How Private Equity will Transform Franchising - Franchise Performance Group (2022)

How Private Equity will Transform Franchising - Franchise Performance Group (1)

By Joe Mathews, CEO of Franchise Performance Group

Private equity (PE) firms have been aggressively entering franchising over the last 10 years. A few years ago I hosted an IFA roundtable on franchise development strategy, and out of the dozen or so participants, 8 were partners in PE firms looking to acquire franchisors while learning about franchising. At any given time, half or more of FPG clients are PE-backed franchisors or PE firms themselves.

If you read the backgrounds and credentials of many PE Managing Directors and Partners you will quickly come to the conclusion they attack business with a classical MBA strategic approach bolstered by observation, data, and metrics. Having worked with PE partners, I’ve found PE groups often know each other and share observations and applied learning with the same level of transparency and familiarity as franchisor executives do at IFA events.

As PE firms have gained experience in franchising, how they think about and evaluate franchisor investments have evolved through three distinct paradigms. The latest paradigm is likely to forever transform franchising.

Here is a brief look at how PE’s three paradigms have evolved, and where the current paradigm is headed. PEs, franchisors, and vendors who embrace this evolution stand to reap strong returns for ownership and shareholders.

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Old PE Paradigm 1: Franchisors are like any other B-to-B or B-to-C retail or service model

PE firms bought franchisors thinking they were buying typical consumer-facing models. When they were confronted with typical leadership issues and organizational resistance and demands that franchisees bring, they quickly learned that franchising is a business unto itself. Often, these investments were passed through loan committees with very little diligence done on the quality of the brand as a franchisor. Inexperience in franchising often became the brand’s primary limiting factor.

Many PE firms raised $100MM or more and thus were looking for franchisors with $5MM in EBITDA or greater, which created a strong market for the top 5% to 10% of franchise brands. These brands were being valued at 10X of EBITDA or more, creating enterprise values of $50MM and more. This caused tremendous competition for few deals, driving enterprise values higher.

Paradigm shift 1: PE realized every franchisor is in two businesses: the consumer-facing model and the business of franchising

And the greatest limiting factor of a franchise brand is whichever business they are weakest in.

Current PE Paradigm 2: the emergence of the value-add, smart money fund, and the platform play

Experienced franchise executives and large multi-unit franchisees then entered the PE picture and started heading up funds. Based on their past success as franchisees and executives, they believed they could take 100++ unit or territory franchisors and use their operations expertise to drive the business forward towards critical mass.

Many began looking at investments as low as $2MM in EBITDA, catching late stage Emerging Growth brands earlier in their growth cycle. They knew that the growing from $2MM to $5MM+ can happen in just a few years if the franchisor has its operations figured out. As FRANdata and FranConnect recently estimated, more than 80% of brands have fewer than 100 locations or territories and competition for these deals quickly escalated, driving enterprise value higher. These brands quickly started selling at 8-10X EBITDA or more, creating an enterprise value of up to $20MM.

How Private Equity will Transform Franchising - Franchise Performance Group (2)


These funds would often look to start by acquiring an anchor brand and then acquire similar or related franchise brands they could fold into the anchor brand organization to achieve economies of scale. Platform players like Neighborly (formerly Dwyer Group), Roark, and others pioneered this approach and achieved great success.

(Video) Full Length Version - Private Equity & Franchising - Franchise Growth Solutions, LLC -

But some of these smart money funds were less successful because while the leaders had achieved strong individual success as franchisor executives and franchisees, they lacked franchisor processes, systems, training programs, and intellectual property required to scale multiple franchisor brands simultaneously. Because these brands were often earlier in the franchisor life (late stage Emerging Growth Brands rather than mature Regional and National Brands), these brands demanded more time, expertise, and scalable franchisor processes and systems to scale the brand. The needs were greater than the simple advisory services some of these fund’s leadership had the ability to provide, which hurt growth and stymied enterprise value.

Paradigm Shift #2: Aside from strategic advice, franchisors need franchisor-model intellectual property (proven and scalable franchisor processes, systems, and best practices that can be embedded into multiple brands simultaneously) to grow enterprise value, mitigate risk, and achieve economies of scale.

