The do’s and don’ts of restaurant M&A

Restaurant franchises have been alluring to entrepreneurs and investors since the mid-1950s when McDonald’s created the operational template for this important business segment. Some buyers are attracted to a proven business model, name recognition and support from the franchisor. Others want a brand that can grow and offer economies of scale.

But for many, a franchise is rarely held forever. Reasons for selling range from the desire to retire to having taken the concept as far as the operator wants to or can with their existing team — or simply to capture the value they’ve created. Regardless of the reason, though, “getting ready to either acquire or sell takes work, and experienced operators know to start well in advance,” says Edward “Ted” Lynch, managing director with Bank of America Global Commercial Banking’s Restaurant Group.

What sellers need to know

If you are in the day-to-day trenches of running your business, getting ready for a sale is akin to taking on a second job. While strong concepts are always in demand, it helps to be realistic about what your operations can sell for. Here are some things you can do to make your deal attractive, regardless of your size.

People moves

• If you’re a family-owned business, ensure all family members involved are on board with selling the company. Many businesses have an emotional element when it comes to exiting, but none more so than those still owned by the founders or a family.

• Assemble a team of advisors, starting with bankers, attorneys and accountants, all with significant restaurant franchise M&A experience. Gather both legal and operational options on how to attract the right buyers.

• Determine the appropriate time to tell management and employees that the company is for sale, and consider incentive offers to retain good employees.

• Consolidate ownership so there are fewer players on the sell side. The simpler the seller’s ownership structure, the better the sale execution.

• Be as transparent as possible with prospective buyers. Have answers to questions about your operations before a buyer has to ask.

Financial moves

• Assess each restaurant and location. If you have unprofitable stores that will affect the sales price, consider ways to turn around or exit the location.

• Review your leases to see how much time remains on each and be proactive to make sure they are transferable. Look, too, at the terms of individual leases: Oftentimes, an off-market lease or one that calls for rent increases that exceed profit growth can be challenging when establishing a price for a sale.

• Ensure that your P&Ls are clean and that your records are in good shape and free of unusual or hard-to-justify adjustments.

• Expect that the buyer will engage a reputable accounting firm to conduct a quality-of-earnings analysis — a critical step before a sale.

• Invest in your own fixed assets and establish a capital basis for both tax treatment from sale gains and to remove a potential price-adjustment negotiation for underinvestment presumed by a buyer.

• Invest in technology that both streamlines your operations and addresses labor issues.

Finally, know your numbers, but trust your gut. No amount of economic modeling or forecasting can beat a long-term owner’s experience and sense of what is right for their business, including who its next owner will be.

What buyers need to know

“Scale matters,” says Lynch. Although the restaurant industry has gone through several up-and-down market cycles, there are still a lot of reasons to be a buyer. So, whether you’re looking to grow or diversify your brand holdings, here are some factors to consider and things to do to prepare for a purchase:

Strategic considerations

• Have a clear picture of what you want to accomplish with this acquisition. Define short- and long-term objectives.

• If national or international expansion is your game plan, be sure the concepts you’re considering can grow beyond local or regional chains. The most successful franchise chains have a deep, incentivized and capitalized pool of franchisees always looking to expand. Make sure your assessment of growth capacity includes fellow operators with similar goals.

• For larger chains, be sure there are still expansion opportunities and an appetite outside the brand’s current core area.

Tactical considerations

• Assemble a team of experienced M&A bankers, attorneys and accountants to advise you on the deal, its structure, historical market context, tax implications and other key elements of the transaction.

• Have a reasonable understanding of what could go wrong.

• Go in knowing what you can afford to pay and identify your funding sources. Evaluate and/or grow your available cash and liquid assets (low-risk securities that can quickly be converted to cash if needed).

• When evaluating a deal, look at each lease to see if the rent makes sense, how much time remains and whether they’re transferable.

• Consider external factors like geography that can also affect a deal. Salaries, health insurance benefits, sales, taxes and other expenses in different areas of operations are all things to consider in evaluating whether it’s the right deal for you.

Parting thoughts

For both buyers and sellers, the disruptions, constant adjustments and changing consumer behavior are factors that never go away. The restaurant industry requires owners to be nimble. If you’re thinking of selling or buying, assemble your team of advisors who can help you decide if it is the right decision and terms for you.