The Role of Private Equity in a Post-COVID Landscape

Anybody who whips out a COVID-19 crystal ball might as well start selling elixir, too. Nobody can say for certain what the pandemic shakeout looks like for restaurants. How many will truly close? How many will reopen? Will big chains gobble up real estate vacated by independents? Will new operators surge into the spaces left behind? Yet enough time has passed to bank one reality—M&A isn’t going to take a backseat during the action. Whether it’s chains trading hands out of bankruptcy or investors grabbing stakes where opportunity speaks, the money behind the curtain is going to move in the COVID arena. It already has.

In crisis, there’s undeniable room for growth. From SPACs forming across the sector to equity firms repositioning, who’s pulling the strings on the backside of COVID is a major storyline worth tracking.

Tom Wells lives this landscape day-to-day. As managing partner of 10 Point Capital, he has more than a decade of experience in private equity. Wells and his team have helped brands like Tropical Smoothie Café and Slim Chickens scale. Most recently, 10 Point Capital, which identifies as a group that enables “founders [to] create dominant brands,” invested in Walk-On’s Sports Bistreaux this past fall. The Cajun-themed chain hopes to open 25 units this year and has more than 150 locations in development.

Wells spoke with QSR about 10 Point Capital’s COVID journey, what the future holds, and how brands can position themselves to land an investor as they prepare for 2021 and beyond.

To start, give us a little background on 10 Point Capital, its investments in the restaurant space, and overall, what is the brand’s mission statement?

We founded 10 Point Capital to invest in visionary leaders to build dominant brands. We look for founder-led franchisors with potential to be dominant in their market where we can accelerate growth by providing capital and strategic support and guidance.

What makes 10 Point Capital different from some other firms out there, and why has it been so successful helping scale brands, such as Tropical Smoothie and Slim Chickens?

We are highly focused on high growth concepts that represent the future of their segment. We partner with great leadership teams and brands, with a focus on accelerating development through implementation of what we call the “Franchise Acceleration Plan.” We target one transaction a year, which allows us to then spend a significant amount of time working closely with the leadership teams to accelerate growth.

We have significant flexibility in how we invest. We can invest in a minority or majority stake and can hold short- or long-term (over 10 years). We frequently help founders round out the leadership team to scale the business, allowing them to focus on the core areas of the business that they love.

Our investments in the restaurant space focus on three key themes:

Consumer Tailwind: We look for brands in segments that are “on-trend." Tropical Smoothie Café addressed the “better-for-you” and healthier lifestyle trends. Slim Chickens is in what we call the “Premium Chicken” segment. These are multi-decade trends, not the next big thing.

Convenience: Technology has raised consumer expectations on convenience and ordering options; we look for brands that view technology as integral to serving their customers’ needs. This may be through technology and a drive-thru at Slim Chickens, or through order ahead and carry-out at a brand like Tropical Smoothie Café or Walk-On’s.

Tremendous Consumer Value: We look for brands that combine experience, product quality, and price, finding that customers are willing to pay a premium for brands that consistently deliver the combination. Millennials and younger consumers, in particular, look for brands they can affiliate with, and we target brands that can become part of the consumer’s identity.

Private equity and restaurants have had a long history, as you know. Not all of it good. What are some things you would caution operators to look for when searching out a partner?

In many respects, a partnership with private equity is like a marriage. The partnerships last for years and are incredibly hard to unwind. Knowing this, we spend significant time pre-investment getting to know management teams and their goals and sharing what we are like to work with and how we define success for an investment. I’m constantly surprised at how few founders do reference checks on the private equity group. Specifically, I always recommend speaking with leadership from other investments of that firm. Key areas to align are on the length of the investment, what each party views as success, how key decisions will be made, and who specifically will be working on the deal post-close.

For a restaurant brand, when would be the right time to look for an equity partner?

I view this as highly specific to the founder. A brand looking to grow more quickly needs to be able to show strong unit economics and brand differentiation. A smaller concept with less than five locations is generally going to attract investment from friends and family, or a local investor group.

The most important aspect of taking an equity partner as a founder is understanding that you will give up a significant amount of control. This can be tough for entrepreneurs who are used to being the sole decision maker. While you can sometimes retain full control, any equity investor is typically going to have a say in big decisions.

Tropical Smoothie Cafe

Tropical Smoothie Cafe opened 99 new cafe in 2020, including its 900th location in Fort Benning, Georgia.

If they decided to take that route, what should they make sure they have in order? In other terms, what does 10 Point Capital look for?

The obvious areas are having the core of the right team in place and being able to demonstrate that the unit economics work. Before taking on outside capital, it is also helpful to have strong legal and accounting counsel. We consistently see these areas underdeveloped when we start to look closely at a business.

