Multi-Unit Franchisee Magazine Issue IV, 2015 | Page 73
ExitStrategies
BY DEAN ZUCCARELLO
Getting in the Game
New entrants must pay more to play
“The secret of getting ahead is getting started.”
—Mark Twain
F
inancial and first-time buyers are
showing tremendous interest in
the franchise space. Yet as they are
continually outbid for attractive
opportunities, the frustration in entering
certain systems may be at an all-time high.
Why is this the case? One reason is that to
be competitive, they will
typically have to accept a
below-market return on
their first deal. This is
also known as the price
of first-time entry, a key
facet of doing deals known
to industry insiders.
At the other end of the
spectrum, we have seen
consolidation in the big
franchise systems in recent years, which has in
turn created the “mega
franchisee.” Why does
it seem so easy for these
massive franchise operators to continue to grow
their holdings, while other
prospective qualified buyers struggle to gain entry?
Sitting in the position of a first-time
buyer or new entrant to a particular franchise concept can be a huge challenge. Not
only do you have to prove you are capable
of operating in a new business model, you
also have to worry about making the right
connections to earn the designation of
“legitimate prospect.”
Let’s assume we have three hypothetical buyers. Buyer A is a new entrant, Buyer B is a small to mid-sized
franchisee in the system, and Buyer C
is a mega franchisee. Employing hardearned business savvy, Buyer A made it
onto the short list of potential buyers for
our hypothetical franchise transaction.
Yet why is this buyer still at a disadvantage? What it comes down to is a lack
of operating leverage. Lacking an existing operating infrastructure to leverage,
Buyer A enters the game down 2-0 from
the start. This is where Buyers B and C
have a distinct advantage.
Consider Buyer B. Being a franchisee
already in the system provides an immediate advantage over Buyer A. Buyer B is
familiar with how this franchise system
functions and has the ability to leverage
an existing infrastructure and business
platform to operate additional stores at
a lower cost than Buyer A.
Yet it is Buyer C who typically has the
greatest advantage of all. Not only does
this buyer have the existing infrastructure and business platform to leverage,
Buyer C’s organization has grown to a
level of operational sophistication where
it can run the business at a lower cost,
thereby producing higher profit margins,
ultimately enabling him to either pay a
higher price or enjoy a materially higher
return at the same price as Buyer A. This
higher return means there is more capital
to then redeploy, continuing the cycle.
This well-oiled machine of an entity has
the ability to take on new stores with very
little incremental costs associated with
the acquisition. Buyer C has full confidence in exactly what action is needed to
integrate the acquisition, having done it
many times before.
These factors all heavily influence the
muf4_c_exitstrategies(71).indd 71
purchasing power of Buyers A, B, and C.
Buyer A, with no existing business platform to leverage, has very little room to
maneuver when submitting a bid to hit
a targeted ROI—and is left in a position
where the purchase must include the
seller’s infrastructure and platform of
operations. As a result, Buyer A’s cost of
infrastructure on this transaction will be
higher than that of his deal competitors,
who can acquire the transaction with a far
smaller incremental cost. This ultimately
translates into Buyer A submitting a lower
offer in order to achieve the returns Buyers B and C can expect.
The net effect is that Buyers B and C
can “overpay” by the standards of Buyer A because their forward multiple is much
lower than the trailing
12-month multiple. Because of this, Buyer A
must be prepared to pay
a higher price to secure a
market competitive deal.
Buyer A’s other option is
to consider acquiring a
business that has more
challenges and is therefore less competitive but
has additional risk.
At some point, Buyer A
must get started, and usually that means paying an
above-market multiple to
acquire the ongoing business platform. Completing this first acquisition
will put Buyer A into a more competitive
position for the next deal bid on.
This is the cost of entry in the restaurant industry, but it is important for
Buyer A to remember that his company
has the potential to become Buyer B and
even Buyer C in the future.
Dean Zuccarello is CEO
and founder of The Cypress
Group, a privately owned investment bank and advisory
services firm focused exclusively on the multi-unit and
franchise business for 25 years.
He has more than 30 years of financial and
transactional experience in mergers, acquisitions, divestitures, strategic planning, and
financing in the restaurant industry. Contact
him at 303-680-4141 or [email protected].
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