Find out what to expect during a financing/sale process
August 17, 2017
Steve Rockwell has more than 35 years of experience in the restaurant industry, including as a restaurant analyst, finance executive, investor, investment banker and consultant. This article does not necessarily reflect the opinions of the editors or management of Nation’s Restaurant News.
I wrote a column earlier this year recommending restaurant owners needing capital or thinking of selling to take advantage of high valuations and look for investors.
While the timing of the column may prove to have been close to the high-water mark for valuations, there is still a lot of money available to invest in the restaurant industry. How should owners looking for capital prepare for, and what should they expect, during a financing/sale process?
The first step is to objectively evaluate the business. The market is currently bifurcated based on two factors: positioning and performance. Regarding positioning, the struggles of traditional casual-dining chains have pushed many investors away from that segment, and what little interest there is is reserved for only brands that are both disrupting their respective sectors and performing at very high levels. Performance is the second level of bifurcation. While this is always the case to some degree, buyers appear to be even more selective in the current environment, creating a wider spread in valuations between the brands performing well and others.
Several critical elements of the business to evaluate are sales performance, including same-store and average unit sales; return on capital (at least a three-year, and preferably shorter, cash return on investment on the average restaurant); depth of management team; demonstrated success in multiple markets and the ability to open multiple locations in a market; and the perceived attractiveness of the sector in which the brand operates. A good analogy is residential real estate. A spectacular house in a terrible neighborhood will likely be worth less than an average house in a great neighborhood.
If all of those elements are strong -- same-store and average unit sales increasing, top quartile return on investment, good management team, demonstrated multiple market success, all in the right “neighborhood” –- an owner can expect a high valuation. But in today’s market, if one of those attributes is weak, not only is the valuation likely to be reduced, but finding an interested investor could be a challenge.
Assuming all the fundamental aspects of the business are positive, the next step is to make sure that internal documents are in order. These include audited financial statements, credible three- or five-year budgets, and legal documents such as articles of incorporation and/or LLC agreements. It is best to have these items up to date and easily accessible before initiating a sale or financing to avoid slowing the process down.
Choosing an investment banker is the next step. There are several qualities to look for. Most importantly is their experience in completing restaurant transactions similar to the one under consideration. Part and parcel to that is their knowledge of the buyers, both financial and strategic, with that knowledge extending beyond only the firm to the individual decision maker within the firm. Owners should ask for references and talk to them. Some questions to ask: Was the senior person involved in the process, or did he delegate it to others? Did they get to the right person in the buying group? Did they truly understand the dynamics of the company, or did they follow a process that was more formulaic?
Once engaged, the investment banker will be responsible for writing the Confidential Information Memorandum (CIM) and other information to generate investor interest. Management will need to work closely with the banker in this process providing the necessary background and financial information so the CIM fairly represents the company. In addition to an investment banker, the company should engage an experienced lawyer to advise on the transaction. This is an extremely important decision: A good lawyer can save both time and money.
Eventually, all financial and legal information including details such as leases, employment and supplier information will be loaded into a virtual data room so that it is accessible to interested parties as they do their diligence. Preparing for the actual marketing is time-consuming and should be overseen by one person at the company, typically the CFO.
The banker will refine a list of potential investors based on a profile discussed with management. Things to consider are whether a strategic investor is preferred over a financial one, how much ongoing input is desired from the investor (all will want at least a board seat), and whether management is willing to give up control (almost all private-equity firms will require control).
The banker will contact a broad list to gage a level of interest and get preliminary valuation feedback through indications of interest. That group will be narrowed to a handful that will be invited to meet with management. After the management meetings, prospective investors will provide a letter of intent. The banker and management will choose one investor, after which the time-intensive diligence process begins. Every letter of intent will be subject to diligence, so management must be responsive and engaged with the potential investor.
The entire process, from hiring a banker to closing the deal, should take about six to seven months. Staying focused on the business and interacting with the investment banker and investor can be a challenge for many companies. Organizing information and establishing clear areas of responsibility can lessen the distraction, and some companies could benefit from hiring an outside advisor to help manage the process. Finding an investor or partner is one of the most important steps a company will make up to that point, and organizing the process in a disciplined, professional way will increase the chances of success.