For instance, a partner of a $2 billion PE firm with a franchisor fund once told me his business mantra: “Buy right, build right, sell right.” FPG signed an operating agreement with this firm to be the “build right” in order to “sell right” part of his equation. They valued our franchise development system, intellectual property, and dedicated team as a multi-brand growth accelerator which drives enterprise value. They valued our philosophy of only recruiting top franchisee talent who support the CEO’s vision and have the requisite capital, skills, and desire to execute well. Equally, they valued our desire and discipline in red-flagging franchise candidates who may represent marginal performance, drain organizational resources, and create brand risk. This Partner understood that in a franchise brand, great execution starts with great franchisee recruitment. And great franchisee recruitment means knowing to whom and when to say, “yes” and when to say “no.” and maximizing your wins with those are a fit. They also used FPG to provide diligence and feedback as to the quality and predictability of earnings as a franchisor, not the consumer-facing model, which was a separate and distinct diligence process.

Based on these conversations I have had with the leadership of multiple PE firms involved in franchising, I believe PE paradigm 3 is now underway.

According to Joe St. Geme, Director at Thompson Street Capital Partners, their goal is to partner with motivated franchisor leadership teams and provide them with resources such as consulting, infrastructure investments, and operational best practices to help accelerate the growth of their brands.

Along the same lines, Satya Ponnuru, Partner with NewSpring Capital, said his firm likes to invest in companies with great brands and strong customer value propositions, proven unit-level economics and great management teams at an inflection point. “NewSpring provides both the financial and human capital brands need to accelerate growth and profitability.”

Future PE Paradigm 3: Franchising as a platform unto itself

For years franchisor executives have successfully migrated across diverse business categories such as food, hospitality, home services, pet services, child services, automotive, senior care, education, and others. Franchisor executives understand “franchising is franchising,” meaning that aside from the product and services being marketed, franchise brands act materially the same.

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FPG defines franchising as “recruiting, training, developing, resourcing, and leading a team of entrepreneurs to build a brand.” When we present this definition to career franchise executives, we are always met with a nod of agreement. Missing from this definition is any mention of a brand’s product or service.

Along this vein, franchise executives have been successfully migrating their personal brand of know-how and intellectual property in franchisee recruitment, logistics, operational training and support, and finance for years. And it works.

But franchising has never done for franchisors what successful franchisors do for franchisees, which is to codify the entire model, including such things as:

  • Strategies, tactics, people, and systems for franchise candidate lead generation and franchisee recruitment to stimulate quality growth.
  • Training and support for developing the franchisor’s staff who work with franchisees training, coaching, consulting, and conflict resolution best practices.
  • Leadership and development training and support for franchisors in how to develop and maintain a franchisee friendly and participative franchisee-franchisor culture.
  • Standardized franchisor metrics that predict the brand’s health and quality of earnings as a franchisor and what these metrics mean.
  • A strategic playbook which details how franchisors predictably need to adapt and grow, with detailed inflection and reinvention points.
  • Standard budgets, uses of capital, and organizational development plans for Emerging Growth franchisors.

The above intellectual property all exists as a hodge podge collection of vendors, suppliers, and in the minds of executives. But the franchisor winning formula was never documented and imparted in the same way a franchisor documents and imparts their model to a franchisee.

Put another way, franchising is a nearly trillion dollar business which has never been codified and professionalized.

Over the next decade, PE will professionalize franchising. There is too much at stake not to.

PE firms will start buying thought-leading suppliers with strong intellectual property with the same gusto they are now buying franchisors. For instance, FPG has helped franchisors collectively recruit over 4,000 franchisees and build over $1-billion in enterprise value with our franchise development processes and systems. What is the value of FPG’s capacity and experience to a PE firm who owns or is planning to own 10-20 brands? What is the value of Greg Nathan’s Franchise Relationships Institute to drive culture change, and FranConnect’s back end systems for standardization of measurement and reporting?

(Video) Full-Length Version Private Equity and Franchising. FranGrow.com

PE Paradigm Shift 3: The need for a “franchisor of franchisors.”

PE will develop intellectual property and partner with franchising thought leaders to codify the franchisor model, offering portfolio brands the same quality centralized services such as training, support, and marketing services a quality franchisor offers its franchisees. The 80%+ of Emerging Growth franchisors plus turnaround brands will place a high value on both franchisor model intellectual property and support team who will help the brand master and embed the franchisor model.

Such PE firms will differentiate themselves in the market not by the size of their checkbook, but by the value they add through their proven PE brand and franchisor processes, systems, and support, driving the likelihood for a fairytale exit.

Remember the PE Partner’s adage: “Buy right, build right, sell right.”

Undercapitalized, outmanned, and outgunned owners of quality brands will sell some or controlling interest of their brands at a discount for their chance at $5MM+ in EBITDA and a $50MM-$200MM exit. Intellectual property and smart money funds marketed properly will solve the “buy right” and “build right” sides of the equation. And if a brand is profitable and built right, sell right part of this equation will always take care of itself.

