What Role Does Private Equity Play in Franchising Your Business?
With the strong growth of the franchise industry, it’s no wonder private equity firms are looking closely at it for investment opportunities. From franchisors to multi-unit franchisees across all segments, private equity firms are increasing their role as a source of capital investment in different ways.
And, franchisors, who typically look for sources of capital to grow their franchise system, are increasingly more open to working with private equity firms for a variety of reasons. Some are looking to infuse their business with capital to spur expansion efforts, while others are hoping for a strategic partner to provide direction, guidance and insight to help the company prosper. Still, some founding franchisors seek private equity investment as an exit strategy.
But, it’s important for franchisors to understand how private equity firms operate and what their motivations are before giving up any equity.
The Role of the Private Equity Firm
In simple terms, private equity firms are made up of different kinds of funds that investors have contributed to. The firms use the money from the funds to invest in other privately-held companies. Typically those companies are established, profitable, and have growth potential. Naturally, investors expect a return on their investment.
Franchises are attractive to private equity firms because the revenue stream is steady and predictable thanks to the royalty flow from franchisees. The cash flow is also strong and the capital investment is low as franchises are typically asset-light businesses. Plus, franchising is a proven business model, so investing in a franchise company is a relatively low-risk deal for private equity firms.
Investments made by private equity firms stem from a variety of scenarios, which often dictates the role they will play, including:
- Provide growth capital – Private equity often assists franchise companies with product development, geographic expansion or acquisitions. Franchising is all about growth, so it’s not uncommon for franchisors of successful brands to need additional capital to continue expanding the concept.
- Company buyout – A private equity firm may buy the entire franchise company in a control sale. It may or may not keep on the founder or management team. If the firm likes the success the franchise company has experienced or sees that franchisees respond well to current company leadership, it may decide to keep the old guard on and work as a strategic partner to provide guidance as well as capital. But, as new owners, the private equity firm can also replace the leadership and bring in individuals that may be more effective at achieving the firm’s goals.
- Founder cash out – The owner/founder may be ready to retire or move on for other reasons and want to sell. Private equity firms may buy out the owner/founder, but keep the leadership team and existing investors. However, firms are typically more interested in these types of sales if they can acquire a controlling stake.
- Recapitalize – Private equity firms are often open to investing in struggling franchises as long as they see real potential for revitalization and growth. The capital may be used to restructure the company.
Considerations Before Going with Private Equity
Private equity firms can provide a tremendous shot in the arm to franchises. But, it’s important to keep in mind that the investors at these firms are primarily concerned with a return on the investment they’ve contributed to the firm’s funds. They also typically only hold an investment for five to seven years and then the fund will force the liquidation of the investment, meaning that your franchise may change hands often. This can be very tumultuous for franchisees who like relationships and predictability in their ownership.
As a franchisor, if you’re concerned about losing any control, you will have to invest time and resources into negotiating the terms of a private equity deal. If you’re interested in a control sale, or a sale in which the firm acquires majority ownership of your business, it’s important to carefully consider your role in the company’s success and be prepared to negotiate that as well.
For help deciding whether seeking private equity help is right for your brand, turn to Winmark Franchise Partners. With 30 years of franchising experience and more than 800 franchise owners representing over 1,225 locations for five brands, Winmark Franchise Partners can help grow your brand through sound strategy and expert franchising advice. Contact us here or at (844) 234-8520.