Private Equity and Franchising: 7 Pitfalls to Avoid

Last week, I had the privilege of speaking on a panel at the 2013 International Franchising Expo with esteemed private equity leaders from Fisher Zucker LLC, The Dwyer Group (full disclosure: a client of BDO’s), The Riverside Company and Harris Williams & Co. We discussed the role private equity has to play in the growth of the franchise space, and what companies—both franchisors and private equity firms—need to be on the lookout for when injecting private capital into a franchise.

Over the course of the conversation, we discussed some of the common mistakes franchisors and PE firms make when finalizing a deal. Here’s a list of these pitfalls, and what companies can do to avoid them and pave the way for a smoother transaction:
  1. Not investing in qualified professional counsel. Whether you’re the franchisor or the private equity firm, having skilled legal and financial counsel is a bottom-line requirement in these types of transactions. Investing in good advisors up front will help you avoid snags during and after the financing.
  2. Inadequate or non-existent due diligence. Both the buyer and the seller need to complete thorough due diligence before entering into a transaction. On the buy side, a private equity firm should be looking in particular at the management team, the strategy and the value proposition of the franchise. On the sell side, the franchisor must be sure to get their house in order with updated, clean balance sheets and a clear understanding of the unit economics of their company.
  3. Failing to plan in the long-term. With these types of deals, a franchisor is often selling his or her most significant asset, and needs to be thinking in terms of not only their success, but also the success of the franchise itself. Any franchisor going into a deal thinking only of his or her own bottom line will likely put off a prospective investor.
  4. Failures of communication. As with any financial transaction, the investor and franchisor must align visions and agree upon a direction forward. More importantly, however, all parties must be transparent with each other about their goals, and maintain clear and open lines of communication.
  5. Trying to change company culture too quickly. In investing in a franchise, a private equity firm is investing in an established culture. While some cultural changes may be required to improve the business, any efforts to force change too quickly and with little consensus will likely encounter resistance from all sides.
  6. Overleveraging the franchise. Saddling the franchise with more debt than it can bear could stifle its growth and ultimately undermine the soundness of the investment.
  7. Maximizing profit at the expense of the franchisees. When investing in a franchise, a private equity firm isn’t only entering into an agreement with the franchisor—it is also entering into an agreement with a large network of franchisees. The fortunes of the franchise rise and fall on the success of these business owners, and the deal must take into account their long-term growth and health.
We believe the best way to avoid all of the above perils is to manage the investment from the bottom up, taking into account the needs and growth of each franchisee and building the strategy from there. An inclusive, holistic vision is critical to the success of any major transaction in the franchising space.

Jay Duke is an assurance partner and leader of the Franchise practice at BDO USA.

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