Eventually, PE firms will brand their franchisor IP (such as Neighborly) in such a way franchise candidates will begin to place a higher value on these brands than franchisors perceived with less experienced ownership and homespun or incomplete franchisor processes and systems.

Additionally, PE will start creating smaller emerging growth funds aimed at franchisors with 10-100 units, offering proven value-added resources in franchisor best practices to create feeder systems and proprietary deal flow for the larger funds they or their colleagues own, akin to the way minor league baseball teams are a feeder system to the major leagues.

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Eventually, there will be a robust economy of PE firms participating in and adding value in every stage of the franchisor Life Cycle, buying and selling brands among themselves, professionalizing franchising, adding more value to the customer and better returns for the franchisors and franchisees, creating a win-win-win scenario.

FAQs

What are the 7 salient features of franchising? ›

The seven key characteristics are:
  • Alignment. Alignment of the values and ethics of a business is essential both with the internal behaviour of the employees and externally with business partners. ...
  • Commitment. ...
  • Mutual interest. ...
  • Communication. ...
  • Accountability and responsibility. ...
  • Professional conduct. ...
  • Pre-agreed dispute resolution.
28 Oct 2015

What are the 4 types of franchise arrangement? ›

Below are four types of agreements franchised businesses commonly form.
  • Single-Unit Franchise Agreement. In a single-unit agreement, the arrangement grants the franchisee the right to open and operate a single franchise unit. ...
  • Multi-Unit Franchise Agreement. ...
  • Area Development Franchise Agreement. ...
  • Master Franchise Agreement.
18 Oct 2017

What are the benefits of franchising and what are challenges that franchisees face? ›

Advantages, Challenges of Franchising
  • Advantage #1 - The Experience of the Franchisor. ...
  • Advantage #2 - Training. ...
  • Advantage #3 - Buying and Advertising. ...
  • Advantage #4 - Ongoing Advice, Research and Development. ...
  • Advantage #5 - Business Synergy. ...
  • Challenge #1 - Working Within the System. ...
  • Challenge #2 - The Risk.
15 Apr 2019

What are three 3 points that should be considered prior to buying a franchise? ›

What Should I Consider Before Buying a Franchise?
  • The type of experience required in the franchised business.
  • The hours and personal commitment necessary to run the business.
  • The track record of the franchisor, and the business experience of its officers and directors.
  • How other franchisees in the same system are doing.

What makes a successful franchise business? ›

A franchise becomes successful because people recognize the brand, and people know the brand because of consistent services. This is why a standardized business process is essential to running a successful franchise.

What are the keys to franchise success? ›

Below, we've listed 10 keys for franchise success.
  • Make sure you have enough money.
  • Follow the system.
  • Don't neglect your family and friends.
  • Be an enthusiastic franchisee.
  • Recruit the best and treat them with respect.
  • Teach your employees.
  • Give customers great service.
  • Get involved with the community.

What are the 3 basic types of franchising? ›

There are three main types of franchise opportunities available, these are: Business format franchises. Product franchises, or Single operator franchises. Manufacturing franchises.

What are the benefits of a franchise agreement? ›

There are several advantages of franchising for the franchisee, including:
  • Business assistance. One of the benefits of franchising for the franchisee is the business assistance they receive from the franchisor. ...
  • Brand recognition. ...
  • Lower failure rate. ...
  • Buying power. ...
  • Profits. ...
  • Lower risk. ...
  • Built-in customer base. ...
  • Be your own boss.

What is the best type of franchising and why? ›

Business Format Franchise

The franchisor offers a detailed plan and procedures on almost every aspect of the business, provides initial and ongoing training and support. Business format franchising is the most popular type of franchise system and the one generally referred to when talking franchising.

Why is franchising important in today's economy? ›

Franchises support the national GDP through billions of dollars in products and services, payroll, and the creation of American jobs. Local economies benefit from franchises by providing jobs, tax dollars, and community involvement. Voters trust franchise brand power for its consistency, quality, and value.

What is the main purpose of franchising explain? ›

Franchising is a contractual relationship between a licensor (franchisor) and a licensee (franchisee) that allows the business owner to use the licensor's brand and method of doing business to distribute products or services to consumers.

Why franchising is a smart business solution? ›

Franchising allows companies to compete with much larger businesses and saturate markets before their competitors can respond. Franchising can help a business grow on both sides of the fence. The franchisors' principal benefit is that they can expand more entities rapidly across different locations.

