PwC said in early January the starting bell was beginning to sound for M&A. It also acknowledged the country was slogging through “one of the worst bear markets for M&A in a decade.” The puzzle was a convoluted one, mainly drawn by inflation, interest rates, and difficulty accessing capital to fund growth. The climate, broadly, made it challenging for many brands to generate profitability through high-cost measures, like commodities and building materials. In all, it depressed valuations, which made it appear wiser to wait things out.
PwC’s thought, however, was decelerating inflation and expected reductions in interest rates, along with pent-up demand for (and supply of) deals could tip the scales later this year.
In this special report, we’ll touch base with some of the restaurant industry’s top thought leaders in the investing arena to take their pulse on the current state as well as what could be coming next. Additionally, we’ll explore how brands can position themselves to partner with investors and what they need to check off before taking that leap.
The state and setbacks
There are a few converging factors muddying the growth proposition, says Lauren Fernandez, CEO and founder of Full Course, a restaurant industry incubator and accelerator of early stage brands. You could start with the high interest rates tied to construction lending. It’s also true for general business lines of credit. These rapid rate hikes, she says, did nothing to support banks wanting to lend because they weren’t sure when things would level out. “So like many investors in this space,” Fernandez says, “they were just waiting to see what’s going to happen.”
That lack of lending action showed up in different places for restaurants in 2023. Big deals slowed since private equity firms didn’t want to buy and sell without leverage. Large bank offers were hit by unfavorable interest rates. And, in turn, activity ground to a halt.
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Andrew Smith, cofounder and manager partner of Savory Fund, a group that oversees 11 brands, says 2023 was the toughest year over the last 15, even more so than 2020 or 2021. “I think a lot of people kind of felt like, gosh, what is this next phase in the F&B industry? And all I would say is from a Savory standpoint, our team, our leadership, will be the first to say that we are extremely excited and bullish about the future. We feel like the future is going to be better than the past.”
Fernandez agrees with PwC on the point of there being a backfill of demand and people sitting on the sidelines ready to go when money starts moving.
So does Pete DiFilippo, principal at C Squared Advisors. “The state of financing for restaurants is varied,” he says. “National tier 1 brands with solid operations should not have trouble finding a finance partner. Lenders and non-traditional capital sources are hungry for deals after a particularly slow 2023. Those operators in regional or less established brands continue to face more challenges when seeking financing as capital providers are being more cautious with structure and terms.”
Erik Herrmann, partner and head of investment group at CapitalSpring, thinks the current landscape has to be viewed through the tumult of the past few years. In some ways, as tepid as it was, 2023 was the first glimpse of a “new normal” since 2019. This coming year is similar minus one caveat—the commodity and labor environment (outside of California) is relatively stable. However, the consumer outlook is weaker than it’s been thanks to inflation and challenges with discretionary spend. “I think a lot of the concepts that we invest in are differentiated—they’re going to market based on value and convenience,” he says. “They’re decently well insulated but not immune from that consumer dynamic. So I think it’s probably a year of net headwinds for the industry after a year of normalization in 2023.”
There’s also the presidential election to consider, “which is going to be off the Richter scale in terms of craziness,” Herrmann adds. “In many ways, you need to be thinking about 2025 as the next buying year for banks. I think there’s been a massive repricing of risk.”
Herrmann says the country lived in a world, for a decade-plus, of money being free. Interest rates and inflation hurts the model. And because the cost to build a store goes up, labor costs are higher, materials cost more, so does financing, and as a result, the path to accessing and deploying capital changed. An operator just might not build that incremental site in a B-plus trade area they would have before given how much more they need to pay in what was once a more affordable equation. “You used to be able to borrow money for 4–5 percent. Today, that same loan is probably 8–10 percent,” he says. “It’s a challenge. Then, on the investor side … you just don’t have the financial engineering benefits because of where the rates are.”
“I think it just makes your work harder to grow or to refine your model,” Herrmann adds. “To find ways, whether it’s making it more efficient, or reduce the development costs so the units can still generate attractive returns. It’s just tougher today. But it really hits you from all sides.”
Chris Elliott, CEO of FSC Franchise Co., owner of Beef ‘O’ Brady’s, The Brass Tap, and most recently, Newk’s Eatery, says, by and large, M&A has lagged along since COVID. He believes it will gain momentum in 2024.
