Legal: Early-Stage Equity Investors

Many of our early-stage emerging franchisor clients have been getting calls from private equity groups looking to make an investment. The reaction ranges from skeptical: “What would private equity want with me?” to irrational exuberance. A middle approach is warranted. The key is to understand the rationale of the caller.

Rather than looking at historical numbers and current “EBIDTA (earnings before interest, taxes, depreciation and amortization)”, early-stage private equity investors look at the long-term potential through the strength of the concept, the management team and, most importantly, the unit economics of the franchisees. The rationale is: “If we can put cash into the business, hire a bigger team, put in proper controls, benchmarking and build an infrastructure, we can grow faster.”

From the founder’s perspective…

…it may be expensive money, because you may end up giving away a large percentage of your company to do the deal. But you should scale faster, and a smaller piece of a larger future deal is still better than a larger piece of no deal. Think of these early-stage investors more like venture capital than private equity.

Many early investors are friends and family, past business partners or others who believe in you and your system; although lately, as multiples have skyrocketed for more mature systems, professional investors are dipping their toes in the early-stage franchising game. If your interest is from the former, it is critical you don’t lead potential equity investors into thinking that franchising is a sure thing.

There is enough risk in being a franchisor

You don’t want to be accused of taking investor money without properly disclosing the risk. Consult with a securities attorney. If you don’t, you are potentially creating personal liability for yourself. Securities law violations typically don’t get shielded by corporate entities and can be even more punitive than franchise law violations.

At a high level, you may be required to put together a PPM (Private Placement Memorandum) to properly disclose the risks. Just like franchising, these investments are regulated at the state and federal levels. Always remember, however, that early-stage equity financing can be very expensive money if you are successful.

Giving away equity too early may be very costly in terms of the dollars invested to the potential future returns expected. It’s worth it if you want to speed up the process, however. Just be aware that this is your future generational wealth nest egg and each percentage of equity you part with now will lower your personal return when you finally make it to the big exit.