November 17, 2010

Private Equity and Franchising:

When Will the Money Get into Game?
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Your Hosts

M. Avi Epstein Darrell Johnson, CFE Christine Friedberg, CFE Craig R. Tractenberg Daniel F. Dovi
VP, Legal Affairs President and CEO Dir of Sales Innovation Partner, Franchise Associate, IP

Sterling Partners FRANData FRANData Nixon Peabody LLP Nixon Peabody LLP
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CLE Information
• An attendance CLE verification code will be
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Please make a note of it.
• CLE documents are downloadable from the
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• Complete and return your CLE certificate of
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• When we receive your attendance verification
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completion within 10 days.
• All attendees will also receive a link to the
presentation slides and a recording.

Dan Dovi| Associate | Rochester, NY

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Agenda

• Private equity landscape: where are we in the cycle?

• Why is franchising appealing to private equity?
• What kinds of things are happening now?
• How do you prepare for private equity funding?

Craig Tractenberg | Partner | Philadelphia, PA; New York, NY

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Private Equity Landscape

• Where are we in the cycle of private equity investing activities, and when
will the money become available?
› Fundraising
› Investment
› Exits

Darrell Johnson | President and CEO, FRANdata | Arlington, VA

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Fundraising

Christine Friedberg | Director of Sales Innovation, FRANdata | Arlington, VA

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Fundraising Overhang

Christine Friedberg | Director of Sales Innovation, FRANdata | Arlington, VA

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Private Equity Landscape

• Where are we in the cycle of private equity investing activities, and when
will the money become available?
› Fundraising
› Investment
› Exits

Darrell Johnson | President and CEO, FRANdata | Arlington, VA

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Deal Size

*Through Q3
Source: PitchBook

Darrell Johnson | President and CEO, FRANdata | Arlington, VA

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Private Equity Landscape

• Where are we in the cycle of private equity investing activities, and when
will the money become available?
› Fundraising
› Investment
› Exits

Darrell Johnson | President and CEO, FRANdata | Arlington, VA

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Exits

*3Q 2010

Christine Friedberg | Director of Sales Innovation, FRANdata | Arlington, VA

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Why is Franchising Appealing to Private

Equity?
1. Proven business model: brand or concept has already been developed,
successful, and expanded
2. Predictable and recurring revenue stream
3. Underlying demand for brand or concept or product or service
4. Franchisor’s, and/or existing management team’s knowledge of market and
business
5. Clarity and transparency in franchise business standards, operations, and
earnings
6. Growth model straightforward to execute
7. CapX needs are usually modest

Darrell Johnson | President and CEO, FRANdata | Arlington, VA

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What Private Equity Firms Look For in a

Franchise Concept
1. Market share and/or differentiation
2. How make $
3. Opportunity to grow business in 3 to 5 year time frame
4. Proven management
5. Good system support infrastructure
6. Solid unit economics, low adverse unit turnover

Darrell Johnson | President and CEO, FRANdata | Arlington, VA

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Where is the Company in its Growth

Curve?
Private equity firms view the investment opportunity differently based on
the size and trajectory of the potential investment. Important factors:
• Early growth stage
› Cash flow positive
› Differentiated product offering (innovative? how many competitors?)
› Does the franchisor have its act together (processes and procedures)
› Solid (although lightly tested) thesis on unit economic model
› Knowledge of customer base
• Larger franchise businesses
› Steady income (EBITDA stream)
› Proven unit economic model
› Quality of franchisee system
› Stability in the operating/financial model
› Competitive landscape

Avi Epstein | Vice President, Sterling Partners | Chicago, IL

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What Kinds of Things Are Happening Now, and

What Deals Have Already Occurred?

Franchisor Investor Purchase Price

Burger King 3G Capital $24/share, 9x EBITDA
Papa Murphy’s Lee Equity Partners Estimated at $180 million, 10x
EBITDA