“From a private equity standpoint, there’s a lot of dry powder, meaning, there’s a lot of people that are looking and have money to spend,” he says. “Sellers are getting better valuations and are looking to make a deal. If we get some favorable news from the Fed on interest rates, that will be a positive indicator to the market that now is a time to consider M&A. The biggest obstacle to deals in 2024, will be agreement between seller and buyer on valuation.”
“You really only have one opportunity to introduce the business to the market.”
Erik Herrmann, partner and head of investment group at CapitalSpring
Elaborating on the notion of this affecting segments differently, Fernandez says mid-sized brands with multi-unit developers in their franchise systems, those who wanted to grow themselves, have struggled to access mezzanine-level debt. Or interest levels were so high economic models got strained. That stalled growth, too. “A very easy example of this,” she says, “is think of when you’ve got a multi-unit franchisee whose got a 10-pack deal and they’ve signed three leases for the year. What happens to those leases into the brand as a whole when those three units can’t open because your franchisee cannot get debt from a bank? This is happening in real time.”
Morven Groves, a managing partner at 10 Point Capital, which holds investments in Walk-On’s, Slim Chickens, and Smalls Sliders, relayed the idea interest rates slowed M&A, “with the greatest impact seen in the middle of the market.”
“The impact on the highest-growth brands is less,” she says, “given that they typically need more equity. The deals that are getting done are using less debt—and more equity—with the intent being to refinance the debt in the future as rates come down.”
Going down the ladder, Fernandez adds the market deeply impacted emerging restaurants—the field Full Course thrives in. There was a higher number of “really solid” businesses, she says, operating on non-cash reserves who were unable to pay for their next level of development because, again, they couldn’t get debt. And they depleted cash to perhaps meet some development obligations signed previously, or to overcome hurdles like paying back PPP or EIDL out of COVID.
“The overall snapshot I would give you is the growth of the industry, while being pushed by outside forces like population growth and consumer demand—which has not really deeply slowed down post pandemic, except for very recently with some inflationary behavior—that demand is not necessarily being met at a pace that the market wants to meet it with growth and development because banks are not necessarily lending,” Fernandez says.
In some respects, it’s been a market ripe for investor-operator partnerships. If funding isn’t available in traditional markets, the lack of runway will always send growth-minded brands elsewhere.
But there’s more to that, Fernandez says. One of the trends the space witnessed, especially in foodservice, is the understanding that not all money is handed out the same. Fernandez has been both a multi-unit franchisee and brand developer, serving as a strategic growth partner for companies such as Chicken Salad Chick. Before forming her own companies, she was general counsel at GoTo Foods (formerly Focus Brands).
So all those stressed pathways of restaurant operations, from supply chain to labor, Fernandez can offer help and insight as well as a paycheck.
The landscape of banks not lending tends to encourage some unique behavior, she continues. Things like seeking venture capital, crowdfunding, trying to IPO. Fernandez cautions, in all those cases, to make sure there’s an understanding of what each option actually costs. Audits, quarterly reporting to the SEC, shareholder meetings, PR firms, and so forth.
“There are several challenges operators face as they are searching for the right financing partner,” DiFilippo chimes in. “Many have experienced significant fluctuations in their COGs and labor over the past two years. Commodity prices have increased rapidly and at a high volume in some cases. Minimum wage increases and the legislature surrounding it have also affected many restaurants and franchises. These fluctuations in many cases continue to have a great impact on profitability and stressed cash flow.”
But like PwC, throughout the industry, DiFilippo says many expect Feds to lower rates throughout the year. Operators gearing up for investment must evaluate their operations and profitability ahead of the changing tide. “Franchisees should focus on controllable aspects of the income statement. COGS and labor should be at the forefront of this discussion,” he says. “Consider the inventory and ordering practices of your management team. Are there areas that can be improved to save time, expense, and waste? Look for ways to reduce or eliminate costs and increase cash flow.”
Michael Schatzberg, cofounder and co-managing partner of Branded Hospitality Ventures, an investment and advisory platform with over 25 years of experience in the industry, says a lot of companies cycled through cash last year as they tried to meet growth targets. And valuations were crushed. It’s not entirely a bad switch, he says, given some of the go-to-market runs in recent years were simply not realistic. You’d see companies with $1 million in sales raising money at $100 million valuations, Schatzberg shares. “It’s not sustainable,” he reiterates.
