Advisory Mar, 28 2011

Explore External Funding Options

Franchisors seeking expansion and growth look out for external resources to raise funds. It has further got a boost with the availability of various funding options. The article discusses the dynamics of funding options like PE and IPO for franchisors tha

By Namita Bhagat
Feature Writer
Explore External Funding Options

Franchisors often require additional funds in order to market their franchise opportunities and need to evaluate available financial resources to procure funds to grow their franchise systems. Private Equity (PE) is significantly emerging as a favored funding source for the franchisors. Usually franchisor offers minority stake in its existing business to the PE firm and continues its ownership. The financial sponsorship by PE firm provides sufficient capital to support franchisor’s expansion plans. The funds can also be used to ease debt position of the franchisor in the balance sheet. Alternatively, a PE firm could invest in a financially unsound franchise company and seeks to eventually buy it out or turn it around. To attract PE investment, the franchisor requires reputation, prospects for growth and profitability and predictable cash flow along with high degree of managerial credibility. It may have to give representation on the board to the PE investor. Also the franchisor should be in position to offer well planned exit opportunity to the PE investor which usually seeks investment horizon of five to seven years.

PE success story so far

In year 2000, Jubilant Foodworks Ltd, a master franchise of Dominos Pizza with presence in India, Nepal, Sri Lanka and Bangladesh had procured PE investments of  USD 11.6 300 mn from JP Morgan and IPEF and achieved substantial growth in its franchise network. In 2010, the company got listed and provided its PE investors exit with excellent returns.

Recently, TVS Capital Funds based out of Chennai has invested in Indian Cookery, a venture of Celebrity Chef Sanjeev Kapoor and Better Value Brands. Earlier, it obtained a minority stake in Om Pizza & Eats, Chili Grill & Bar and The Great Kabab Factory by investing Rs 50 crore.

Pros of PE route

The PE firm is able to align its business interest with the franchisor. The availability of sufficient capital in timely manner helps the franchisor obtain high ROI due to the possibility of rapid expansion and scalability. This is also the objective of the PE investors which looks for high returns on its investment by extending funds to franchisor for five years or so.

Cons of PE route

Franchisor has to share economic interest with its financial sponsor i.e., the PE firm. Franchisor will have to share the profits as per the terms of the agreement with the PE firm for the risk capital it provides. Also, the franchisor has to address the concerns of the PE firms regarding operational issues of the business, deficient operational control due to franchising that may result in risk of brand dilution and situations like breach of contracts by its franchisee.

PE backed franchisors opting IPO route

The franchisor may choose IPO route to provide the exit funds to the PE investor. It taps capital markets to leverage its growth, procure cash to fuel its expansion journey and provide ‘cashing out’ or exit funds to PE investors. Franchise companies have potential for fast growth and fit the bill of the perfect avenue for capital market investments. Factors like size of the firm, management capabilities, profitability and growth potential are vital for franchisor to go public. IPO stands for Franchisor’s continued ownership and that it may sell part of its equity investment. IPO success depends on quality of its underwriters and investor confidence in the image, management and growth potential of the company. Successful IPO is a win-win situation for all parties. The franchisor can raise growth capital and expand, investors get exit funds with high return and stake holders from the public can take well informed investment decisions by tracking performance of the franchisor.

Considerations for franchisors accessing IPO funds

Franchisor’s decision to go public should be in conformity with its investors and franchisees. It has to brace itself for challenges like statutory requirements, compliance expenses, the apparent loss of control and the time commitment. Also, the franchisor has invariable pressure to do well to maintain value of the company and delisting process is quite complicated. An IPO may not create immediate liquidity for the franchisor. By law, franchisor has to observe ‘lock in’ period (six months to two years or more) before it can sell substantial amount of its stock.

IPO route, a natural progression for PE backed franchisors

Cocoberry Retail Pvt. Ltd, based out of Gurgaon a frozen yogurt chain raised $20 mn by PE route from Ajay Relan of CX Partners. It plans to obtain additional PE funds before taking the IPO route in 2013. Jawed Habib Hair & Beauty Ltd is in process of floating an IPO. Previously, it provided ‘cash out’ to its PE investor Sparrow Hill Advisory Pvt. Ltd with handsome returns.

Conclusion

To conclude it is only apt to say that selection of the financial strategy and resource is very critical for achievement of the franchisor’s business objectives. But it is only one of the business decisions that an entrepreneur takes to catalyse its franchise success and various other factors like, operational efficiency, management decisions, human capital, business environment, legal and political constraints etc are significantly important for the sustainability, optimality, growth and profitability of businesses.

Related: Hot spots of franchising

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