Massage Envy Sentinel Partners Not disclosed. $2.8 million

EBITDA

ReBath Webster and Sorenson Capital Not disclosed. $5.7 million

EBITDA

Rubio’s Mill Road Capital $8.70/share, 7.5x EBITDA

Darrell Johnson | President and CEO, FRANdata | Arlington, VA

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Valuation Multiples

Christine Friedberg | Director of Sales Innovation, FRANdata | Arlington, VA

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Concerns Beyond EBITDA

How should a franchise system prepare for private equity funding?
A. Franchise sales dynamic (private equity invests in multi-unit franchisees, or
franchise networks, as well as franchisors)
B. Differences between sales to individual franchisees and large private equity
investors
C. Negotiating control: Equity financing results in some business decisions
being made by the investor
1. Private equity is focused on investing not management, but requires a certain
amount of control
2. Private equity wants to know when to get in and when to get out
3. Exit strategies and some flexibility in the typical franchise agreement are key to a
private equity deal and are elements that will affect how franchisors and multi-
unit developers operate

Dan Dovi| Associate | Rochester, NY

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Concerns Beyond EBITDA

B. Negotiating control: the private equity investor’s perspective
1. Exit Strategy: key elements for private equity funding in multi-unit
developers or franchise networks
a) Transfer restrictions (when may franchisee’s exit and who may enter the system)
a) Franchisor’s right of first refusal and options to buy
b) Restrictions on initial public offerings
b) Development right for additional units or new territories
2. Other provisions particularly important to private equity investors
a) Restrictions on ownership of other brands/concepts, in-term non-competes, post-
term non-competes (operating multiple brands, selling similar products)
b) Owner involvement in daily operation of business (non-owner representative)
c) Training requirements (certified trainer)
d) Personal guarantees for equity owners (risk exposure and predictability)
e) Clarifying or modifying franchisor’s “sole discretion” provisions

Dan Dovi| Associate | Rochester, NY

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Concerns Beyond EBITDA

C. Negotiating control from the franchisor’s perspective – protecting the
brand and franchisor interests:
1. Private equity investors ask how can I grow the brand and exit the
investment after reaching the desired return
2. Franchisors ask how important is growth; is it strategically more important
to focus on brand/concept improvement; how much control should I
relinquish?

Dan Dovi| Associate | Rochester, NY

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Concerns Beyond EBITDA

3. Key Provisions from the Franchisor’s perspective:
a) Maintain control over brand standards and the franchise system (confidentiality,
specifications/standards, image construction, production standards, supply
agreements)
b) Maintain strict control over all IP – especially considering the potential
weakening of non-compete covenants
c) In the absence of personal guarantees, negotiate other financial protections
i. Letters of credit
ii. Ensure general partner of the private equity investor has and maintains a
minimum investment in the acquiring company

Dan Dovi| Associate | Rochester, NY

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Getting Ready for the Dance of Diligence

1. Using the bankers and lawyers effectively
2. Organizing and retrieving archives
3. Do you need a trade secret audit?
4. Proactive brand and patent management
5. Assessing the role of franchisees in the process

Craig Tractenberg | Partner | Philadelphia, PA; New York, NY

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Thank you! Questions?

M. Avi Epstein Darrell Johnson, CFE Christine Friedberg, CFE Craig R. Tractenberg Daniel F. Dovi
VP, Legal Affairs President and CEO Dir of Sales Innovation Partner, Franchise Associate, IP

Sterling Partners FRANData FRANData Nixon Peabody LLP Nixon Peabody LLP
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On the Nixon Peabody Website

Upcoming webinars
• December 14, 2010: False Advertising

Recent recorded webinars

• Sustainability for Franchise Systems
• Best Practices in Protecting Your Brand in the New Media
• Mid-Year Franchise Case Law Round-up
• Document Retention and Destruction: Issues for Franchisors

Alerts
• California Franchise Relationship Act sets the “floor,” not “ceiling” of
franchisee rights
• Franchise industry receives a jolt from the Small Business Jobs Act
• Choice of law and forum provisions in franchise agreements: jurisdictional
differences in enforcing the covenant not to compete
• Federal judge likens franchising as business to “modified Ponzi scheme” and
holds that franchisor is employer of Massachusetts franchisees
• U.S. Supreme Court raises threshold for constructive termination and
constructive nonrenewal
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CLE Information

Attendance CLE Verification CODE:

NPCLE NPCLE 11172010

Send forms to:

Lauren Gomes
lgomes@nixonpeabody.com
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Thank You! Contact us

Avi Epstein Darrell Johnson Christine Friedberg Craig Tractenberg Daniel Dovi
AEpstein@sterlingpartners.com djohnson@frandata.com cfriedberg@Frandata.com ctractenberg@nixonpeabody.com ddovi@nixonpeabody.com

Twitter: @nixonpeabodyllp
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