Yet despite headwinds, the pool of brands looking to expand does warrant accelerated activity. A changing palate of consumers spawned brands like CAVA (which went public in June and raised $318 million), in one instance, to support capital infusions. “I think we’ve also seen a prioritization of what operators are really thinking about,” Schatzberg says, referring to some of the technology whitespace, everything from inventory to procurement to digital omnichannel ordering systems. “I think a lot of people are probably on a wait-and-see side,” he says. “Do I want to retrofit my restaurant for total automation? Or am I thinking about when I’m designing a new restaurant to maybe implement within the new design some room for that type of thing. But I think there’s some real low hanging fruit on automation like self-pouring beverages.”
The operator angle
If you fall into that camp of wanting to find an investor, Fernandez starts with one piece of advice: don’t wait until it’s perfect. “Just be ready and prepared to show and explain,” she says.
It’s a bigger red flag from her perch if an operator is unwilling to show their books than if they can explain what’s going on, good or bad.
Schatzberg says being too early and too late can often feel the same. Namely with technology—a space the group invests heavily in—it’s not always about the merit of the idea, but rather if the timing aligns. So does the brand (or solution) fit a pressing need? Investors, he says, can generally identify that and figure out the rest. “There’s certainly a lot of money on the sidelines right now in this country,” Schatzberg says. “But I think if you have a compelling story and your company is doing good things and you’ve got a good pipeline and you are growing, you’re getting the funding you need.”
Groves says investors like 10 Point Capital want to quickly understand the brand, its sources of differentiation, and, ultimately, the growth outlook.
“Having an easy-to-follow data packet with unit-level information—economics, location profiles, ownership, etc.—and information about the brand/company more generally, like management team, guest feedback, brand positioning, makes it easier for a possible partner to engage,” she says. “Taking this step ultimately protects the management team’s time, allowing them to spend real time with only serious potential partners.”
And to be blunt, Fernandez continues, the most common holdup is many brands simply don’t realize what their options are.
No. 1, investigate the landscape out there, which Fernandez says falls into three buckets:
Debt options; equity options; and grants or sponsorships/scholarships. Minorities, socially economically disadvantaged individuals, and veterans generally have access to capital or can subsidize debt Fernandez feels would be a better decision before deciding to give up equity.
The danger she often sees is people gravitating to the equity route and making that play too early. “What I always explain to people is you get one bite at that apple,” she says. “If you give up a majority controlling interest of your company too early, you’re not going to get the real value out of it, not just because you reduced your share, but because you only have once chance to sell that equity for value.”
“And if you sell it too early, the value on the company is going to be very low, right?”
Herrmann concurs. “You really only have one opportunity to introduce the business to the market,” he says. “And so, you have to put in the legwork and pick your moment, so to speak. You go out with middling performance or your unit-level economics aren’t there or growth has been lackluster, it’s going to obviously impact your brand in terms of evaluation, level of interest, the terms you might get. … You want to pick that moment when you can make your best case to the investment community that you have something special. More foundationally, you obviously have to have a concept that works. You have to have a differentiated positioning to the consumer. It should translate to healthy to above-average unit-level economics because any investor looking at a business regardless of whether it’s quick service, fast casual, or full service, is going to say ‘OK, what are the unit economics thereafter, right?’ And I think having a differentiated concept will eventually manifest itself in unit economics.”
The general rule of thumb: wait for equity until you’ve appreciated book value in the business and unlocked some of that enterprise value and there’s clear space for growth. This way, Fernandez says, an investor will see and understand what the brand is worth—and could be worth—in a way they can help subsidize.
Beyond the timing, though, she can’t stress enough how much unit-level economics matter as much as the top line. “How the parent company roll-up looks on the financials is important, how much headcount you have, how smart you’ve been with your spend, but it also matters that you’ve fixed the unit-level economics and I cannot tell you how many times I see brands trying to grow to make more money,” she says, “instead of trying to fix the things that are broken about their profitability. And it’s shocking to me that people try to sell franchises all the time for brands that don’t even show a profit.”
If an operator can’t prove the business model works, why would an investor buy in, or a franchisee for that matter?
