FRANVOICE®: Getting Your House In Order: Pre-Sale Clean Up – An Interview with John Goldasich (M&A Advisor)
June 13, 2017 | Posted by Bret Lowell, Founder, and John Goldasich
Todays’ interview is with John Goldasich of Arlington Capital Advisors, an investment banking firm that works with franchisors. Here we explore the topic of pre-sale cleanup.
Bret: The competition for Franchisor deals seems to be getting more intense lately, what power to sellers bring to the transaction? Can you provide some color on what they should expect from today’s market?
John: For well-performing franchisors, this is a seller’s market. But even with that dynamic, sellers should hire an experienced M&A advisor who knows the franchise landscape, knows who the buyers are and knows how to drive the most favorable terms for the franchisor.
The dealmaking process has also shortened significantly. Several years ago, I would have said that the process usually lasts about 6-9 months. Now, it can take 4-6 months. The introduction of rep & warranties insurance and the competition in today’s market has cut time to close in most instances. Sellers need to initiate a process with clear objectives and work with their advisors closely before approaching the market to make sure that they are prepared for the accelerated timeline.
Bret: We often work with Franchisors who are selling their business for the first time. Can you tell us what to expect in the due diligence process and more specifically, how to avoid red flags cropping up? Where should Franchisors start when they are thinking of selling?
John: Many of our transactions are with first time sellers. We work closely with our clients on the front end of any transaction to understand their objectives and tailor a process for them. The main thing we educate our clients on is that buyers of franchisors are attracted to the royalty based revenue model and the high cash flow margins that are produced by that royalty base; therefore, the health of that recurring revenue stream is most important to a buyer.
A lot of operators get fixated on EBITDA or the size of their system or growth opportunities. But above all else, an acquirer or investor is going to look at the health of the franchisee base, because that is the underlying driver of the health of that business. It is the one factor that has the most impact on valuation in franchising.
The main thing that buyers are looking to diligence is what the strength of the franchisee base is. They want to know if the franchisees are happy – if they are making money, if they are committed to opening new units, or are they meeting their development schedules.
Bret: What makes a standout seller?
John: Providing visibility into franchisee health is critically important. We recommend that all emerging franchisors provide a fully disclosed Item 19. Item 19 is the section in the FDD that addresses franchisee profitability. We also encourage franchisors to require that their franchisees maintain a standard chart of accounts and that they submit unit-level profit and loss statements to the franchisor. That way the franchisor has visibility into the overall health of the system, can compare franchisee performance to others in the system and can provide that information during the sale process.
Acquirers also really want to see a healthy development schedule. It is very telling if you have a lot of franchisees that are behind on their development schedule. That shows that the franchisees are not willing to invest or grow with the franchisor.
The other thing we look for is does the franchisor have the infrastructure in place to support future growth? Often, franchisors operate on a shoestring budget and a buyer is going to look at that and say ‘well I have to add ten incremental people to the SG&A to support the business and future growth,’ so they may deduct that expense from the EBITDA. You also want to know if there are any unresolved issues up front. Those could be finance issues, legal issues, franchisee issues and so on.
Buyers also want to see if a franchisor has hit a critical mass and thereare some hurdles that are indicative of that. Every system is different, but one of them is $5 million in recurring revenue – that can come in the form of royalties, sales of products to franchisees, or rebates. We typically also see critical mass in the form of over 100 units or over 100 franchisees. High franchisee validation rates also factor in.
Without those items, the acquirer is going to have to look at other ways to gauge the health of the business and the franchisee base and those can be more difficult to execute. It could mean the acquirer takes a survey of the franchisee base or conducts one-on-one interviews. Those more difficult options can create confidentiality issues or lengthen the time to close because it is a less straightforward process.
Bret: If red flags do pop up in a process, what should sellers avoid doing if they don’t want to make things worse?
