The Impact of Private Equity on the Franchise Industry
The capital infusion private equity brings to the franchise industry is an exciting way to grow for many brands, so long as they’re willing to open themselves up to outside influence.
The relationship between franchising and private equity is a complex one that only continues to pick up steam in our industry. As more and more franchisors explore private equity investments as a growth vehicle, it’s worthwhile to explore what these relationships actually entail.
Brands engage in conversations with private equity when they’re in search of a few things—namely, the chance to scale faster than they would be able to otherwise. Private equity provides franchise brands with access to capital, ample resources in the form of vendor relationships and support teams, and the goal of accelerated growth.
Conversely, private equity sees opportunity in the franchising space due to its ability to provide a scalable revenue stream. There are clearly identifiable trends in private equity’s preference in franchise concepts. Young-but-growing brands are attractive to boutique PE firms, where 50 units or more seems to be the sweet spot. Larger PE firms will look for brands to have over 100 operating units.
So, when is the right time for franchise brands to engage with private equity firms? This question has more to it than meets the eye, as there are several factors franchisors must consider before diving into the private equity pool.
For starters, painting private equity with broad strokes isn’t beneficial to brands; franchisors must refine the type of firm they’re targeting. Are you interested in pursuing an investment from a small boutique firm or a huge firm with global reach? If neither, where do you fit in between? When exploring potential private equity partners, take the specifics of your brand into account.
Some firms are aligned strategically and may focus on a particular industry – service, retail or restaurant for example. Others may want diversification in their portfolio. You will want to find a partner that fits your model and can help you reach your growth goals in a manner that appeals to you, as well as your preferred level of involvement.
Oftentimes, franchisors have been fully immersed in their business for multiple years and can clearly see the potential for growth, but bandwidth and financial resources are being maxed out within the current constraints they’re operating under. Working with private equity undoubtedly improves a brand’s financial capabilities to grow in line with its vision; however, as an example, if you operate a home-based home improvement franchise with five territories sold, you may not be ready to engage. If you’re a 50-unit pizza franchise seeing consistent success at the regional level, on the other hand, exploring the options available to you may make more sense.
Also, important to consider ahead of the decision whether or not to engage with private equity is the culture of your franchise system. The franchisees’ role in the private equity assessment process isn’t related to the decision of who to partner with or whether to engage but is more so related to validation during the due diligence phase. If your franchisees aren’t successful, or are at odds with your vision, a private equity firm vetting your brand will uncover less-than-ideal validation and they’re not going to be interested in investing. The entire process takes several months, and is time consuming, so make sure your brand is ready before considering this.
Despite its surface-level attractiveness, private equity isn’t for every brand. Understanding how your role as a franchisor will change when engaging private equity is a key aspect in determining whether or not it makes sense for you at this point in your brand’s history. Ask yourself: how much control am I willing to relinquish?
When a franchisor elects to sell a portion of their company to a private equity firm, they’ll have a new host of partners to navigate, and people to answer to, as a result. If that’s not something that sounds appealing, private equity may not be the best source of capital infusion.
When controlling interest is sold, decisions are no longer solely yours. Executive boards will be formed that current brand leadership may or may not be included in. Sometimes, founders are kept on as figureheads, other times, firms clean house and bring in their preferred teams to run the business.
Bringing on an investment partner is a big step for any franchise brand, and important aspects of the business as it stands are bound to change as a result. Franchisors should make sure they understand what is slated to change when bringing private equity into their brand and what their new role will be. In the end, private equity can be a very exciting form of growth for a brand. The key is to decide when that is the right strategy for your company.