M&A activity in large public chain concepts is well documented and thriving. In fact, Atlanta-based Roark Capital / Inspire Brands acquired their way to the 2nd largest restaurant company in the US. Indeed, M&A activity has grown at a 9% compound annual growth rate (CAGR) over the past five years and “has topped more than $4 trillion globally, across all sectors.”[1] Krispy Kreme recently acquired Insomnia Cookies. Caribou Coffee acquired Brugger’s Bagels. Inspire Brands acquired Jimmy Johns and then, within the year, Dunkin…for $11.3bn. But what about independent restaurants? The industry is teeming with high profile deals worth millions and even billions of dollars, but what about the small private companies… is M&A activity too advanced for them? Do they need to sit on the sidelines and leave it to the big players? Not at all! And they can apply the same principles to private deals.
Any restaurant or group of restaurants that is performing well should be interested in growing. But growing doesn’t always mean building new units. Yes, your concept may have achieved prototype economics where you can “stamp them out” one after the other…but there is a lot to consider before putting your head down and grinding out more units. For instance, how far away do you have to go so your new location doesn’t cannibalize your existing location(s)? Is the next market town the same as the market(s) you currently thrive in? If not, how far will you have to go to find the same magic? What stresses do you put on your corporate infrastructure when you open another location?
Sometimes it makes sense to stay in the same market, but you can’t open the same concept right next door. Other times, you envy the efficiency with which a competitor operates some component of their business or you are impressed with their ability to provide good service. Sometimes you have a competitor that occupies a special niche that you wish you occupied (BBQ for instance) but you don’t have the expertise or the capabilities to launch a new concept to compete with it. In still other cases, the acquiring company possesses capabilities the target company does not, so the distressed target can be easily fixed.
The most important considerations when acquiring or merging with another company are price and contract terms. Small independent restaurants don’t need to worry too much about anti-trust rules as they are generally never going to be big enough to influence the restaurant industry at large. Independent restaurants that practice fiscal responsibility and maintain clean books are usually the exception, not the rule. As such, there is often a gap between what the original owner/creator thinks their restaurant is worth and what the actual value is. Generally speaking, a restaurant is worth 3x to 4x their EBITDA (earnings before interest, taxes, depreciation, and amortization). A healthy restaurant should deliver between 12% and 20% EBITDA. Anything more may mean something is being neglected, misreported, or there is insufficient management running it. If a restaurant sits on property owned by the restaurant, the valuation shifts to include the property asset and an opportunity to introduce debt as a tool to acquire it. In any case, properly valuing the business (price) and carefully constructing a deal (structure) that doesn’t overburden the new merged entity are critical components to a good deal.
Independent restaurants and multi-unit chains are often not public which means they have no stock trading in the financial markets. This means hostile takeovers and friendly acquisitions are not usually part of the mix. Instead, mergers and acquisitions are borne of a desire for the ownership group to grow horizontally or vertically.
- Horizontal M&A – occurs when the acquiring restaurant seeks to expand through targeting competitors in the same space. These scenarios there may be a “glamour” component to the transaction where the target restaurant has some brand appeal that will enhance the acquiring company’s brand. Often the goal is to grow market share without saturating the market. One company can simply acquire another company through a leveraged buyout – a combination of private equity limited partnerships, adding debt to a debt-free balance sheet, and seller financing.
- Vertical M&A – occurs backward/upstream when the target company is a supplier – say a farm or a vendor – or forward/downstream to new channels like expanding lines to retail for grocery store placements or spinning of an “express” or takeout-only concept from the original brand.
In either case, the goal for any M&A activity is the same for independents as it is for highly public, multi-billion dollar deals: increase shareholder (owner) value. What is also true for small transactions and large, is that the target company will almost always experience a boost to company value through M&A as the value of the target usually starts off lower than the value of the acquiring company. The acquiring company, in seeking to add to their dominant position, must demonstrate synergies and economies of scale before the value of the acquiring company improves. It’s usually just a matter of time before the combined company bears fruit.
M&A sounds complicated – and it can be – but there are firms that can help with the details and due diligence. The important thing to remember is that just because your concept is successful doesn’t mean you’re limited to riding that one concept to growth. Consider growing exponentially through merging with, or acquiring, another business that serves your same market or even a different market. Just look for companies that enhance your brand, that offer something you don’t have, or that you can help scale with capabilities you have that they don’t. Appropriate leverage, accurate valuation, and well-placed seller financing (seller note, seller rollover, and/or seller earnout to keep everyone honest) is all that an independent restaurateur needs to successfully grow their companies through M&A.
Ray Camillo – Founder & CEO, Blue Orbit Restaurant Consulting
[1] Aaron Allen & Associates, “Restaurant Mergers and Acquisitions Reshaping the Foodservice Industry”. https://aaronallen.com/restaurant-mergers-and-acquisitions