What are the four big factors to consider when selecting a franchise? ›

Before choosing a franchise, take the time to consider these 10 vital signs that the company is the right fit for you.
  • Proven sales record. ...
  • Growing market. ...
  • Competition. ...
  • Repeat business. ...
  • Healthy living. ...
  • Upsell opportunities. ...
  • Profitable business model. ...
  • Personal interest.

What are the five factors you should study before getting into franchising? ›

So before you decide if it's right for you, here are 6 factors you should consider before buying a franchise.
  • Demand. As is the case before starting any new business, find out if there is a demand for the product or service you intend to offer. ...
  • Track Record. ...
  • Investment. ...
  • Competition. ...
  • Training. ...
  • Restrictions.
20 Sept 2013

How do you identify a good franchise opportunity? ›

5 Easy Ways To Identify a Strong Franchise Opportunity
  1. 1) Location is favorable. ...
  2. 2) Sales at existing locations show steady growth. ...
  3. 3) Little competition for the same goods or services. ...
  4. 4) Ample support from franchisor. ...
  5. 5) Contract is simple to understand.
12 May 2016

What is the most important element of the franchising business plan? ›

Financial projections

This section will form the main body of your business plan. Here, you'll need to predict how your business is going to perform and detail any costs and fees. Developing accurate financial figures is integral to the success of the business. This is where franchisees can benefit.

What is the most important aspect of franchising? ›

Brand consistency and service consistency across multiple franchise outlets are key factors in running a successful franchise business. Establish strong standard business processes and practices which will enforce consistency across all of the franchise outlets.

What makes a franchise company an attractive franchisor? ›

The primary reason most entrepreneurs turn to franchising is that it allows them to expand without the risk of debt or the cost of equity. First, since the franchisee provides all the capital required to open and operate a unit, it allows companies to grow using the resources of others.

What are 5 keys to success in owning a franchise? ›

But even with the support of a strong, reputable franchisor, a successful franchise owner should have the following characteristics:
  • Motivation to Succeed. Successful franchise owners are devoted to their brand. ...
  • Follow the System. ...
  • Open to Support. ...
  • Avoid Burnout. ...
  • Become a Valuable Community Member.
13 Jul 2021

What skills do you need to run a franchise? ›

5 “Must Have” Skills to be a Successful Franchise Owner
  • Marketing Skills. ...
  • Business Management Skills. ...
  • A Business Owner Mentality. ...
  • Family Support. ...
  • Ability to Follow a System.
24 Mar 2018

What are the two types of franchises? ›

There are two main types of franchising, known as Product Distribution Franchising (Traditional Franchising) and Business Format Franchising, which are conducted under a variety of franchise relationships.

How do you expand a franchise business? ›

How to Expand a Franchise Business
  1. Add More Units. ...
  2. Become a Top-Producing Franchisee. ...
  3. Help Your Franchisor Grow. ...
  4. Join the Owner's Advisory Committee. ...
  5. Take Advantage of Leadership Opportunities. ...
  6. Strategically Use Financing. ...
  7. Prepare for Growth. ...
  8. Add Another Brand.
23 Jun 2021

What are the two most important forms of franchising? ›

The two most common forms of franchising are product distribution and business format. In product distribution franchises, franchisees sell or distribute the franchisor's products through a supplier-dealer relationship.

How do you create a franchise model? ›

How to Franchise a Business
  1. Make sure your business is ready to franchise.
  2. Protect your business's intellectual property.
  3. Prepare a financial disclosure document (FDD)
  4. Draft a franchise agreement.
  5. Compile an operational manual for franchisees.
  6. File or register your FDD.
  7. Set a strategy to achieve your sales goals.
2 May 2022

Which is the main benefit of franchise ownership? ›

Advantages of buying a franchise

Franchises have a higher rate of success than start-up businesses. You may find it easier to secure finance for a franchise. It may cost less to buy a franchise than start your own business of the same type.

Is a franchise a good investment? ›

If you're a fledgling entrepreneur or a seasoned business person wanting to diversify your holdings, you've probably wondered, “Are franchises a good investment?” The simple answer is yes, especially if a great opportunity presents itself. There is an obvious appeal to starting a business via buying a franchise.

What is franchise marketing strategy? ›

Franchise marketing refers to the marketing strategies and tactics franchisors and franchisees use to attract new clients or customers to increase awareness and drive revenue to their franchise organization. Franchise marketing has evolved to almost 100% to digital marketing.

