Operations

Money talks: A look into what private equity looks for

Unprecedented change across any business, like that of the last year, tends to also trigger a flood of interest from investors. Such is the case with the fast food and pizza segments of the restaurant industry which are garnering new levels of consideration by private equity investors, in particular.

What does private equity have to say about what these types of investors look for in the restaurant sector now? (Photo: iStock)

March 23, 2021 by S.A. Whitehead — Food Editor, Net World Media Group

As tough as the last year has been, it's also triggered some real churn in restaurant investment. From the many brands that have fallen victim to the savage market of the past 12 months leaving behind potential opportunities in their boarded-up storefronts, to the increasing prevalence and ease of starting up presented by ghost kitchen concepts, those who have the cash are looking at the restaurant industry in hopes of making more of it.

And a big chunk of that activity is taking place in the private equity realm where groups of investors are looking for existing brands with untapped potential or even concepts in their infancies in need of some cash ammunition to help fire that starting gun.

Naturally more than a few budding, or even longtime restaurateurs, with a yen for some cash, want to know how to get it from private equity. In fact, any gathering of restaurateurs will often bounce onto the topic of just what magic dust makes a brand show up on private equity investors' radar screens in the first place. Restaurateurs are always interested in what the "money people" are looking for now in restaurants, along with the types of trade-offs owners of those brands might have to make for a share of private equity's cash.

Fortunately, one of those private equity firms, 10 Point Capital in Atlanta, was willing to field some questions around this subject. More specifically, 10 Point Capital Managing Partner Tom Wells availed himself to QSRweb to help us better understand what private equity groups like his are looking for generally in a restaurant brand at the moment and how those behind foodservice brands can determine whether this is the right area of investment opportunity for their brand to play in.

"We think strong experience and product quality are critical for ongoing growth; we have found that price matters, but being the heavy value chain (eg. lower price, lower quality) is tough right now. The shift to QSR/fast casual over the last year has raised consumer quality expectations, even at a value price."
-Tom Wells

By way of brief background, readers should know that 10 Point Capital has put its money muscle behind limited-service brands like Tropical Smoothie Café, Slim Chickens and Walk-On's Sports Bistreaux. The company — like most like many restaurant investors — has not slowed down much in its shopping and investing, despite the pandemic.

Q: Within the realms of fast food and pizza restaurants, what are the characteristics that make a brand particularly attractive to private equity?
A: Fast food and pizza are two of the hottest restaurant segments right now. Investors are looking at both due to positive long-term trends in each, as well as performance during COVID. The most important areas for investment groups looking at the segment:

Strong performance from existing units performing.
Brand leadership that is focused on the right areas.
Product innovation and technology adoption across the brand. (For instance,) is the brand a leaders in its space?
If investing in a franchisee group, making sure the right store level operations are in place.

We think strong experience and product quality are critical for ongoing growth; we have found that price matters, but being the heavy value chain (eg. lower price, lower quality) is tough right now. The shift to QSR/fast casual over the last year has raised consumer quality expectations, even at a value price.

Q: So can you break down each segment and what 10 Point Capital, in particular, is looking for now?
A:Segments we think are strong and high growth (not all where we'd invest since we only invest in franchisors):

Pizza: Franchisees of major players (Domino's, Pizza Hut, Papa John's), delivery-centric concepts with great unit economics.
QSR: Premium chicken, burgers.
Fast casual: Great-tasting with health perceptions, convenience/technology-driven.

Q: If I may double-back on part of your first response regarding "strong performance from existing units," can you give our readers an idea of how your company actually defines "strong performance" including some examples of what kinds of store metrics that might include?
A: We dig deeply into all of the data for more insight. The main items we closely review include:

Payback period: The key metric that we look at is how much does it cost to build relative to the profitability from the store. This dictates whether it makes sense for franchisees (or corporate) to build additional units. The simplest calculation is the ratio of total investment Cost to EBITDA. Three years or better is a great rule of thumb. For example, $750,000 of total investment to open and $250,000 of EBITDA means that the payback is three years. If the returns aren't great, it doesn't make sense for anyone to build.
Store level margins: We want to make sure the franchisee has store-level margins that are better than or in-in with its segment. If it is a pizza concept and the store level margins are much worse than other similar pizza concepts, something is likely wrong.
Same-store sales: It's key to understand how the existing units perform over time. Same store sales provide a good indicator of if customers continue to return year-after-year, how effective the company is at marketing once open, and how much pricing power the concept has with consumers.

Q: Alright, let me also dig a little deeper on what you said your company seeks in a brand's leadership that makes the company particularly investment-worthy in your eyes. You said leadership should be focused on the "right" areas. Can you break down what you mean by that?
A: We believe a CEO should focus on culture, strategy and people.

Culture is really what drives the "why" behind a brand and motivates everyone from corporate to the store-level employees to perform at a high level. Without culture as a North Star, it's easy for a brand to lose its way while it grows.

Strategy can seem overly complicated, but the two places to focus on are the customer preference and store-level profitability. Major initiatives at a restaurant brand need to deeply understand the impact to these two areas.

Finally, people drive the outcome of these investments. Great leaders attract, develop and retain the best possible talent. Leaders that recognize the need to bring in great talent provide great insight into likelihood of success for brand.

Q: Let's return to your previous stipulation that investment-worthy brands are those where product innovation and technology adoption extends across the brand. In relation to that and the idea that brands should lead their sectors, what would 10 Point Capital consider to be the bare minimum needed for a brand's use of tech to gain investor consideration?
A: In restaurants, if you aren't innovating, you are dying. Customer trends are constantly evolving, and it is easy to get left behind if (a brand is) only focused on the short-term. Today's consumers increasingly want limited-time offerings and periodic menu innovation.

At minimum, brands need to have base technology in place consisting of digital marketing, online reputation management, online ordering and an understanding of third-party delivery (even if not actively using it). More technology is needed over in time, but these are the table stakes.

Q: You also referred to the fact that brands you're considering must have the "right" store-level operations— what would you consider those to be?
A: Good investments all come down to people. There needs to be great store-level leadership in place before even attempting to grow unit count. The two items to look for in great leadership are ability to follow process and a sales focus.

It's much easier to succeed if the operator is following the playbook in a strong brand and is actively involved in the community to drive sales. Good indicators of leadership quality that can be measured include strong customer service, clean restaurants, correctly prepared food and consistency. If these areas score well, then store-level profitability will follow.

Q: One final question related specifically to pizza brands, you specified the company's interest is in pizza companies that are franchisees of major pizza brands. Why not smaller, up-and-coming brands as well?
A: We invest in concepts with the ability to scale into a dominant national brand. The pizza segment has been dominated by three players: Domino's, Papa John's and Pizza Hut. Marco's is the emerging No. 4 player.

Outside of these brands, there are countless smaller regional concepts that have never been able to grow past their limited area. In addition to being a highly competitive segment, the large brands have gotten to scale in brand awareness, technology resources and marketing spend.

It doesn't mean small brands can't succeed and do well, it just doesn't fit into our framework for where we invest.

About S.A. Whitehead

Pizza Marketplace and QSRweb editor Shelly Whitehead is a former newspaper and TV reporter with an affinity for telling stories about the people and innovative thinking behind great brands.