Want to buy a franchisee of a well-known brand? It’s going to cost you.
As we wrote yesterday, large franchisees are fetching higher prices — making this one of the best sellers’ markets in recent memory. These days, prices for large-scale franchisees are approaching eight times cash flow.
That’s a lot. “When I started and you talked about the value of a franchisee, people talked about 4.5 to 5.5 times EBITDA,” said Bill Kraus, senior managing director of GE Capital, Franchise Finance. “That might still be true. But for consolidators that have a lot of scale, prices are in the 7s now.”
Not all franchisees can fetch these multiples. These prices are typically reserved for the best-known brands with large, market-dominating positions. Still, the recent run-up in prices is due to a number of factors that have generated a perfect storm, allowing sellers to break the bank when they want to exit their investment. Here are the reasons, not in any particular order.
There are a lot of restaurant lenders. The post-recessionary environment has brought a lot of new lenders into the restaurant space. These lenders are determined to generate new business, making them compete for loans. In many cases, they’re convincing existing franchisees to expand their business. “There’s a push to create more borrowers,” said David Epstein, principal with J.H. Chapman Group LLC, which tracks restaurant mergers and acquisitions. “If you have an existing borrower that is an existing franchisee who knows how to operate, lenders are encouraging them to bid on some of the spinoffs of the parent.”
Interest rates are low. As long as interest rates remain at historic lows, buyers will have the fuel to pay high prices for franchisees. It’s simple math: If you’re paying less money on a loan, you’ll be able to pay a higher price for an acquisition. And Epstein noted that many operators have refinanced loans, providing them with equity to make deals.
Private equity is involved. According to the M&A census, private equity involvement in restaurant deals fell in 2014. But they still involved 22 percent of all deals. Equity funds have been increasingly involved in restaurant franchisees in recent years. That move has generated increasing competition for deals, which drives up prices. “Private equity likes to blame it on we lenders for providing too much capital,” Kraus said. “But it takes two of us to make that happen.”
Existing operators can pay higher prices for stores in their own systems. As Epstein pointed out to me this week, many franchisees are gobbling up stores in systems they currently operate. These operators already have the infrastructure in place to support restaurants, and can spread general and administrative spending over a larger base of stores. That’s an easy way to increase profitability at acquired locations, which makes a higher price work. One franchisee once told me he would, on the surface, pay 6x cash for an acquisition, when in reality he was paying 3x because he could make simple changes to increase profits at the new locations.
Restaurant franchisees are surprisingly low-risk investments. It’s not much less risky to buy a franchisee than to start your own business. But they are a lot less risky when the brand you’re buying is a well-known brand name with a long history. So the brands fetching high multiples include Taco Bell and Wendy’s and Papa John’s and others that have been around the block for a few decades. In addition, the buyers are purchasing entire markets of these brands, removing the risk that a rogue operator could mess up a brand’s reputation in that market. As more buyers discover these benefits, they’re jumping into the market and they’re bidding up prices.