Franchisors seeking to grow in a tight credit environment and slow economy are turning to private equity to counter a slowdown in financing and cash flow. For struggling systems, capital "infusions" or outright acquisition by private equity firms can replace diminished royalties and franchise fees; for successful brands, this source of additional capital can be used to accelerate growth and provide a competitive advantage.
For many reasons particular to each brand, franchisors are trading loss of control for an injection of capital and investor expertise to fund growth-oriented initiatives such as hiring new sales staff, increasing training programs, upgrading technology, launching marketing campaigns, and offering reduced franchise fees and/or initial royalties to build the system - secure in the knowledge that they have partnered with deep pockets. They can use the funds to penetrate a new market, even to acquire a local competitor.
Regardless of how the money is used, the goal generally is to apply it to building the system - and, especially for cash-strapped franchisors, it relieves the pressure to generate short-term revenue and allows management to concentrate on growing the system over time.
Partnering with private equity can be a rational choice in a tight credit environment, depending on your time horizon, growth and profitability goals, and the state of your cash flow. For some, partnering with the professional managers provided by private equity partners relieves the burden of strategic decision-making; although for others, the loss of autonomy is a deal-breaker.
A few recent examples from the news highlight what may be a growing, if not cascading, trend:
What does this mean for franchisors, specifically restaurants? Will there be a domino effect? Will franchisors feel compelled to seek out private equity capital as a defensive move against newly strengthened competitors? Will the huge backlog of pent-up investment capital begin to flood into franchising, creating a flurry of growth initiatives in a consumer environment still struggling to regain its footing? Will cash-rich franchisors overbuild and find themselves facing another economic downturn?
And what is the "price" of capital for franchisors, in terms of loss of control over such crucial issues as brand identity, the pace of development, and time horizons for ROI? Private equity firms are bound to repay their fund investors by a specified date. Whether that horizon is three, five, seven, or 10 years, strategic and tactical decisions will be affected.
So who's next? On May 18, the Motley Fool investor site (http://www.fool.com) ran a piece on the spate of restaurant acquisitions by private equity firms, predicting more ahead: "Restaurants have become popular acquisition targets, a trend that's likely to intensify in the coming months," the author wrote, continuing:
"Several factors suggest that these buyouts are simply starter courses:
He named three public restaurant companies - California Pizza Kitchen, McCormick & Schmick's, and Cheesecake Factory - as likely candidates: "These are the stocks to watch. Don't focus entirely on market darlings such as Panera Bread and Chipotle Mexican Grill, which have little reason to cash out. You need strong brands with just enough hiccups to make them vulnerable to going private, provided the premium is fair to shareholders."
For now, restaurants are the darlings - and acquisition targets - of private equity. Will other industries and sectors follow?
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