John: A lot of these issues can be handled right up front through the initial marketing process. For example, if financial statement quality is a concern, you can work with your advisor and a CPA firm and put together a sell-side quality of earnings diligence report that you can make available alongside the transaction marketing materials. If consumer efficacy is an issue, you can work with a consumer research firm to do a consumer survey and add the findings to your marketing materials.
Working with a good advisor that has seen red flags pop up before and worked through similar issues in the past can help mitigate red flags considerably. This is also why we advise emerging franchisors to develop and maintain relationships with highly qualified accounting, legal, consulting and M&A practitioners as the business grows.
Bret: When sellers are thinking about an exit strategy, what’s realistic? How do you find the right audience?
John: It really depends on the seller’s objectives. If a seller wants full liquidity, such as looking to retire, then the M&A advisor will look at marketing the business to a strategic acquirer or a dual track process with strategic bidders and private equity bidders. If strategic focused, that means they are positioning the business to a larger organization and pitching it as a new business line or as an incremental revenue stream with potential cost or revenue synergies associated with the acquisition. There’s a different buyer universe for strategic acquirers and they are sub-sector specific.
If the objective of a franchisor is to take partial liquidity or bring on a partner to facilitate additional growth, then you’re really looking to transact with private equity investors. Private equity might see the business as a platform investment or as an add-on acquisition to a franchisor within their existing portfolio. There’s no cookie-cutter process and we work with each client to tailor a process that is most impactful at meeting their transaction objectives.
FRANVOICE®: Finding Buyers – An Interview with Amy Forrestal (M&A Advisor)
Todays’ interview is with Amy Forrestal of Brookwood Associates, a middle-market investment banking firm that focuses on restaurant, franchisor, and franchisee transactions. This interview is an exploration of how investment bankers find buyers for franchisors.
Bret: Amy, how far in advance of a sale are you ideally engaged?
Amy: Typically, we like to know our clients many years before they start a sale process. Sometimes that happens, and other times we meet a potential client only months before we begin the process. The earlier we know and begin to work with a sell-side client, the more helpful we can be to properly position their business for a rewarding exit.
Bret: Once you are engaged, how do you prepare your client to be sold?
Amy: We have an extensive due diligence list that we review with the client which includes financial, operational, and legal issues. To begin, we typically spend a day or two on site to understand the business and its potential. We are obviously initially focusing on financial metrics like Average Unit Volume, same store sales, store level profitability, and cash-on-cash return of building new units. If a client has not done an audit, we suggest that early in the process. We also want to understand the infrastructure and the management team. We also look at lease terms, franchise agreement terms and expirations, and remodel requirements. Growth is another important area — we want to really understand the brand, its historical growth, and the potential for future growth.
Using the above information, we often make suggestions. For example, if there are items than can be improved, like obtaining another option on a lease, we make that suggestion. Also, most times, clients are focused on after tax proceeds from a transaction, so working with their attorney and accountant to consider best deal structure and estate planning issues are often critical early planning steps.
Based on all this gathered information, we then prepare a teaser and a Confidential Information Memorandum (“CIM”) which describes the company and explains the opportunity for potential buyers.
Bret: How do you find potential buyers?
Amy: We have an extensive network of buyers with whom we are constantly in discussion. The website, www.FranchisorPipeline.com, is also a great source of buyers.
Using such resources, we prepare a focused buyer list for our client’s approval. The scope of the list will depend on the client’s goals and objectives. Buyers can include strategic buyers, private equity groups and family offices. The type of buyer will depend on the owners’ objectives, such as whether they want to reinvest in the deal in a rollover scenario or would prefer instead to exit and retire.
With the list complete, we then contact the decision makers for the buyers to describe on a “no name” basis the situation, and deliver a teaser. If the prospective buyer is interested, we have a Non-Disclosure Agreement (“NDA”) signed before delivering the CIM and other information.
Bret: What is the process of narrowing down the field of potential buyers?