Assuming the unit economics work, we typically look for a few major items:

A founder-led business where the founder wants to remain active.
Brands that are proven outside their immediate home market, where we can accelerate growth through franchising.
Passionate customer bases.
Brands that perform well in secondary and tertiary markets, so have potential to scale.

What are some pros to working with a capital firm?

Capital partners typically bring a different skill set to a visionary founder-led business. Key areas a capital provider will bring are a focus on data-driven decision making, an ability to creatively structure access to capital to grow faster, and experience growing multiple brands. Capital firms are also going to have deep expertise in working through brand strategy and ultimately preparing a business to be sold.

Let’s talk about COVID. There’s a lot of chatter about the real estate opportunity and simply the growth potential for brands not stumbling out of this. Is that something you’ve seen as well?

For the first time in several years, the real estate market feels as though it is shifting somewhat in favor of the brands and their franchisees. It’s early days, but landlords are proactively reaching out to strong brands, cutting deals to get the brand in their development. Landlords appreciate that the best brands give their sites the best chance of success and bring needed traffic through their developments. Drive-thru real estate is still highly competitive—everyone has seen how well [quick-service restaurant] brands have performed during COVID and now wants a drive-thru. For creative brands, conversion of other failed concepts offers a huge opportunity, and we expect this will persist over the next 24 months.

How did 10 Point Capital approach COVID? A lot of deals across the industry fell through and some partners exited investments. Did you try to take the long view? Or was it a case-by-case basis?

Philosophically, we focus on building great brands with unit economics that allow them to perform well regardless of the broader economic environment. We were fortunate that our concentration on brands offering strong consumer value and convenience meant that all of our concepts performed throughout COVID.

Additionally, we can take a very long-term outlook on how we handle an event like COVID given our flexibility in terms of investment hold.

10 Point Capital

Talk about Walk-On’s in particular. How does that opportunity embody some of the things we’ve talked about? How did it come about, and why are they the ideal chain to partner with?

Walk-On’s has a tremendous leadership team. Brandon Landry and Scott Taylor have built an incredible brand and culture, factors we have found critical to creating a dominant brand.

We believe Walk-On’s is the future of the casual dining segment. They are well-positioned for continued growth, offering customers great food and a family-oriented atmosphere, unique for a concept with a sports angle. Sports brings people together regardless of age or background, and we love that Walk-On’s is able to be at the center of their local community. Finally, we saw a business that both had consumers coming back consistently to eat great food and had built a substantial carry-out and delivery business.

The deal arose from a friendship that my partner, Scott Pressly, and I have developed with Brandon Landry (one of the brand’s founders) over the last three years. We had always wanted to work with Brandon to help accelerate growth and were finally able to make it work for everyone involved.

What do you think the M&A climate is going to look like after COVID?

We expect the M&A market to remain strong over the next 24 months. There is still lots of capital chasing restaurant deals. Currently we are seeing the best brands trade at pre-COVID valuations, and distressed brands trade at distressed valuations. The middle of the market is a little slow as buyer and seller expectations reset. We see COVID-driven hesitancy decreasing and expect to see a run of transactions in the restaurant space.

There’s been a lot of talk about SPACs in particular, as you see groups forming funds to acquire chains. How do you approach that as competition?

We don’t really see SPACs as competition where we invest. A handful target the restaurant space, but the majority are not focused on restaurants. The SPAC market tends to be focused on high growth businesses that are going to change entire segments or markets. This is harder to find in the restaurant space where most concepts aren’t growing 100 or 200 percent a year, and few are going to change entire segments. My guess is that we’re more likely to see a ghost kitchen chain or restaurant technology business go public via a SPAC than many branded restaurant chains.

Lastly, where do you think some of the biggest opportunities will lie as move forward into (hopefully) a post-pandemic landscape?

Restaurant technology will be a differentiator. We are in the early innings of what restaurants can do by leveraging technology. The first iteration has brought us the dominance of Domino’s, online reputation management, online ordering and loyalty, and third-party delivery.

Ghost and virtual kitchens are interesting but it’s very early in their lifecycle. Looking at what Mr. Beast has done leveraging online celebrity and 300 ghost kitchens is fascinating, as is the emergence of newly created virtual brands leveraging excess kitchen space. I’m excited and curious to see what this means to consumers in terms of what it takes to be a strong brand. If anyone can create and launch 300 locations overnight, what will it take to grab attention and loyalty from consumers?

Finally, consumers increasingly seek out brands that match their personality. A great product is table stakes; concepts must also have a compelling brand story. Brands like Apple, Lululemon, and Starbucks (or Dunkin’ depending on where you live) have married the two, building fanatical followings. We see acceleration of this trend in restaurants and believe it will be critical to the next generation of great brands.