Not so many years ago, less than 30, the words “franchise” and “private equity” were rarely used in the same sentence. Today, private equity firms routinely buy franchise brands and they occasionally do so at head-spinning multiples.
Some recent acquisitions at rare multiples of EBITDA in the low to mid-20s are difficult to fathom, and while many experts say the astronomical payouts won’t last long, everyone agrees that private equity and franchising are a perfect fit. The news is heartening, especially for franchise founders looking for their big payday.
A perfect example
In recent years, countless franchise brands have been gobbled up by private equity firms; none more famously than The Dwyer Group (renamed Neighborly) launched in 1980 in sleepy Waco, Texas, by the late Don Dwyer, Sr.
A franchise visionary, Dwyer saw franchising as an opportunity to help ordinary people build personal wealth one business at a time. He also saw a franchise home office as an opportunity to offer multiple concepts that could enhance growth and operating efficiencies. In a sense, Dwyer envisioned private equity outcomes even before private equity discovered franchising.
Shortly after establishing his first franchise brand, Rainbow International Carpet Dyeing & Cleaning, Dwyer explained that his home office, which provided all the services needed to support franchisees, was like a “birdcage.”
It bothered him that his cage (he actually had one outside his office) housed only one bird! Thinking that was a missed opportunity, Dwyer went hunting for more “birds.” By the early 1990s, his home office was supporting nine brands, most of them home services franchises. But all those birds required capital to grow, so Dwyer’s next move – pre private equity – was to take his company public.
Upon his sudden death in 1994, Dwyer’s company, with outlets across the U.S.A. and in several countries and system-wide sales pushing $150m, would be managed by his children, including Dina Dwyer- Owens who was appointed CEO.
Within a couple of years Dwyer’s management team, which controlled 62 per cent of the stock, and the company’s board of directors, realized the public market was not suited for the business.
“That’s when we enlisted a banker to help us return to a private company,” explained Robert Tunmire, who led Dwyer’s franchise development efforts for nearly 40 years. “We had never heard of private equity – we thought we’d find a strategic buyer.”
But suddenly, private equity showed up! And in late 2003, with system-wide sales of $424m, The Dwyer Group returned to private ownership with funding provided by the Riverside Company, which paid an impressive multiple of seven times EBITDA.
With plenty of capital, Dwyer’s management team pursued more opportunities, and after seven years of increasing growth, with annual system-wide revenues topping three-quarters of a billion, Riverside sold the company to another private equity firm in 2010 and then, four years later, with system-wide sales nearing $1bn, bought it back only to sell it again after a second bite of the apple.
The company, renamed Neighborly in 2018, reached system-wide sales of $3bn by 2021 when it was sold to the global investment firm KKR. Stay tuned because it’s unlikely KKR will hold the company – it needs to reward its investors.
Meanwhile, is there a more amazing story in franchise history? What started as a modest family business with a founder who “risked it all” numerous times mushroomed into the world’s largest parent company of 29 (and counting) home service brands and nearly 5,000 franchises in nine countries. It couldn’t have happened without money from private equity.
While most private equity deals in franchising will never achieve Dwyer-esque status, private equity continues to produce impressive outcomes in franchising. And it’s not just about the money anymore.
Money and expertise
“Thirty years ago,” says John Nies, a managing partner of JMH Capital in Boston, Massachusetts, money was the primary benefit that private equity investors could provide to franchisors. “Capital allowed for rapid growth. While it typically took a franchise brand many years to grow to 100 units, a private equity-backed brand could achieve the same results in a matter of a few years.”
For franchisors not looking for other people to be accountable to or to participate in the growth of their business the money option still exists. However, Nies points out, “PE has evolved to where there are firms that focus exclusively on franchising and they have significant expertise.”
PE firms can provide money and expertise to enhance marketing, training, site selection, technology and other competencies that catapult a brand into rapid growth.
It’s all about growth
PE’s model is predicated on growth, upside potential, scale, risk and market dynamics attests Neighborly’s dynamic CEO, Mike Bidwell.
