| “What
to Expect From Venture Funds in 2002” |
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by Timothy
R. Ring and Randy B. Evans |
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from Franchise Times Articles, March 2002 issue |
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The retail franchise sector has been plagued with a lack of equity capital for operations for years. The void in recent years was filled through securitized debt instruments structured with high loan-to-value underwriting methodology. These high loan-to-value products minimized the need for equity capital infusions.
Prudence in operational longevity requires equity, as recent events reconfirm. The good news is that several large and small venture funds exist in the retail franchise sector, and new venture funds are being formed at a growing rate. Three major factors are contributing to the increase in the number of funds and the availability of equity capital:
(1) Publicly traded restaurant stocks have out-performed the general broad indexes in the marketplace;
(2) The decline of securitized financing; and
(3) The reduction in restaurant values.
Most of these funds have unique investment model requirements that limit overall equity capital available to the general retail franchise sector.
Venture funds typically receive their money from high net worth individuals or institutional investors such as insurance companies, investment banks and large money center banks. In the mid to late 1990s, these funds could extract from their investors any terms they desired on a take-it or leave-it basis. This has changed recently and institutional investors in venture funds are now able to dictate investment conditions and returns, which will mean higher pressure on venture funds to generate immediate cash flow from their investments. What does this mean for retail franchise operators?
Based on recently consummated deals, venture funds are driving tighter due diligence investigation and operational controls. You can look forward to more sophisticated financial covenants along with management fees payable to the venture fund itself. These fees for deal consummation or as on-going management fees, on a relative basis, are not deal killers. You should also expect higher yield return incentives through the issuance of warrants or other hybrid equity. The yield return incentive devices, however, can be based on financial performance, thereby minimizing dilution of ownership, which is good news for the franchise operator.
Several investment funds do exist and are in the process of being formed to provide a variety of different products for the retail franchise sector. These funds include minority management, turn-around, growth and value approaches, each being critical for the retail franchise market. The growth funds focus on territorial development rights and expansion opportunities. The value funds focus on re-capitalizing balance sheets and inherent enterprise value, and the turn-around funds also focus on re-capitalization with both value and growth objectives.
The great news for this sector is that capital is available. Literally billions of dollars await deals. If you are interested in pursing an investment fund, please call us. We would love to put our experience to work for you.
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