Franchise M&A Experts Say Outlook Is Optimistic, Despite Economic Uncertainty
Leaving the annual Restaurant Finance & Development Conference in Las Vegas in November, it’s clear experts are cautiously optimistic about 2024’s dealmaking environment.
“The reality is, there’s cycles that we go through and 2024 is going to be potentially another one of those,” said Anish Gandhi, a managing partner at Brookwood Associates. “Ultimately, I think that you have to look at your business with a long-term outlook. If you’re looking to go to market, you have to be able to demonstrate and communicate the long-term outlook of a business, not just 2024.”
With unpredictable events impacting the global economy, it’s hard to be sure what’s to come in the M&A space for 2024—or ever. “Dealmaking has a lot to do with certainty. You’d like to have some certainty before you make an investment,” said Andrew Smith, managing partner at Savory Fund. “The problem is, there’s just so much uncertainty in the world, in the economy, with the consumers.”
The Federal Reserve increased interest rates by more than 5 percent from 2022 to 2023 after lowering rates significantly upon the onset of the COVID-19 pandemic in March 2020. The hike slowed mergers and acquisitions in 2023, following a prolific market in 2021 and 2022. In 2022, major deals included Larry H. Miller Co.’s purchase of a majority stake in soda brand Swig, Gala Capital’s acquisitions of Rusty Taco and Dunn Brothers, and NRD Capital’s sale of Fuzzy’s Taco Shop to Dine Brands.
Now, Swig is thriving, having opened about a dozen stores in 2023, with hundreds sold, Smith said. Savory Fund helped Swig grow to almost 50 units before the sale. Savory evaluates deals based on a so-called “it factor,” Smith said. “It’s when you go into a restaurant and you leave and you’re like, ‘Oh, man, that was amazing.’ … We’re not just investors, we’re consumers.”
In a slower market, patience is the name of the game, Smith said. “I think we’re just being a little more cautious and we’re looking for those that rise above the rest,” Smith said. In 2021 or 2022, Savory would look at, say, 50 brands and of those, 20 would be “really good targets.” This year, it’s been more like one for every 50.
Franchise Equity Partners launched in late 2021, but founder Michael Esposito has worked in the M&A space for decades, previously a partner at Goldman Sachs. “2023 was a transitional year in a few ways,” Esposito said. “The consumer was resilient, but softer. You needed to be more selective.” Sellers weren’t necessarily getting the price they sought, so some decided not to sell.
Heading into 2024, and assuming interest rates remain stable, “It’s going to put pressure on companies that leveraged up a lot in the last two or three years and didn’t hedge their interest rate exposure,” Esposito said. “Any of the buyout deals that were done in the 2020 to 2022 period, where the company didn’t hedge their interest rate exposure, leveraged up a lot, could start to have real challenges where people are hitting covenants.”
Private equity firms need to return more capital to their investors, but the capital return pace has decreased significantly, Esposito said. At some point, those investors will demand their money back. “I think both between the bank covenant issues as well as this emerging pressure in private equity firms, I think it’s going to force people to think hard about it,” Esposito said.
Franchise Equity Partners has eight investments across four verticals, as of early December, including Taco Bell franchisee Pacific Bells, large Focus Brands franchisee Fresh Dining Concepts and, most recently, Neighborly franchisee Rapp Operations.
In the grand scheme of things, a 7-plus percent interest rate is not really that bad, Brookwood Managing Partner Amy Forrestal said. “People are panicking because we got so spoiled by such low rates for so long. It’s basically free money, which is what drove a lot of valuations,” Forrestal said. “I think there is going to be some adjustments on everyone’s cards. Also, a lot of buyers, when they hear ‘potential recession,’ they want to go get a deal, they want to buy and they’re gonna have to be realistic that you’re not going to get to steal stuff.”