“PE firms want to ensure a good outcome. They raise a fund from investors to buy companies, typically paying a market price, sometimes even a premium price, and they need that company’s EBITDA to increase so they can sell the company again, typically to another PE firm, thereby returning capital to their investors. The PE firm keeps some of the upside.”
Most PE companies, says Bidwell, do not want to operate the business. “They are there to support and nudge” the outcome they desire. The PE firm brings positive pressure and capital to grow a business bigger and faster than it would typically do with a founder in charge.
Beneficiaries include franchisors and franchisees
“PE provides founders a great exit option,” says Bidwell, but he cautions that multiples vary widely. “The PE partner is often a cash buyer paying a compelling multiple for all those years of sweat equity expended by the founder.” PE can also provide tremendous incentives for a management team.
But does it benefit franchisees, the people who provide the money, time, and talent that ultimately makes a franchisor attractive to a PE investor? Most experts say it does, but not always.
PE companies must eventually return a profit to their investors and in the process of doing that they may decrease the level of support provided to franchisees or they may require franchisees to achieve higher benchmarks.
“Franchisees who don’t meet the standards may have to exit the network,” explains Mark Siebert, founder of iFranchise Group in Chicago, Illinois. “If you’re a bad operator, PE may not work in your favor.”
On the other hand, Siebert says PE may bring expertise that will help the franchise network negotiate pricing discounts, improve marketing and technology, attract better-skilled professionals to work in training and operations, and ultimately create more aggressive growth that generates more brand awareness, and improves the value of the business overall, which pleases franchisees and franchisors.
Nies, who pursues opportunities with both franchisors and franchisees, points out that private equity isn’t just for franchisors. He explains, “PE firms are pursuing franchisees who need capital to open more units. Multi-unit development is very attractive to millennials and Gen X franchisees.”
How to attract PE firms
Attracting private equity opportunities is less challenging than it used to be because PE firms are “all over franchising,” says Tipton Shonkweiler, president of Accurate Franchising, a subsidiary of United Franchise Group in West Palm Beach, Florida.
“Dozens of PE firms are constantly seeking brands, including small brands, that fit their mold. They’re eager to have discussions about how they can help a brand grow and we’re going to see more of this, not less.” Shonkweiler says this is encouraging news for franchise companies with “a good story to tell.”
That story used to be more difficult to create than it is today, says Nies. “A good story used to include a half dozen to ten elements of competency to grab the attention of PE firms, but now these same firms are comfortable working with less developed opportunities because they’re confident they can bring expertise to the table to ensure success.” Nowadays the story needs to include the following elements:
- Unit economics – “Franchisees must be making money,” says Geoff Seiber, CEO, FranFund, Fort Worth, Texas. “PE firms want concepts where the unit economics show at least $1m in annual revenue.” Tunmire adds that in addition to financial success, franchisees must be “happy”
- Clean business – “You aren’t likely to attract PE money if your business has legal issues or if your accounting is inaccurate,” explains Tunmire
- Growth – “We look for brands that have the ability to lead their vertical,” says Rob Weddle, CEO, Authority Brands in Columbia, Maryland. “Six of our 12 brands are number one in their space.” Weddle says he wants to acquire brands that can be at least in the top three in their category. Tunmire says PE firms want to see not just topline growth but also EBITDA value
- Management team – “If a member of the PE company walks into the home office and asks, ‘Is this a great business?’ the management team better be on fire,” says Tunmire. It’s not enough for the team to be competent; Tunmire says the team needs to be “inspired.”
Few brands have the perfect story to tell; most will have a glitch or two. But in today’s climate, where money is more plentiful than good deals, PE firms are more understanding.
“If the business model is solid and the franchisees are making money, you can have a problem here or there and still attract private equity money,” explains Tunmire. You may even get a multiple that will make your head spin, but all the experts say those numbers are going to decline as the market changes.
Nonetheless, whether you’ve created a franchise system that includes a few franchisees or a few dozen franchisees, private equity and franchising are a winning combination and PE firms are looking for you.
Dr. John P. Hayes, CFE, is the Titus Chair for Franchise Leadership at Palm Beach Atlantic University in West Palm Beach, Fl., where 50 undergraduate students are earning a Concentration in Franchising.