Part two of a three-part series
Last issue, we discussed growth through nontraditional franchises. Private equity firm investments of significant amounts of capital in franchisors and in franchisees represent another avenue for sales growth. Economic travails have led to the availability of sites with increased negotiating leverage for prospective tenants and experienced franchise talent. But in this tight financial market, where are the dollars to take advantage of those opportunities? We explore private equity firm concerns, what to expect in negotiations, and when franchisors should "just say no."
Over the past few years, private equity firms have invested in troubled franchisors; brands that are mature and well-known; brands that lack the funds to go to the next level; and multi-unit franchisees that control their markets. Predictability, clarity, and meeting investors' expectations for a return on their investment are paramount considerations. Those considerations require a franchisor willing to compromise on some long-standing policies and franchise agreement provisions and that understands the private equity firm's need for expansion rights. Private equity firms research when to get in, and conversely, when to get out. When the time is ripe, private equity firms will seek to exercise an exit strategy consistent with their investors' expectations, usually within 3 to 10 years.
Exit strategy drives negotiations between private equity investors and franchisors (even when the potential investment is in a franchisee). Expect requests to:
Exit strategies are not the only concerns in a potential franchise relationship. Other important negotiating points for private equity investment are to:
Balancing the interests of the franchisor and the interests of a private equity firm may take some fine-tuning. How important is sales growth to the franchisor? Might a franchisor favor concentrating on improving its concept or providing extra help to its franchisees, rather than on expansion while financing is unavailable? Where will expansion financing come from, if not from private equity groups? How much control will a franchisor want to abandon to entice private equity investment? All are tough issues for franchisors to think about.
If a franchisor decides that private equity financing would be beneficial for the overall health of the chain, it will nevertheless want to stand firm on any provision in a franchise agreement that protects the brand. A franchisor will want to:
These and other critical issues must be carefully evaluated, often with the assistance of an experienced business and legal professional. With an understanding of this different world, challenges can lead to opportunities.
Jan Gilbert is a partner and Gayle Cannon is of counsel in the Franchise and Distribution Practice Group of Haynes and Boone LLP and can be reached at firstname.lastname@example.org and email@example.com.