DiFilippo echoes the point. “Understand any challenges and hang-ups throughout operations. Be prepared to explain any new initiatives, promotions, or management projects on the horizon,” he says. “Gather and review contracts, agreements, and leases in preparation for a capital event. Most of the time operators can leverage equity within their current network to position them for the upcoming investment. Speaking with trusted advisers can also provide valuable feedback and information as these partners see numerous transactions a year and can provide insights into the current marketplace.”
Fernandez notes unit-level economics are sometimes a matter of being able to decipher what’s in front of you. Put things on the books for stores that are necessary to running the business.
From a more holistic standpoint, the restaurant industry has long been one navigated on guts and passion. That flows both ways. Fernandez says she’ll talk to interested parties who begin with the food. “OK,” she says, “well, let’s start with the numbers.”
Groves says a concept, once its financials are tight, also needs to resonate with today’s guest. It’s likely those two things go hand-in-hand if the brand is making money. It’s not always true the other way around. The food must win in the segment it plays in and be core to the restaurant’s identity. “We find that this passion and clarity of purpose helps brands navigate and prioritize the multitude of decisions that need to be made as the brand grows in new markets and with new franchisees and team members,” she says.
Shauna Smith, CEO of Savory Fund, adds it needs to start with an “it factor.”
“There has to be something that has drawn us to it and also customers and guests because we need to be able to see that visibly in the numbers,” she says. “We absolutely need to see that. And when I think about what attracts us and who the best candidates are, it really is first that it factor. Also, that there’s a lot of white space for whatever this product is. There’s an opportunity to bring this product to the masses. So maybe they’re in one geography or two geographies at the moment in time where we invest.”
Herrmann says CapitalSpring gravitates toward brands with a “unique mousetrap. Something that’s working well and working better than its competitive set.”
“You have to start with having an understanding of what you’re trying to accomplish,” he says. “Because there are so many different permeations out there. People don’t always know, and just the process of going out and talking to people becomes a way to figure out what you want to do.”
Operators, Fernandez continues, especially those involved on the ground level, need to understand who they are and what they want to do; where their strengths are; and the job duties they’d be better off handing to somebody else. It’s an industry anchored with people, Fernandez says. It’s personal. “Not to be denigrating,” she says, “but if you’re not clear about what it is you want as a founder and what you need as a business partner, No. 1 you’re going to partner with the wrong person. You’re going to end up with a private equity firm who maybe provides zero support or an angel investor who maybe provides too much support and maybe debt that’s not the right thing for you. I think being very sharpened and very real about your limitations as a founder, what you need to hand-off, where you need support, where you want the company to go, are all very important things to making sure that you pick the right partner to sit next to you at the table.”
Fernandez suggests operators ask themselves if they’re wearing a lot of hats. The answer 100 out of 100 times is “yes.” So what are the top five you hate putting on? “And 99 percent of the time they want to hand off things they’re neither qualified nor like doing,” she says. “And the reason they have friction is because it’s hard for them to do it because it’s either not a natural skill or they have no experience in it.”
Rethink it as, if you could use 100 percent of time and focus and service to the company, where should it be? Then get help everywhere else.
Herrmann shares CapitalSpring saw 600 opportunities last year. Flip that script. “What they don’t understand,” he says, “is there are 599 other people we looked at. So understanding that you’re going to need to view it through a comparative lens. You may not have that context because it’s your own business.”
At least for Fernandez, this dovetails into also knowing when to walk away. If a founder thinks they can do it all themselves and just wants money, it’s a hard no for her. “Because you’re asking me to invest in what would be normally a high-risk investment, so early stage, we have a formula and a process to protect you and our investors and if you don’t participate in that process and accept our help, we’re not writing the check,” she says. “It’s too risky.”
“When someone comes to us and says, ‘I just see the money, I know what I’m going to do,’ first of all, it flags for us an inordinate amount of ego and hubris,” Fernandez adds. “Not going to play that game. And two, what, I’m going to give you the check and let you go run with it? You’ve got to be kidding me.”
Schatzberg says a partnership, like any business, should be looked at like a marriage. When it goes wrong, divorce can be dirty and expensive. “You have to be really, really careful about who you partner with,” he says.
