries, bankers and former operating executives who themselves are deeply wired into that particular sector. Some may be on the payroll and others are merely friends of The Firm. This is true in franchising as it is in any sector where PE firms are active. And it's smart because it helps PE investors make well-informed decisions. So, if your franchise brand is of reasonable size, if you're a large multi-unit operator, or even if you're a single-owner franchisee within a system that's seeing a lot of roll-up activity, you may be on private equity's radar potentially years before you actually decide to sell your business.
How to build a valuable reputation
What is your brand's reputation across this ecosystem? What is your opportunity to shape impressions and boost your value ahead of time? If you want to eventually exit via a private equity buy-out, then you must own, control, shape and nurture your business reputation with potential investors just like you curate your brand's reputation with franchisees, the press, community and customers.
First, build a franchise that is valuable to your franchisees: Private equity looks at unit-level economics and franchisee validation first and foremost. If you build a business model that is valuable and attractive to franchisees, your ultimate exit valuation will be higher than market averages for comparative size/sector transactions. Meanwhile, the business will continue to grow because franchisees are excited about what's happening. It's a win-win.
Unless private equity investors are turnaround specialists, they will pass on franchise stall-outs in favor of easier and more certain options: Your reputation precedes you, and any hidden problems will be discovered during due diligence. Disabuse yourself of the notion that a growth-oriented private equity firm (they pay the best) will suddenly sail in, buy you out of your bad model and fix it for you. They won't. Only turnaround specialists will even kick the tires, and they expect to pay much less due to higher risk and associated costs. So, get busy addressing any model weaknesses or festering issues. Your brand reputation should basically be that of a company with a solid franchisee value proposition with lots of expansion potential that is going places.
Be methodical and purposeful in your external communications: Never attend a business conference or event casually — whether private equity attends or not. Think of it as networking with an agenda. Prepare ahead of time. Convey a few crisp talking points about the quality of your franchise, your healthy unit-level economics and your great management team. Nothing happens in a vacuum in franchising. It's a very small community. Be professional and be prepared. If your model is weak, fix it before getting out there. Sometimes a casual drop of information at a conference can work to your advantage if you do it thoughtfully. But standing at the bar and complaining about your unhappy franchisees or revealing that your business partners are fighting is a bad idea.
Build a trusted board of advisors — with signed confidentiality agreements: Get support and good advice. Being the boss can be lonely! It's something not often talked about, but perhaps should be. You cannot build a truly great franchise brand alone. And if your goal is to one day sell to private equity, one of your advisors should have PE experience.
Designate one business partner, one board member or an outside consultant/advisor/attorney/banker to speak to private equity: Minority partners, especially, can get ahead of their skis when talking to private equity. In their excitement or even arrogance, these partners can over-share, convey inflexibility or misguided expectations or otherwise send the wrong message. At the very least, coordinate your key talking points amongst all the partners to project a consistent story. Or designate a lead, who could also be a non-operating partner such as a board member or advisor, to run point because conversations are time-consuming.
Don't network with private equity for the purpose of getting a "free valuation opinion:" You can create a reasonable working assumption value range through consultants or a little market research. The range will continue to change anyway, based on market conditions and buyers' willingness to pay. Follow a strong sale process with an experienced advisor when you're ready to get serious. Your designated PE lead should focus instead on building relationships and getting to know the people and culture of private equity firms active in franchising.
Cultivate strong franchisee validation: Franchisees have never had more influence over enterprise value or more outright power to scuttle deals than they do right now. How you treat your franchisees and whether they believe enough in the franchise to open additional units is absolutely part of your brand reputation.
Be thoughtful also about managing your reputation with your entire supplier ecosystem: Realtors know if you or your competitors are expanding and where. Brokers and outsourced sales groups know if you're selling new license agreements. Artificial intelligence and research firms are tracking your average tickets, customer traffic and growth trends. Marketing firms know if it's easy or hard to find great stories to tell about your brand. Executive recruiters and staffing firms track attrition. How well does the broader franchise ecosystem "validate" your brand? Private equity firms can and do form opinions about your company and leadership team without ever speaking to you directly. Your business results and Franchise Disclosure Documents (FDDs) are revealing, but your reputation in the franchise community is also critical.
Stay focused on running a great business: Far too often, I see sellers try (and fail) to "outsmart" private equity but instead end up only out-thinking themselves. Stay focused on creating great outcomes for your customers, team and franchisees. That's where the greatest long-term value for everyone is created.
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