What FRANdata Thinks

2024 Could Be A Positive Year For Franchise M&A

December 19th, 2023 by Meme Moy

What does 2024 hold for franchisor M&A? During a time of economic uncertainty, it’s especially hard to make forecasts. However, there are some emerging trends that suggest that there will be some deal activity in 2024.

Data from Boston Consulting Group shows that through the end of August 2023, companies had announced approximately 21,500 deals year-to-date, with a total value of $1.18 trillion. Deal volume fell by 14% compared with the same period in 2022, and deal value plummeted by a staggering 41%. A higher cost of capital, limited debt financing, and softening business conditions put pressure on M&A throughout the first half of the year. These trends held in the franchising space in the first half as buyers and sellers waited for better conditions before coming to market.

The second half of the year in franchising told a different story. Big deals like Roark’s planned acquisition of Subway, smaller deals including the sale of Cannoli Pizza Kitchen to UFG, as well as a variety of bolt-ons, showed that at least somewhere buyers and sellers were able to get deals done.

As we look ahead to 2024, there are several data points that suggest deal activity could increase. Markets broadly, and debt markets in particular, will go into the new year with more clarity on interest rates than they have had in the past 18 months. Fed data shows that while pockets of inflation have remained persistent, at a high level, the existing rate increases appear to have had their desired impact. As a result, it is unlikely we will see significant interest rate increases in 2024 – we could even see some rate cuts.

Private credit funds – the primary financiers of middle market deals – are also on pace to raise $200 billion this year, according to data from PitchBook. This puts 2023 on par with 2022 and 2021 and indicates that while leverage will be more expensive, it will be readily available to finance deals in 2024.

Boston Consulting Group’s analysis of recent deals further suggests that buyers and sellers have come back into alignment on pricing and valuations, which means it will likely be easier for parties to come to terms in 2024. Analysts also note that many private equity funds have been waiting on the sidelines for several months now and could be running out of time to get deals done during investment periods if they don’t start to deploy capital in 2024.

Sponsors may find a number of opportunities if they start looking. In a recent interview, investment banker Ken Moelis, told Bloomberg the deal pipeline at Moelis & Co. is at the highest level ever due to significant pent-up demand for mergers and acquisitions after almost two years.

Advantages to franchise M&A transactions
For sponsors on the hunt for deals, franchisors offer a number of unique advantages in this climate. Franchisee paid royalties, relatively low capital investment costs, and road tested business concepts, mean that franchisors perform relatively well even during low growth periods in the economy.

Franchisors already operating low-cost business models will be well positioned if the economy slows further. What’s more, many service oriented franchisors operate in industries like professional cleaning, HVAC, plumbing and other residential and commercial services that typically maintain demand even during recessions. Franchisors in the restaurant space have also recently shown that they can successfully pass through costs during inflationary periods. Taken together, these factors show that franchisors can be a durable all-weather investment.

Franchisor M&A deals in 2023 were largely dominated by platform investments and add-on deals. Roark’s acquisition of School of Rock for its platform Youth Enrichment Brands and FAT Brands acquisition of Smokey Bones Bar & Grill are two examples. These types of deals are likely to continue into 2024. Sponsors like Roark and The Riverside Company that are active in franchising have a number of large platforms and continue to make add-on acquisitions that expand the reach of those brands.

Despite these positive trends, there are still some headwinds. The FTC is taking a closer look at M&A deals of all types and new rules governing M&A transactions will require close scrutiny. The National Labor Relations Board has also recently made moves to clarify joint-employer rules which could have implications for franchisor liability, so it will be especially important for buyers and sellers to make sure all new transactions fall in-line with current regulatory requirements.

Writer’s Bio:

Bret Lowell, Partner, DLA Piper

Bret Lowell is an internationally recognized leader in franchise and distribution law, and has counseled and represented clients across a broad spectrum of industries, including restaurants and food service, car rental, hotel and motel, health care, financial services, high tech, real estate and retail.

Bret’s experience includes extensive analysis as to whether arrangements constitute “franchises;” drafting and negotiating domestic and international franchise, distribution and license agreements; preparation and filing of disclosure documents; counsel and advice regarding the establishment and operation of franchise and distribution systems; counsel and advice regarding termination, transfer and renewal obligations; dispute resolution, including representation before federal and state government agencies; mediations; and trademark and other intellectual property matters.

Bret is heavily focused on the buying and selling of franchisors. He has worked on both sell-side and buy-side transactions, representing private equity, investors and strategic players. He regularly provides legal advice concerning strategy, document preparation and due diligence in connection with franchisor dispositions, acquisitions, mergers, public offerings, financings and investments. For more information contact Bret at bret.lowell@dlapiper.com, access more articles by Bret here

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