Mirroring Fernandez, there are options where a dollar is a different kind of dollar if you’re adding a strategic partner versus trying to load up on cash to do it yourself. He’ll often talk to some brands who have a Hollywood-ready list of backers. But are they going to industry events? Tapped into trends and networks?
Groves says self-reflection by founders or leadership teams is critical to making funding choices. “Our initial conversations are focused on discovering the founder’s aspirations for the brand, and on understanding the role that they want to play post-investment,” she says. “Does the founder want to stay active in the business, for how long, and what role do they want to play in decision-making going forward? Are they looking for a strategic partner, or for capital only? Answering these questions helps clarify whether debt or a partner is the better near-term fit for the brand. Additionally, in the case of choosing the partnership path, they help the brand identify a partner with whom they can be aligned.”
Smith agrees with a notion Fernandez brought up earlier—that things don’t have to be perfect. She wants to see a growth-minded team where “humility is a huge component.”
“Hard-working people who have been scrappy and were hard-working before we came along, we’re pretty sure they’re going to be that way after we come along,” Smith says.
Once more, it boils down to understanding what you’re looking for. Capital? Or a partner? There’s no right or wrong answer as much as making certain operators have a sense of what they need and what they’re getting into. “We built our company on the premise that maybe you are one of the rare unicorns who is good at ops and development, but the reality is you can’t do both at the same time,” Fernandez says. “You can either be an operator and run your business or you can grow it, but you probably can’t do both. That’s what we do. We say you run your business and we’ll grow your business and together we’ll get there faster.”
Smith refers to this as the “feedback loop.” Brands that have something to gain and want to be successful, she says, often start by soliciting advice. “If this is what you are wanting to do, feedback is going to be essential and asking people who know is a great place to start,” she says. “And we’ve seen that successfully work for some of the brands that we are surrounded by.”
Looking at the relationship from the angle of a multi-concept operator working to round out a portfolio, Elliott says FSC seeks complementary concepts that don’t directly compete with existing ones. Also, these add-ons should be in the operator’s wheeling where there’s relevant experience, systems, processes, and talent in place to support bringing the brand in.
“Acquired concepts need to have good DNA,” he says. “Even if growth has stalled, good DNA—high-quality products, profitable unit-level economics and growing AUVs, then there’s something to build on. Additionally, it is best to have obvious synergies in areas like purchasing, overhead and marketing, which all help make a deal more attractive.”
It’s valuable to examine culture alignment from both sides, too. It makes integration easier. “Ultimately, a deal price that works is critical and some additional top spin is great: a concept that has a decent pipeline, is easily [franchised], and has retained good talent,” Elliott says.
For a parent company, like FSC, he stresses the organization needs to be in good shape with current brands. Acquiring another brand likely isn’t going to fill a hole that’s already there. “You should have bandwidth within your existing team to absorb the new brand,” Elliott says. “It’s best if you already have systems and processes in place that can be shared with the acquired brand for ease of integration.”
And for a concept hoping to find a buyer, in the broadest sense, he notes, “investors like unique, scalable concepts with compelling value propositions. Investors are looking at whether the concept has high quality food and accessible pricing. We look at AUV and comp sales trends to evaluate whether the concept is showing positive trends.”
“If they are a franchised group, investors will want to see your pipeline—how believable is it?” Elliott adds. “Do you have systems in place to control food and labor costs? Bottom line is: to be attractive to a buyer, you need to have a unique selling proposition, demonstrated growth with your systems, processes and financials buttoned up.”
Schatzberg’s Branded Hospitality Ventures pays close attention to track records. Has the operator seen success and worked with it as well? In other terms, even if they have an emerging concept, it helps to have witnessed expansion somewhere else. It’s not as exciting to Schatzberg if somebody approaches the company with the notion they hadn’t thought about growth previously. He’d rather they understand what they want to do and how they want to get there. They’re just seeking the capital and partnership to make that happen. “We’re looking for small footprints, lower CapEx, and a good AUVs,” he says. “You have to have a couple of stores. We’re looking for $1 million, $1.5 million, at least, on the average-unit volume. And like I said, we love success in the past. Even if it wasn’t in the restaurant space. Entrepreneurs who have had success, that line of sight. … Then all of sudden you’re like how did this guy assemble this dream team? And so that’s the kind of stuff that we like to get involved in. And we’re minority shareholders and we just look to help that growth.”
