Let's take a look at the pros and cons.

For restaurant operators that want to grow and need funding, partnering with a private-equity investor can be a good place to start, as long as operators fully consider the pros and cons.

Private-equity firms can provide significant benefits to a restaurant company, such as providing the financial backing that can fuel substantial growth. The challenge can be identifying an investment company with an approach that’s the best match for the company.

Possible downsides? Private-equity firms make short-term financial commitments, so restaurant operators will have to find another funding partner after the first firm exits. And no matter which firm operators are working with, the equity partner needs to be included in decision-making, which could slow down the decision-making process.

With that said, private-equity investors are often highly successful in working with restaurant companies. But it’s important for operators to understand their own worth to secure the best deal.

The business of private-equity investors and understanding a company’s worth

Private-equity firms want to invest in companies that show strong and stable cash flow. The firms raise funds by getting financial backing from a variety of sources, and then make a number of investments so they can dilute risk while generating quality returns.

Private investment companies often have aggressive repayment obligations, since they will have to make substantial repayments to their investors, so it’s essential they invest in strong, steady and predictable cash generators.

To successfully partner with a private-equity firm, tell a compelling story. Operators should have a clear strategy in place, showing how they can use their restaurant’s offerings to create value for the investor—and then highlight them to any potential equity partner. Also, it’s important that restaurant operators show that their business has the potential to grow substantially and quickly.

Why restaurants are attractive for private-equity investors

At first glance, the restaurant industry may not seem particularly attractive for investment, considering ever-increasing labor, food and real estate costs. But changes in consumer purchasing behavior and demographics that are driving more business for restaurants are positive for the industry’s long-term outlook.

Along with this, private equity firms are attracted to the restaurant industry because of the following:

  • Restaurants are cash-based businesses. Restaurants offer relatively predictable cash flow, giving them an allure to an investor. The value in the industry is that production and payment happen almost simultaneously.
  • The restaurant industry is resilient. As consumer preferences change, restaurants can change their offerings. For example, a popular purchasing trend is eating on the move, which makes restaurants with grab-and-go meals highly attractive.
  • Licensing deals offer more opportunities to put a brand in front of its customers. As an example, consumers can sometimes buy their favorite restaurant brands in a retail setting, such as restaurant-branded pizzas or soups that are sold in supermarkets.
  • The industry is on the cusp of its own digital revolution. There are more opportunities to leverage technologies for increased efficiencies and marketing through new delivery options, online or app-based ordering, digital loyalty programs and mobile payment solutions.
  • Business models are proven, lowering the risk for franchising. Compared to manufacturing or other types of businesses, the risk for investment in a restaurant’s expansion is much lower. Also, cash flow generated by a new restaurant site can be forecasted with a certain degree of confidence, since similar sites have usually been launched and then fine-tuned.

The exit strategy

It’s important for restaurant operators to keep in mind that from day one, they are working with the private-equity investors toward exit. Private-equity firms typically have no intention of keeping a business long-term. The typical lifetime of an investment of this kind is 3–5 years.

With this in mind, operators should expect investors to constantly be putting forward initiatives that will build growth and generate cash, always keeping the end goal in sight.

For the restaurant industry, exits from a private equity relationship can include an equity buy-back, a sale or an IPO. Exits are most commonly done through a sale to another player in the same industry, or a secondary deal where the business is sold to another private equity firm for the next leg of its journey.

Finding the perfect funding partner can seem like a daunting task for restaurant operators looking to grow. But it’s doable. The bottom line is this: understand and leverage the restaurant’s business value to get the best deal when negotiating with a private-equity firm, and then do the homework to find the perfect partner.

Feature, Finance, Leader Insights