Competition | May 2010 | By Rodger Head

Let’s Make A Deal

Rodger Head, CEO of Duke & King Acquisition Corp, takes big risks and gets big rewards when his company buys distressed units. He tells you how to do it right.

Quick-service operators should consider buying distressed stores as a way to exp
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Q: Is it smart to buy my second store off a franchisee who’s in over his head?

There are a lot of challenges restaurateurs can run into when acquiring a unit that’s already in operation. Some of the biggest ones are the unexpected time it takes to close the deal in the first place. There are a lot of unpredictable particulars that pop up. Our last deal took nine months.

Usually, if the seller is selling, it’s for a reason. So your holdups come from that. If they didn’t have a succession plan in place or they’re in financial trouble—and it’s usually the latter—it becomes difficult because you’re dealing with creditors, and the seller is trying to get the best deal he can get. So the financial stability of the seller in many cases becomes a big challenge.

The other challenge is making sure you have new leadership in place. You don’t want to stay with the same leadership in most cases. If you’re buying a market, like we typically do, that new leadership is going to come at the regional level. We usually put in a new regional vice president.

The other big thing that’s important is making sure you pick a brand or business that you are familiar with and have expertise in. You need to know how to manage that particular business. You have to do an awful lot of homework. And it depends on the strength of your team whether you can buy into a new brand that’s different from your first franchise.

Our plan all along was to accumulate a couple hundred restaurants. When our first franchisor cut off that growth and didn’t want to have large franchisees like that anymore, we looked around. That’s when you have to be very careful about what company you pick. Obviously, when you’re buying out an existing franchisee of a brand, you want to make sure that the franchisor is strong, has clear vision of the company’s future, and has demonstrated that they know what they’re doing. As a franchisee, you’re following that franchisor’s lead. You need to be doing an equal amount of, and maybe even more, research than when you chose your first franchise, because you can crater your original deal if it’s good.

But it’s not only about the franchisor. You need to have faith in your management and your skill sets as well. You need to be confident that you can turn that business around if it’s failing. In our case, we like to buy distressed businesses. You want to be able to buy and instantly be able to create equity through improved EBITDA (earnings before interest, taxes, depreciation, and amortization). If you buy a great-run business, you’re going to pay top dollar, and there’s little to no upside in creating value for the business if you can’t create more EBITDA, which translates into more equity.

That’s not to say that sometimes you shouldn’t just walk away. I walked away from two deals last year, because I thought the businesses couldn’t be saved. We looked at two markets and decided they didn’t fit us. They would have required too much from us. We did our research from a demographic standpoint and geographic standpoint. We can fix restaurant operations and put our systems, discipline, and management in place and enhance the guest perception, but you can’t fix a bad local economy or consumers moving out of a city. We don’t just look at the concept. We do a very deep study of the demographics of the city, then decide if we want to pursue it. And that all goes into the pricing equation.

The shape of the facilities, how much it’s going to take to bring it back up to standard, is also something we look at on the store level. Sometimes it doesn’t make sense because we don’t want to put that much money into it, and we won’t get our return on investment. We definitely walk away from deals.

Because our company is really experienced and we have a lot of tenured restaurant veterans, we’re looking at real estate, construction, R&M, and the people play a part in terms of are there multiunit supervisors. We don’t just buy one unit, we buy a whole market. We examine whether we’ll have to move our people into that market, and all those things play into the price of the deal. At the end of the day, it all comes down to how much you are going to have to invest above and beyond the purchase price. It could be equipment or it could be people, either way it’s an investment.

The facility improvements are dictated to some degree by the franchisor. They’ll determine the timeline and the degree of work you have to do to bring it up to their standard, and that is all part of the negotiation. Now, the franchisor isn’t involved in the price negotiation, but you have to go to them and tell them you want to buy out the existing franchisee. From there, they’ll send out someone to figure out how much needs to be done to improve the units. And then they have to approve you as a franchisee. That’s when they’ll give you the timeline for the improvements. The good franchisors are willing to work with you because they want that enterprise to improve.

When you’re buying out an existing franchisee of a brand, you want to make sure the franchisor is strong and has clear vision of the company’s future.

Beyond those kinds of improvements, we don’t usually make a grand announcement that a unit is under new ownership. We don’t put anything on the menuboards or take an ad out in the paper. We think you’re better off creating that buzz internally and letting the guest experience that change. It’s easy to make an announcement, but a lot of times that creates false expectations that maybe you can’t live up to immediately. If it’s really bad, we’ll sometimes do a grand reopening, but that’s if we can’t drive sales any other way.