Amy: After distributing materials to potential buyers as described above, we ask for Indications of Interest (“IOIs”). These IOIs give a price range, source of financing, and identifies items that the buyer still wishes to receive and review. Based on these IOIs, we select the proposals that best fit our client’s objectives. We then set up face-to-face management meetings and open a data room to which will be downloaded a plethora of documents for the serious bidders to review. We also distribute to prospective buyers a draft Purchase Agreement at that time. Overall, we want the buyers to see the concept, meet management, and get all their questions answered. Once we have had those meetings and given time to finish up due diligence, we then ask for Final Bids from this group of buyers. Details and final price are then negotiated with the best fit. The “best fit” is usually the best price but also factors in comments on the Purchase Agreement, rollover equity requirements, escrows required, indemnification levels, and personality fit.
Bret: Once the field is narrowed, what comes next?
Amy: Once we have picked the winning bidder, we typically sign a Letter of Intent (“LOI”) which almost always includes an exclusivity clause. This exclusivity could last as short as 30 days to as long as 90 days. Exclusivity is a negotiated item and depends on how much data has been shared in the data room, whether or not the financials are audited, and whether a “Quality of Earnings” analysis has been done pre-sale. During this time, multiple tasks are undertaken:
- due diligence is being completed by having a third party confirm the numbers,
- legal due diligence is proceeding,
- insurance due diligence is ongoing,
- financing is being firmed up and finalized, and
- the Purchase Agreement is being negotiated.
Bret: How do you get to the finish line — a final Buy-Sell Agreement and a closing?
Amy: Once diligence is completed, various documents then need to be assembled. These documents include financing documents, lease assignments, liquor license assignments, Hart Scott Rodino antitrust filings (depending on the size of the transaction), environmental approvals, and more. And, unless the seller is the franchisor, approval from the franchisor may be necessary, including waiver of any applicable rights of first refusal and execution of new franchise agreements and other documents. A final flow of funds also needs to be prepared and confirmed, and working capital needs to be analyzed and projected. We work with the seller and its legal counsel and accountants to get all these documents, schedules, and other documents in order. And, when these pieces are fully assembled, the Purchase Agreement typically is then signed. Eventually, everything comes together and the closing can occur.
This sale process from launch to closing is at a minimum four months but is more typically a six to seven month process.
FranVoice®: Interview with Burt Yarkin (M&A Advisor)
An important player in many sales of franchisors is an “investment banker” — an intermediary whose role is to shepherd the transaction — from finding a buyer/investor — to seeing the transaction through to completion. Below is an interview with Burt Yarkin, Managing Director of The McLean Group, a leading investment banker for middle-market franchisors.
Bret Lowell: How does a franchisor know when it’s time to sell?
Burt Yarkin: Franchisors face numerous issues and challenges leading up to and during the sale process. A big question is: when is the preferred time to pursue a transaction? The decision involves three considerations: (a) company-specific variables, (b) existing market conditions, and (c) synergistic opportunities with potentially interested parties.
As to (a), at a certain point in a company’s growth, the management team is likely to desire growth capital or a strategic partner to accelerate growth. As to (b) — market conditions — it is important to evaluate the company’s recent performance and look at recent transactions of similar companies to gather an accurate picture of valuation. Market analysis of the state of private equity and availability of investable capital is also important. Regarding (c), franchisors should consider synergistic opportunities with other brands, such as access to new customers, a wider geographic footprint, and expanded product/service offerings.
Bret Lowell: What is the process to sell a franchisor (or partial equity in a franchisor)?
Burt Yarkin: A sell-side transaction is a multi-step process that typically takes 4-9 months. The process usually begins with the management team and a trusted advisor/investment banker working together to understand objectives, determine a preliminary range of value, and develop a tailored positioning strategy for strategic and financial buyers. A strong presentation of favorable performance trends and a clear articulation of growth strategy are critical to a successful exit for the franchisor, shareholders, and the franchise system. The ultimate goal is to generate multiple offers through an efficient and competitive auction involving a variety of motivated buyers.
