When it comes to the intersection of private equity (PE) and franchises, advice can be difficult to find, and the overlap can be complicated to understand. That’s where great leaders come in—leaders like Alicia Miller.
Miller is the Managing Director of Emergent Growth Advisors and the author of Big Money in Franchising: Scaling Your Enterprise in the Era of Private Equity. With two decades of go-to-market leadership in the corporate world, plus experience as a multi-unit franchisee and as an advisor to franchisors, multi-unit franchisees, and private capital firms, she’s seen firsthand where the PE and franchise worlds overlap and where they present big opportunities for savvy leaders.
Miller wrote her book to address what she calls a “huge gap in understanding” in today’s business landscape. “Franchising isn’t well understood, and private equity has a similar problem. The mash-up of the two together created the perfect storm of misconceptions and misinformation. I could see that although PE had become a dominant player, the rest of franchising hadn’t found a way to digest that reality and do something with that information.”
Blue Rock Search sat down with Miller to discuss the impact of private equity on franchising, how leaders in both fields can shape great results, and which opportunities and obstacles to keep in mind.
How Private Equity Is Transforming the Franchise World
The presence of private equity in the franchise landscape has grown exponentially in recent years, and Miller describes a resulting market split between the “haves” and the “have-nots” from a PE perspective.
“Only around 20 percent of franchise systems have been touched by PE at the brand level, the franchisee level, or both. No surprise, there is heavy overlap among the top systems in terms of revenue, the brands that have the best franchisee satisfaction scores, and those with the fastest growth,” she explains. “PE dominates, but they’re very selective! And their assistance in many cases does what it is intended to do—it accelerates brands.”
In contrast, this selectivity on the part of PE firms means that thousands of franchise systems don’t have PE support and probably never will. “PE needs to invest, but they can’t stretch their model too far,” Miller says. “They prefer proven brands with some scale and relatively sure bets. They avoid turnarounds, sub-scale brands, and drama if they can.”
Once these franchises have gotten PE involved, Miller describes the PE-driven transformation of the franchise world as akin to creating a new ecosystem or weather system.
“Private equity swept in pretty fast. Franchisors and franchisees were focused on running their businesses. Then, seemingly overnight, PE was everywhere. Now everyone needs to factor PE into the equation,” she says. “They’ve created their own mini-weather system within franchising. They invest in a few opportunities and largely trade franchise businesses amongst themselves. Academic research points out that once PE has acquired a company, if it sells again, it’s most likely to be sold to another PE firm—instead of a strategic buyer or going public. That’s exactly what’s played out in franchising.”
These acquired franchises tend to follow a now-established pattern, Miller says. First, emerging brand specialists focus on growing newly-acquired brands to a certain phase, and then the growth-minded firms (ones that prefer to work with larger businesses) take over. At some point, the growth will slow, and value-based investors take the reins and hold it for a longer period. Different companies may have slight variations, but this is a common journey.
Avoiding Common Pitfalls
As with any major move in the marketplace, the intersection of PE and franchising comes with both opportunities and dangers. Miller identifies two significant pitfalls: poor communication and unforced errors.
“In the early days of franchising, PE might’ve had some overconfidence in its ability to turn around struggling franchise businesses,” she says. “But you have this dynamic with independent franchisee business owners: you have to get them on board with your changed agenda. And if they’re just not on board, they might cooperate but might lose their mojo when it comes to wanting to grow again. Now, you’ve got a stall out on your hands.”
Miller reminds franchise leaders to guard against these miscommunications and overconfidence: “PE is not here to fix your problems. They want momentum. They want to back a great team, a great brand that’s going places.” Today, PE’s franchise acquisition focuses on brands likely to thrive, not ones needing serious overhauls.
The second potential problem—unforced errors—tends to come more from the PE side of the equation and often involves common moves that hinder long-term success.
“Loading a business with too much debt is just a bad idea, which is why debt levels have moderated quite a bit and have come down,” Miller says. “You also can underinvest in the future. And if you take that to its extreme, it weakens the brand over time. It weakens franchisees’ enthusiasm for growth if they’re not confident in where the organization is going, which can bring your value down.”
To avoid this particular pitfall, Miller recommends something straightforward: maintaining a true partnership approach. “These entrepreneurs will do amazing things if you let them. But if you start trying to be overbearing and over-controlling, and the balance in the relationship starts to shift, you’re going to run into trouble.”
How Franchises Can Prepare for Acquisition
What can franchises do to make themselves appealing prospects for PE acquisitions? According to Miller, it all comes down to one thing: doing your homework!
“So many people start a business without any exit plan in mind. If you want to be acquired by any sort of sophisticated investor—whether it’s a PE sponsor, a multi-brand platform (many of which are now PE-backed), or a strategic acquirer—you can’t enter the sale process casually. It takes careful preparation and a lot of deep thinking about your objectives and timeframe,” she says.
It’s important not to jump at the first opportunity but to take the time to consider options and evaluate the possibilities.
“Too many founders start taking random calls from PE firms, and suddenly they’ve got letters of intent on their desk. That makes it about them and not you. You will end up wasting time and could get a sub-optimal outcome that way,” Miller says. “In the heat of a sale, everyone is on their best behavior, and it’s stressful. Give yourself the gift of time by getting help early to explore these issues, get ready, and create clear priorities. You’ll get more value and feel much better about the process. You may even be able to delay talking to buyers as you execute your sensible growth plan. Then, when you’re ready to come to market, you’ll have an even better story to tell!”
The connection between PE and franchising is stronger than ever, as professionals on both sides realize how they can mutually benefit. To achieve those benefits, however, both sides must be well-prepared, well-versed in the market situation, and knowledgeable about avoiding the biggest stumbling blocks. It can be a challenging moment, but with the right knowledge—and the right leadership in place—PE investments in franchises can be a golden opportunity to reach more customers than ever.
About the Author
Nancy Estep-Critchett is a founding Partner of Blue Rock Search, with oversight of the Franchise Practice. She has 30 years of successful working experience as a business advisor and executive recruiter in the franchising space. Nancy has built solid relationships which have spanned decades with industry professionals and internationally recognized brands.