Franchising as a business model has always been about scale: taking a good concept and creating a great brand through the local owners acting as brand ambassadors. But as the top fills out for private equity investments, a more interesting trend is the rise of M&A activity in the mid-market franchise segment, which has many regionally strong concepts with significant growth potential.
An internal FRANdata analysis that tracked close to 58 private equity transactions over the 2017 and 2018 period revealed that nearly 60% of these private equity acquisitions were for concepts that had less than 150 units in their franchise system at the time of their acquisition. System sizes ranged from brands with as low as 3 units (Crushed Red acquired by Vitaligent in 2017) to brands, like SkyZone, which have managed to create a strong brand appeal but had only approximately 150 franchised units when acquired.
This trend started back in early 2017 with Roark Capital reaching out to Jim ‘N Nick’s Bar-B-Q, which then had only 37 units and was not even franchised. This has now continued as we enter Q2 of 2018. Earlier this year, a little-known South Carolina-based breakfast chain with 22 units, Eggs Up Grill, was acquired by WJ Partners. The private equity firm is known in franchise circles as an investor in Pure Barre, which has more than 450 locations across North America. Following the acquisition, the new private equity owner beefed up the brand’s corporate infrastructure in several areas, such as franchise development, operations, real estate and marketing to prepare for a more national expansion. At the same time another firm, Baird Capital, which owns Chem-Dry and N-Hance, acquired a 5-unit franchise called Delta Disaster Services, while 85-unit Juice It Up! was acquired by a consortium of investors: Dover Shores Capital, Britt Private Capital and Jupiter Holdings.
So why are mid-market deals attractive to an increasing number of private equity investors? Lately, fundraising has been robust, which means there’s a lot of money chasing the best deals. That, in turn, has driven up prices for franchise companies that are being actively pursued for acquisitions. For PE-sponsored deals valued between $10 million and $250 million, average valuations have risen to 7.4 times EBITDA, the highest they’ve been since 2003. The average amount of debt for those deals has also climbed to an all-time high, at 4.6 times EBITDA.
This turn towards middle market franchise companies does not look like it will cease anytime soon. According to a research by Capstone Strategic, middle market executives are eager to execute acquisitions in 2018. 46% are more than 50% likely or 100% certain to pursue deals in 2018, compared to 35% in 2017. Another survey of middle market executives reported similar findings: about 75% of middle market CEOs reported they are currently involved in or are open to acquisitions.