When the company goes to market, the advisor distributes a confidential information memorandum (CIM) to buyers, answers follow-up questions, and solicits initial non-binding offers. After initial offers are received, a select group of potential buyers are typically invited to meet with management and gather more information. Shortly after management meetings are concluded, the seller will upload legal, financial, and other information to a data room so that buyers can determine an appropriate valuation and submit a final offer. Once a single acquirer is selected, the advisor will negotiate the details of the offer. At the end stage, financing is organized, legal documents are finalized, and the advisor arranges to have the transaction consummated.
Bret Lowell: Why are franchisors an attractive target?
Burt Yarkin: The franchisor/franchisee model stands out as a proven business concept that is a prime target for investors. Investors want differentiated concepts that have unique value propositions and sustainable competitive advantages. Concepts that are able to offer a distinctive service model or environment are particularly attractive to investors.
When analyzing the financial health of a franchisor, investors view unit-level economics as the best indicator of a company’s growth potential and sustainability. A common measure investors examine is year-over-year, same-store sales. And, while unit-economics are important, other factors such as number of closed units and number of troubled units are analyzed. Additionally, investors are attracted to the predictability of recurring royalties.
Bret Lowell: What is the state of the market; what multiples are you seeing — how are franchisors valued?
Burt Yarkin: Overall, the market to sell franchisors is very strong. Private equity firms have $1.34 trillion of capital available to invest, also known as “dry powder.” This figure has grown significantly within the past year and is putting pressure on private equity buyers to invest the cash or return the cash to their investors. Premiums are being paid — sometimes even double-digit multiples of EBITDA — for differentiated, on-trend concepts with strong unit economics, strong management teams, and significant growth opportunities.
Bret Lowell: How will life change post–transaction?
Burt Yarkin: Franchise and private equity relationships are collaborative and are oriented toward the long-term success of building the company. If a private equity firm invests in your company, they generally do not seek to be involved in day-to-day management, but rather to act as a strategic advisor and add value through their advice and experience building businesses. Through an extensive network of operational managers and advisors, private equity firms are often able to strengthen the management team. Typically, private equity firms want to meet with the management team quarterly to discuss financial and unit growth. These meetings are to evaluate the company and to identify areas for improvement.
Life will change post transaction. For it to be fulfilling, make sure you have run a good process and have selected the right investor or partner.
August 5, 2015 | Posted by Bret Lowell, Founder, and Jeremy Dorfman
You have listed on Franchisor Pipeline to find an acquirer of, or an investor in, your franchisor. In doing so, you have kept your company anonymous, and have now been contacted by a prospective buyer or investor. Early in your discussions you should present and have signed a Non-Disclosure Agreement or “NDA.”
Ideally, the NDA will be signed prior to the exchange of any confidential information. If discussions have begun, however, an agreement still can be drafted to apply to talks that have already taken place.
It is useful to prepare a template NDA. This template should reflect the franchisor’s unique business concerns and the specific types of information that it considers confidential. As such, your template NDA will be different from the template NDA prepared for other franchisors.
Also, the template may need to be conformed to reflect the parties to the transaction. For example, if the prospective buyer is a competitor (e.g., a strategic purchaser in your line of business) the concerns and provisions will be different from those that arise when the prospect is a financial buyer or investor (e.g., private equity). Most NDA templates are apt to be subject to some negotiation when presented to the other side.
Some of the differences that may exist (and be negotiated) from one template to another include:
Unilateral vs Mutual Protection
Is it only your information that needs protection, or is the other side likely to also share information with you that requires protection? This need for mutual protection is, of course, more likely when the prospect is a strategic purchaser.
Definitions of “Confidential Information”
There are typically two broad categories of confidential information to be protected.
The first, and potentially most important aspect to be protected, relates to the mere fact that you are even considering a possible sale of (or investment in) your business – that is, that negotiations are taking place. You likely do not wish to have your franchisees, your employees, or your suppliers know that you are contemplating a sale due to concern that they will react negatively. This could be due to their belief that a new owner will be less paternalistic, or more aggressive about enforcement of the franchise agreement, or simply due to fear of the unknown.
