Although activity in private equity deals slowed during 2022 and the first half of 2023, restaurants still remain an attractive target for private equity firms. Strong cashflows and the resiliency in the industry through the pandemic, specifically with those operators who were able to successfully adapt to change, have retained an interest in the eyes of private equity firms. In order to better understand private equity investment and decide if private equity may be an exit opportunity for your concept, we are pleased to launch our From Fork to Fund series in our Table Talk publication that will focus on countless issues, including:
- What is private equity?
- Preparing to take on private equity investment
- Economics of a private equity deal
- Interviews with restaurant founders who have taken on private equity investment
Since selling to private equity is considered an exit or liquidity event, it is prudent to examine other exit strategies outside of a private equity sale. Other options for an exit include:
- Selling to another operator: For restaurants, this could mean selling the business back to a franchisor or other franchisee (for franchised concepts). For non-franchised concepts, this could be selling the brand to another operator. This sale can be attractive when an owner does not desire to remain with the business post-transaction and can often attract competitive, if not higher, values than some other alternatives. In addition, sellers will typically pay cash or finance the deal through debt with little amount of seller financing, meaning an immediate payday for the seller. This option may be attractive when management or future family generations have no interest or do not have the wherewithal to purchase the company.
- Management buyout or sale to family/next generation: When a company has strong and competent management or family members in place who have the desire to purchase the business, this can be an attractive option as the buyer is known and there is little disruption through the sales process to the operations of the company. However, the seller will likely have to remain engaged in the business for a period of time post-sale to ensure a smooth transition of the business. In addition, it is very likely that the buyer will not have the financial wherewithal or borrowing capacity to pay the entire purchase price at closing, which typically necessitates some form of seller financing. This can pose additional risk to the seller if the company is not successful (i.e., the full purchase price may not be recovered), or the seller may find themselves more involved in the business than they desire to ensure the company performs at a high enough level to make payments to the seller.
- Employee Stock Ownership Plan (ESOP): Although less common in the restaurant industry, sales to ESOPs are a larger portion of the overall deal market. An overview of ESOP transactions can be found here.
As an alternative, a sale to private equity often provides the largest windfall to the seller and will often have a chance at a “second bite of the apple” when the private equity firm sells the concept. However, as will be explored, private equity deals are often highly complex, and the sellers need to be often prepared for disruption and significant changes to their business.
This leads us to our first topic in the series: What is Private Equity?
Private equity can be viewed from two viewpoints: From the seller’s (i.e., restaurant owner’s) perspective and from the buyer’s (i.e., investor’s) perspective. From the buyer’s perspective, private equity is simply an alternative investment that typically pools the investment funds of numerous investors. Through the pooled investments, the fund will make a purchase of or into an operating company. The objective is to manage and grow the company with the hope of selling the company within a specified time horizon (typically 3-5 years) for a greater return. Our series will focus on the impacts on the seller.
From the seller’s perspective, private equity can do the following for a business: 1) provide a complete exit from a company, 2) provide a source of liquidity to the business to fuel future growth, and 3) provide liquidity to the sellers which allows them to take cash off the table while still remaining a partial owner of the business (known as “rolled equity”). The private equity firm can do this through numerous deal structures, including acquisitions of the entire company or carving out or purchasing only a portion of the existing company, perhaps based on a specific concept.
After the acquisition, the private equity firm will seek to maximize the value of the company. This could be through cost-cutting, restructuring of the existing business, or the implementation of specialized expertise in the business, which may help the company grow or enter new markets. Since a private equity firm is seeking to maximize value through often dramatic changes, selling to private equity may not be the best exit option for all sellers due to the dramatic changes that will occur post-investment. However, sellers that sell to private equity and remain owners through rolling equity will have a chance at the “second bite of the apple” or participating in the sale when the private equity company sells the operating company within their specified investment time horizon.
Albeit the short introduction above, we will take a deeper dive into private equity investments over the coming months. Stay tuned for next month’s issue of Table Talk, where we will discuss strategies to prepare to take on private equity investment. Be among the first to receive industry news and advice delivered straight to your inbox by subscribing today!
Article written by:
Ryan Kilpatrick, CPA
Director, Tax & Business Advisory Services