Exit Strategies

Welcome to 2018. The future of franchising is upon us. What does the landscape look like? We don't have a crystal ball, but we can make some educated guesses based on what is happening around us today, and what is likely to transpire in the coming years.

The groundwork
President Obama has recently finished his second term in office. The Affordable Care Act has been absorbed by the many businesses it affects, and these businesses have learned to deal with the incremental costs through managing hours and taking price increases as the market allowed. Business owners have also adjusted to increased income and capital gains taxes, and have devised strategies to minimize the bite. After a few years of historically low interest rates and central banks pumping liquidity into the economy, inflation has begun to kick in, and this is now putting a lot of upward pressure on commodities...

The decision to sell your successful multi-unit business is now firmly on the horizon. You have come to terms with the lifestyle implications and changes. What, specifically, can you do now to prepare?
First, contemplate which very real vision of the future you would prefer to have:

During the initial stages of an exit strategy engagement with our clients, we spend considerable time gaining a full understanding the client's business. One component of developing this strong grasp of the client's specific situation is uncovering situations that can enhance the overall profitability of the client's company. This process is critical in assessing the "true" value of the business, which is one of the valuable services we provide our clients.
Typically, our areas of focus will include the investigation of issues such as temporary impacts to the business (e.g., road construction), facets of the business that have not yet matured (e.g., new unit development), and corporate overhead structure to ensure that any excess owner-specific compensation and benefits are removed...

We have made progress digging our way out of the pit of economic meltdown we tumbled into in 2007, but we certainly have a long way to go before we experience the vibrant economy we enjoyed in much of the 1990s and the early to mid-2000s. For many, it seems like we are in a state of purgatory--not knowing if we are heading to heaven or hell. So where does that leave business owners today as many face critical decisions regarding exit strategies? We are finally seeing positive signs that the window of opportunity to sell businesses is open. Will it last? Many owners seem to be at this intersection, but also seem to be having difficulty determining if the signal is red, yellow, or green. Let's take a look at our view of the signals as they relate to various elements affecting the transaction world...

When sellers are contemplating a decision regarding the sale of their business, they overwhelmingly select the bidder with the highest price, only to find afterward that this might not have been the best decision for their circumstances. Just as a financing decision is more complex than simply getting the lowest interest rate, the process of selecting the optimal buyer for a particular transaction entails more than simply selecting the one offering the highest price.
For business owners, the decision to sell requires careful consideration. Frequently, sellers arrive at their decision to sell after a long and thoughtful assessment, which includes an analysis by the seller of their personal, lifestyle, and financial considerations. Unfortunately, after the decision to sell is made, many sellers give considerably less thought to the buyer selection process...

Interest rates right now are low—very low. They’ve been low for a while. And they’re expected to remain low for the foreseeable future. So, when you go to your bank and they have only a floating-rate loan to offer you, no problem, right? Maybe… but you better make sure you’ve considered all the angles before you pass up the opportunity to convert that loan to a fixed rate.
Entrepreneurs securing new project financing are well aware that banks today typically offer only floating-rate products. Although some lenders may not offer fixed-rate loans themselves, they typically will facilitate converting the loan to a synthetic fixed rate by helping borrowers purchase an interest rate hedge known as a swap...

Gordon Gekko, the main character in the 1987 blockbuster film Wall Street, quickly became a popular cultural icon of unrestrained greed. The "Greed is good" phrase comes from his address at a stockholder meeting:

"...greed--for lack of a better word--is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms--greed for life, for money, for love, knowledge--has marked the upward surge of mankind..."

Many restaurant operators and dealmakers are hoping for a return to the pre-2008 environment, when multiples were robust, liquidity was flowing, equity was prolific, and debt capital was plentiful.

We have seen a respectable improvement in restaurant company performance, capital availability, and M&A activity in the past six months, and we expect a recovery in deal transactions. We have seen some market players revert to what we'll refer to as the "new normal," in which buyers and sellers recalibrate valuation expectations and deal structures to reach the closing table. This caution has arisen from the difficult economy, and may be a factor for some time. However, we sense that the M&A market is recovering in lockstep with the general economy and expect 2011 and beyond to be increasingly healthy and active in terms of the deal environment...

Family and entrepreneur-run businesses face many unique and complex challenges, including succession planning. Generally, family businesses are more than just a place of work; there is emotional as well as financial capital tied up in the business, and passing on the family legacy can be stressful and fraught with difficulty.

It is common for small-business owners to be so consumed by running the day-to-day activities of their businesses that they forget to take a step back and contemplate transition planning for the future. Founders work hard to build a solid company, but it is important they take their own needs into account and plan for their eventual retirement and/or the transition of their company. This process becomes even more complicated when families have adult children who are active in the family business and are possible successors to the ownership and management of the company...

Over the past 25 years, franchising has continued to develop and become more sophisticated. The reins of the franchisor have passed from the pioneering founders to established management teams with significant industry experience. Today, many of these companies are publicly traded or majority-owned by institutional equity investors.

Franchisees, too, have grown in size and scope. Many now have a national or super-regional reach, having transitioned from small-scale, mom-and-pop operations to larger, professional, institutionalized operations. As the nature of today's larger franchise companies requires more complex capital structures, various forms of capital alternatives continue to evolve for franchised companies seeking to change ownership or fund growth initiatives...

As we work our way out of the current recession, we are already starting to see early signs of life in the merger and acquisition market.