Which form of franchising is the most common today? ›

Business format franchising is the most widely used form of franchising. Four essential elements of business format franchising.

What is the most popular type of business for franchising? ›

The most popular type of business for franchising is restaurants. The income generated by S-corporations passes through to its owners, and each is taxed individually for this income. When investors successfully take a firm private, the firm's stock is no longer sold to investors on the open market.

Which industries are most likely to have franchises? ›

As well, franchises are commonly seen in business support services such as: Accounting.
...
Other commonly franchised industries include:
  • Automotive repairs and services.
  • Environmental services.
  • Hair salons.
  • Health aids and services.
  • Computer and phone repair.
  • Clothing stores.
  • Children's services.

What are the salient features of franchising and licensing? ›

The salient features of a franchise are as follows: (i) The franchiser owns a trade or service mark and allows the franchisee to use it under a license. (ii) The franchisee pays for the license and becomes a part of the franchiser's network. An initial payment has to be made and than a regular license fee.

What is franchise and its features? ›

Franchising is a form of marketing and distribution in which the owner of a business system (the franchisor) grants to an individual or group of individuals (the franchisee) the right to run a business selling a product or providing a service using the franchisor's business system.

What is franchising explain any three features of franchise? ›

Franchising is a well-known marketing strategy for business expansion. A contractual agreement takes place between Franchisor and Franchisee. Franchisor authorizes franchisee to sell their products, goods, services and give rights to use their trademark and brand name. And these franchisee acts like a dealer.

What is the importance of franchising? ›

Franchising offers people a chance to own, manage, and direct their own business without having to take all the associated risks. This aspect has allowed many people to open businesses of their own who might never have done so otherwise. Franchising plays a significant role in the U.S. economy.

What is franchising and its importance? ›

A franchise (or franchising) is a method of distributing products or services involving a franchisor, who establishes the brand's trademark or trade name and a business system, and a franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor's name and system.

What is the purpose of a franchise agreement? ›

The franchise agreement should outline the rights and obligations of both the franchisor and the franchisee. The main purpose of this contract is to protect the intellectual property of the franchisor.

Why franchising is a smart business solution? ›

Franchising allows companies to compete with much larger businesses and saturate markets before their competitors can respond. Franchising can help a business grow on both sides of the fence. The franchisors' principal benefit is that they can expand more entities rapidly across different locations.

What is franchise strategy? ›

Put simply, a franchise strategy is a road map that gives your business direction by: outlining objectives. helping you to understand the landscape in which you operate. mapping tactics to achieve your goals. planning for any potential obstacles in the road.

Are franchises a good investment? ›

If you're a fledgling entrepreneur or a seasoned business person wanting to diversify your holdings, you've probably wondered, “Are franchises a good investment?” The simple answer is yes, especially if a great opportunity presents itself. There is an obvious appeal to starting a business via buying a franchise.

What is franchising in your own words? ›

Franchising is simply a system for expanding a business and distributing goods and services, and is based on a relationship between the brand owner and the local operator to skillfully and successfully expand.

What are the three types of franchises? ›

There are three main types of franchise opportunities available, these are: Business format franchises. Product franchises, or Single operator franchises. Manufacturing franchises.

What is more effective franchising or independent business Why? ›

Advantages of buying a franchise

Franchises have a higher rate of success than start-up businesses. You may find it easier to secure finance for a franchise. It may cost less to buy a franchise than start your own business of the same type.

What makes franchising different from other forms of business? ›

A franchise is a chance to own your own business, hire a staff, and generate income for yourself–just like a startup. The difference is that in franchising, someone else owns the brand; whereas in a company like Facebook, for example, the brand is property of the entrepreneur, Mark Zuckerberg.

Which form of franchising is the most common today? ›

Business format franchising is the most widely used form of franchising. Four essential elements of business format franchising.

Videos

1. Wylie Fernyhough – Private Equity Stakes (Capital Allocators, EP.208)
(Capital Allocators with Ted Seides)
2. How To Build A Multi-Unit Franchise Empire And Sell It To Private Equity
(Dru Carpenito)
3. FLDC 2018 - Franchise Development Process Growth Culture
(Franchise Update Media | Franchising.com)
4. Joe Matthews, Author Street Smart Franchising, Franchise Performance Group
(The Franchise Academy)
5. An Inconvenient Fact: Private Equity Returns vs The Billionaire Factory
(Saïd Business School, University of Oxford)
6. IFA Presents Finding Your Passion Make It Happen In Franchising
(International Franchise Association)

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