The second type of confidential information to be protected is that which is non-public and is exchanged between the parties. This may be generally described, or may be by reference to specific information such as development and marketing plans, organizational infrastructure, operating manuals, methods of franchisee support, the identity of customers, and sales and profits (of both the franchisor and its franchisees).
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While the terms “Non-Disclosure Agreement” and “NDA” are commonly used, most NDA’s cover more than just non-disclosure. NDA’s also typically require non-use and non-solicitation.
The recipient of the confidential information should promise to use it only for purposes of evaluating the possible transaction. You should also consider requiring the recipient to be responsible for its representative’s (e.g., a buy-side broker’s or advisor’s) use and improper disclosure of confidential information. You may even want to have the representative sign on to the NDA.
Especially if the recipient is a strategic buyer, you are likely to want protection from solicitation. You would not want to the prospect hiring away your key employees. You may also want to prohibit solicitation and purchasing of key products from vendors on which your franchise system’s reputation is based. And, while non-compete clauses in your franchise agreements may be helpful, you may also wish to prohibit solicitation of franchisees whose franchise agreements are due for renewal.
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The NDA should also address the duration of the non-disclosure, non-use, and non-solicitation obligations. Some information and activities may be appropriately protected and restricted in perpetuity, whereas other information and activities may be adequately and reasonably protected only for a few years.
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As a seller listed on Franchisor Pipeline, you should have a template NDA that fits your particular circumstances. Using this NDA, you will be able to rapidly begin discussions when you are contacted online by prospective purchasers and investors.
Staging Your “Franchise House” for Sale
A common approach to selling a home – for top dollar – is to “stage” it. Paint the walls, polish the floor, replace appliances, and bring in the props (the rental furniture and accessories) that make the home look “just right.”
Selling a franchisor – for top dollar – entails much of the same. Be sure that all the components of the franchise house are in place, all problems are cleaned up, and the props (i.e., lists, charts, and other documents) that will appear in the online dataroom that sellers will visit look “just right.”
In staging your home, it is each room that needs to look “just right.” In staging a franchisor, it is each department that must look “just right.”
And, if you are in charge of a department you need to assure that your department looks “just right.” You would not want to be responsible for a buyer’s cancellation of the transaction, reduction in the purchase price, or hold‑back of a portion of the proceeds because your department did not look “just right.”
Any buyer will do a thorough investigation of your “franchise house” before they make a bid to purchase. This investigation is known as “due diligence.” There can be many aspects to due diligence. For example, financial specialists will review financial statements, technology specialists will review software, intellectual property specialists will review trademark rights, and franchise specialists will review compliance with the franchise laws.
But, before the “other side” conducts its due diligence, the seller will want to conduct its own due diligence audit. This will assure that all the components are present, enable any problems to be fixed, and provide a basis for creation of the props (i.e., lists, charts, and other documents) that will appear in the dataroom. This sales planning process can and should begin even years before a sale.
For example, in the franchise arena, and well before a sale, the seller will want to assure that each of the following look “just right”:
- Agreements – franchise and ancillary agreements (such as confidentiality, non-compete, development, and international agreements) must exist, be signed, and be analyzed for any possible issues (g., missing provisions [such as for ad fund, social media, data protection, and alternate dispute resolution]; antitrust violations; state franchise law violations; royalties too-low or waived; vague, overlapping or overly large territories, etc.).
- Disclosure Documents and Registration – there must be timely and effective compliance with FTC, state and international requirements (along with receipts or other proof of delivery), and, for states in which it is required, approval of advertising materials and salespersons.
- System Materials – there must be in place all of the items promised by the franchise agreements, such as an operating manual, training programs, and supply arrangements, and each of these arrangements should be reviewed to assure no contractual, antitrust, or other violations.