2010 is evolving into the year of the transition buyers and sellers have been looking for. The significant unit contraction retail establishments have experienced in the current recession is causing companies to act more prudently when thinking about their growth strategies. Many brands have recognized the limitations of new-unit expansion and the inherent risks that accompany greenfield growth. Companies that have been on the sidelines with their growth plans are now starting to reemerge with a revised strategy for growth focused on acquisition and conversion, and enhanced availability to capital to fund growth...

Historically, franchising has accepted EBITDA as the benchmark for establishing valuation. However, as seen over the past several years, valuations can vary widely across franchisors, franchisees, and company-owned concepts.

Franchising has seen transaction multiples ranging from the low single digits up to lofty double digits. So what is the justification for this wide range in transaction multiples? What makes a buyer willing to pay 8x for one deal, but only 4x for another?

In franchising, EBITDA multiples vary for several key reasons. This article explores the effects of capital expenditures (CAPEX) on franchise company valuations, and how CAPEX factors into the ultimate value a franchise owner receives in a transaction...

Mergers and acquisitions (M&A) have been an instrumental component in franchising over the past two decades, particularly as a growth vehicle for expanding companies. Historically, most transactions in franchising have concentrated more on the "A" than on the "M." Some of the primary drivers for this have been cultural and business trends deeply entrenched within franchising. However, the current global financial crisis and franchising's own changing dynamics may alter this.
Why acquisitions have dominatedHistorically, the franchise industry has been predominantly represented by entrepreneurs in the form of franchisees and emerging franchisors. Given this fact, franchise companies often have a "lifecycle" pattern similar to that of the founding entrepreneur...

Since mid-2008, the economy, consumers, and the restaurant industry have been in the vice grip of the country's deepest and longest recession since the Great Depression.

Finally, a light at the end of the tunnel is beginning to emerge. Most economists are now saying we have reached or passed the bottom. While the going is certainly still rough, business conditions are beginning to improve, unemployment is stabilizing, and consumers are dipping their toes back in the spending pool. Capital flow is increasing, with equity investors coming off the sidelines and lenders beginning to seriously pursue new debt facilities for borrowers.

The economic recovery will bring increases in consumer spending, restaurant traffic, transaction counts, and sales levels...

Robert came to us to help him develop a 5-year Transition Growth Plan so he could sell his company and retire. He had high expectations for what the sale would net him financially, based on his presumed growth rate. Unfortunately, his presumptions were well beyond business reality. He had never utilized a written strategic growth plan or a business model innovation program. And the stagnant state of affairs which made up his company were proof of this.

The Next Step Program identifies the top 12 principal reasons which have caused business owner transitions and exits to be unsuccessful. Each of these reasons impacts the company's ongoing annual profitability as well as an owner's transition and future exit results. This article addresses the 7th of these 12 reasons:

Jake was visibly upset when he came to see us. He had been planning to retire in 3 years by age 55, based on the combined value of his personal investments and his company. This was now on hold for an indefinite period of time. Like many, he had suffered a significant hit in the 2008 through 2009 stock market declines. He wanted to visit about the benefits of a comprehensive wealth plan - something he hadn't taken the time to explore in the past.

The Next Step Program identifies the top 12 principal reasons which have caused business owner transitions and exits to be unsuccessful. Each of these reasons impacts the company's ongoing annual profitability as well as an owner's transition and future exit results. This article addresses the 6th of these 12 reasons:

The historical consolidation of franchise finance sources (local and regional banks, and other institutions) has led to only a handful of major players financing franchised companies over the last several years. These institutions, all well-known household names, have dramatically decreased leverage multiples while increasing interest rates and, most importantly, are tightly preserving capital until general economic conditions show signs of stability. As these lenders limit the flow of debt capital to franchising (or shut off lending completely), there are some trends all franchise owners should consider to ensure their financing needs are met during this recession.

Several recent economic indicators were not as bad as many investors anticipated...

Sam and Louie had been in business for about ten years, operating a chain of retail clothing stores. They were 50/50 owners in the corporation. When Sam approached us he had already been working for about 9 months to try to come up with a proposal which Louie would accept for dividing up their operations.

While they had gotten along well in the early years, Louie's hidden substance abuse problem had gotten the best of him. He wouldn't consider any type of reasonable purchase by Sam or a sale by Sam to Louie. Sam and Louie had never entered into any type of a Buy-Sell Agreement, based on the belief that they would always be able to work things out. No type of mediation was successful. Louie was simply unreachable regarding any type of purchase and the two were deadlocked and unable to reach agreement on any operational issues that needed to be dealt with...

Craig had a sales organization which he had built but had just recently suffered a serious setback when he came to us to talk about his Transition Growth Planning. He had helped develop three key employees whom he felt were primed and ready to eventually take over and purchase the business from him. Unfortunately, he had not yet communicated his vision for these employees to the employees themselves. Shortly before he met with us, these three key employees decided that their best future would be to develop a new business on their own. So they left Craig and took their book of business with them. Much of this business had been initially developed by Craig, who had been transitioning his contacts over to these three individuals.

We have identified the top 12 principal reasons we've seen where business owners have failed to plan, which has caused their transitions and exits to be unsuccessful...

Sam had developed and owned a successful retail operation during his business career. He also tried to be diligent by having what he thought was a sound estate plan executed before he died. He and his wife Sally felt they had everything taken care of. So when Sam died unexpectedly, Sally was dismayed to see the vehement dispute that developed between her two sons as to who would operate the company going forward. Apparently Sam had spoken to both of them about running the company if something happened to him, but he had failed to make this decision. Sally ultimately found her only choice to resolve the dispute was to just sell the business.

We have identified the top 12 principal reasons we've seen which have caused business owner transitions and exits to be unsuccessful...