Restaurant Development & Design

WINTER 2014

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3 2 • R E S T A U R A N T D E V E L O P M E N T + D E S I G N • W I N T E R 2 0 1 4 equity executives acknowledge the AUV bar has been raised since 2007 for several reasons, not the least of which is private equity frms hedging their bets on new and untested concepts. "The sales-per-square-foot bar is certainly higher than it used to be," says fnancial advisor and restaurant investor Mark Saltzgaber, citing increased labor, rent and other costs. "It's also the case that unit-economic models deteriorate over a larger unit base as they grow further from their home market." Parish, who works with restaurant founders, warns that the rules are being rewritten in terms of unit volumes. Once upon a time, $550 per square foot was suffcient to cover overhead and turn a proft. Today, he maintains, emerging concepts need to pro- duce $700-plus per square foot to turn heads. "Clearly, if your units are able to generate enough revenue to make effcient use of capital and people, you are in a much better position," he explains. One PE executive at a frm that invests in emerging con- cepts concedes high unit volumes grab attention. Yet he insists that unit economics are what ultimately matter. He cites an IPO fling for Noodles & Company, noting the company averages $1.178 million per unit in 2,650 square feet of space. "That comes out to about $450 per square foot," says the executive, who wants to remain anonymous. "But they are extremely suc- cessful and have a great model." What metrics suggest high productivity and, hence, generate interest from private equity? Says Saltzgaber, "I believe cash-on- cash returns and return on total investment for emerging brands need to be at least 40 percent and 20 percent, respectively, to cover the overhead required to properly support and manage high- growth rollouts and to generate real bottom-line earnings." Clean-Up Deal Killers Let's say your emerging brand is on-trend, produces high average unit volumes and has the aforementioned margins. Moreover, your management team is top-notch. Your need now is growth capital, which private equity can provide. But there's one more thing to consider, advises attorney Anna Graves of Pillsbury Winthrop. "You need to take a look at the investment structure you have in place with your friends and family and your angel," she says. If you've been fnancing new restaurants through cash fow and bank debt, chances are you won't have a complicated balance sheet. That's something PE frms like to see. But if your current investors have individually fnanced separate restau- rants and you don't have a roll-up provision, "you could be in deep trouble," she says. That's because PE frms do not like to discover "structural defciencies" during the often long period of due diligence. Other defciencies that can kill a deal include landlord control over existing leases and off-balance-sheet items. Graves, who has untangled many such situations, notes that PE frms appreciate it when lawyers experienced with private equity deals represent the founder. Resolve Control Issues By the time you begin looking for a PE sponsor, you should have already resolved control issues. You'll know, for example, that once the deal is closed you won't be launching any new con- cepts for at least the next fve years. In fact, the main reason you'll be sitting on a pile of dough is because the managing directors believe you and your team are the best in class and therefore will increase the selling price by dint of your hard work. Parish has a hard time imagining any founder raising equity capital without "sophisticated fnancial, training and development people on board." Graves adds that while PE typically does not buy majority interest in emerging concepts, their terms may dictate so many rights that founders no longer have sole approval of sites or compensation. "Private equity may have going-forward approval on all leases," she says. Doody acknowledges he didn't need to partner with Catter- ton, having reaped the rewards of a previous private equity sale and a subsequent IPO with Bravo Brio. "I could have fnanced growth myself," he acknowledges, but Piada's growth would inevitably have been slower. He wanted to roll out the budding Italian street food concept before competitors began fooding the fast-casual Italian segment. "If you have something that's scalable that you don't want to franchise but want to grow fast," he says, "then private equity is the way to go." + SEEKING PRIVATE EQUITY Securing a private equity partner isn't all champagne and caviar. Here's what you can expect once the deal is closed: The bright side: • Strategic advice from frm's operating partners • Equity partners devoted to your company's success • Increased vendor contacts • Improved cash fow • Opportunity to invest alongside PE frm • Possible "second bite" upon sale of the company The dark side: • Dilution of founder's ownership • Loss of control over site approval, compensation, etc. • Timing of sale decided by PE frm • Ongoing reporting demands My Place PE UPSIDES & DOWNSIDES

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