- Advertising Fund – should be properly used, have decision-making authority clearly set forth (g., by the franchisor, an Advisory Counsel or an advertising committee), be reconcilable (e.g., regarding surpluses and shortfalls), and provide for effective and timely reporting.
- Other Important System Issues – also must be considered, such as terminations, non-renewals, non-competes, transfers, litigation (historical and pending), intellectual property rights, real estate (owned & leased), accounts receivable balances (royalties, ad fund, product purchases), franchise relations, and more.
If any of the required franchise components are missing, have been improperly or unlawfully dealt with, or will not lead to the creation of the lists (e.g., of agreements, of FDDs, of terminations and transfers), charts (e.g., of system growth), and other documents (e.g., of sources of revenue) that buyers often wish to see in the dataroom — the ability to sell the franchisor, and especially the price paid for the franchisor, will be in jeopardy. It is far better for the seller to identify these business shortfalls and legal liabilities before a buyer does, in order to fix what can be fixed, and to properly explain that which is not repairable. Only an early effort to audit and get your “franchise house” ready for sale will reveal these important components that require attention.
Seller’s Market Opens Myriad Options
November 2014 | Posted by: Jeremy Holland, The Riverside Company
Franchise industry entrepreneurs and management teams may never see a better market for selling all or part of their companies. I have worked in private equity for nearly 20 years and have never seen companies valued at such high multiples of their annual earnings. Many factors are fueling this trend, including competition among interested investors and low interest rates, but one thing is certain — this great seller’s market won’t last forever.
So what’s a business owner to do? As someone who seeks out deals for The Riverside Company, a global private-equity firm, it probably seems self-serving that I’d encourage you to sell now, but private equity offers many more options than simply selling. I’ve heard plenty of myths in the course of my work, and by dispelling some of them I hope to show how you might benefit from this incredibly strong market while doing exactly what you want with your business.
Read the full article here.
Franchisors Are Hot!
June 3, 2013 | Posted by Bret Lowell, Founder
Franchisors have long been sought after investment and acquisition targets. This is because, unlike a stand-alone business, the franchisor owns a proven, replicable business model and system. Also, the purchaser of a franchise system will gain the rights to the franchisor’s extremely valuable assets – intangibles consisting of contractual rights and IP (trademarks, trade secrets, goodwill, etc.), as well as established relationships with numerous customers, suppliers and other vendors. And, franchisors often have rising valuations due to the enhanced unit sales and brand recognition that comes from expanding systems.
Additional reasons why franchisors are “hot” acquisition targets:
1) Established brand – due to a collection of franchised (and company-owned) units, and the products or services sold to multitudes of customers by those units.
2) Recurring, predictable revenue and profitability – due to the statistical aspect of having a relatively constant number of replicated units and relatively constant margins.
3) Proven infrastructure – due to having developed proven methods for franchisee recruitment, store openings, training, product purchasing, customer service, operations, advertising, and more.
4) Non-capital intensive operations – due to the ability to downstream certain costs (e.g., operational, advertising, training, and more) to franchisees.
5) Experienced personnel – due to having in place the relatively small executive and management teams needed to run most franchise organizations.
6) Expansion opportunities – due to the relative ease of reaching new markets (domestic and international) through the use of franchise growth techniques.
7) Transparency – due to easy access to franchise disclosure documents that are revealing with regard to: (a) the franchisor (e.g., franchisee turnover and franchisee costs, sales, and profitability); and (b) other franchisors that compete with the target franchisor (including their otherwise hard-to-access financial statements).
This collection of desirable characteristics makes franchisors unique, and is the key reason why franchisors are “hot.” In fact, there are not enough franchisors for sale at any given time. Buyers expend enormous effort trying to locate and land “proprietary” deals before they come to market, and those that come to market often result in bidding wars.
THE Marketplace For Buying & Selling Franchisors is “red hot” – and it exists here on Franchisor Pipeline!
Please see Franchisors 4 Sale® for a listing of current franchisors for sale.