Inside the Booming Private Equity Market: Experts Share Experiences at IFA Legal Symposium

Private equity investors eager to purchase franchise operations have brought a new dimension to franchising in the past few years and have the potential to keep franchising invigorated in the future. A panel discussion at the International Franchise Association's Legal Symposium in May explored the motivations of sellers and buyers in private equity deals and the role that legal counsel plays in getting deals done.

'We did not have to sell, but we chose to,' said Dina Dwyer-Owens, CEO and Board Chair of The Dwyer Group (Waco, TX), whose experience selling to The Riverside Company, a private equity firm in San Francisco, was the reference for much of the panel discussion. The Dwyer Group owns 10 franchising businesses with about 800 franchises in the United States and 275 in 15 other countries. It was a public company at the time of the sale, but was in many ways still a classic family-owned and family-run operation, with 66% of the shares held by family members.

In early 2001, the Dwyer Group's Board of Directors decided to solicit strategic investors or buyers, and it met with representatives from about 25 firms. 'We felt that the company's value was not being reflected in our stock price, which was stuck at $4.25/share in a thinly traded stock,' said Dwyer-Owens. 'Family members were seeking liquidity.'

Then 9/11 occurred, and investors backed away for a while. When they started calling again in the summer of 2002, Dwyer quickly found a potential buyer, signed a confidentiality agreement, and entered into negotiations. However, Dwyer's Board decided that the buyer's offer of $5/share was insufficient, and that the Board's fiduciary duty required that it solicit other offers.

'We looked for a good financial return and liquidity for the family, and also a good cultural fit with our organization,' said Dwyer-Owens. The cultural fit was important because it provided franchisees with protections that were not embodied in the franchise agreements. 'For example, our franchise agreement allows us to open a competitive business in a franchisee's market. We are not going to do that; but we were concerned that a new owner-partner might want us to,' said Dwyer-Owens.

Just after the original deal foundered in September 2002, Riverside contacted The Dwyer Group with an unsolicited expression of interest. The culture was an immediate fit, and exclusive negotiations quickly ensued.

'We seek small family-owned firms ' though Dwyer was larger than many that we consider,' said Stuart Baxter, managing partner of Riverside. 'We focus on achieving rapid growth and selling the franchise in five to seven years to a bigger private buyer. We are usually working up the equity investor food chain ' selling our companies to private equity firms when revenue is in the $100 million range.'

Growth was on Dwyer-Owens' mind, too. 'The final element in the decision was to find an owner that had enough resources to help The Dwyer Group continue to grow,' she said.

After a few months of negotiations, an offer price of $6/share was made, and attorneys outlined numerous provisions, including:

• The transaction would be structured as a merger;
• Dwyer would be required to meet certain EBITDA targets;
• The agreement would include a breakup fee; and
• Dwyer gave Riverside an exclusive 90-day negotiating period.

Of equal importance, and reflecting the primacy that both sides placed
on cultural considerations, the agreement required that certain executive officers of Dwyer would enter into employment contracts because Riverside emphasized the importance of continuity in the operation. Also, certain Dwyer officers and family members were required to enter into a voting agreement and to make equity investments not to exceed 30% of the new parent's equity.

When management agreed to become part of the new entity, however, Dwyer's Board saw potential conflicts of interest. Therefore, the Board created a subcommittee without any members who would be stockholders, directors, officers, or employees of the merged Dwyer. This subcommittee engaged separate legal counsel and re-evaluated the offer. Ultimately, the subcommittee negotiated an increase in the offer to $6.75/share.

On May 12, 2003, the parties announced the intended merger; the offer represented a 59% premium above the trading price ($4.25/share) on the prior trading day. It was the first that the franchisees had been told about the plan to sell/merge the company. 'We knew that we would be inundated with calls from concerned franchisees, so we prepared a video and sent it to all franchisees within 24 hours of the announcement,' said Dwyer-Owens. 'It was very well received.'

Despite the price premium and the independent Board committee, the Dwyer Group was sued in the Delaware Court of Chancery, New Castle County, for breach of fiduciary duty. Duke Johnston, vice president and general counsel for Dwyer, described the lawsuit as a 'six-month fishing expedition' with extensive, costly discovery. The lawsuit was dismissed with prejudice.

The Securities and Exchange Commission took its turn slowing down the proceedings, too, and so ultimately it was October 2003 before the transaction could be completed. It was about a year since Riverside had first contacted Dwyer.

Issues to Consider

Panelists described a few additional considerations for franchisors weighing a buyout. Baxter noted that franchise owners must understand that 'investors will seek controlling interest in a firm so that it can impose its strategy. Don't count on being able to sell only 30% of a firm to private equity.'

Dwyer-Owens said that the loss of control was balanced to some degree by the benefits of 'getting out of the quarterly earnings box' that all public companies face. As an example, she noted that Riverside built Dwyer's sales team well beyond the investment that the Board was willing to make ' with excellent results. 'We are now selling 250 units per year, as compared to 80 per year prior to Riverside,' she said.

As another example, Dwyer-Owens said that in the midst of the sale to Riverside, The Dwyer Group had the opportunity to purchase Harmon Glass Company, which was a competitor with its Glass Doctor franchise. 'It was an opportunity to purchase nearly 300 company-owned stores, but our public Board said no. So I presented the idea to Riverside, and they agreed to a letter of intent to purchase,' she said. 'Riverside hired an acquisition team to work in the Harmon acquisition, leaving us to focus on Dwyer. Harmon was more than twice as big as Glass Doctor, and all stores were company-owned. Harmon had $25 million in overhead alone in its head office ' And we pulled it off.'

Speed of Transaction

Contrary to common perceptions, as well as the experience of the Dwyer-Riverside merger, panelists said that private equity deals can be done fairly quickly. Six months from start to finish is not uncommon, said Sean McAvoy, partner with Jones Day (Palo Alto, CA). 'As private equity has matured in the last 10 or 15 years, [parties in transactions] have developed norms and terms of agreements, so deals do not get hung up on those norms and terms,' he said.

The franchisor can improve the process by being organized, Baxter added. 'There is a lot of preparatory work involved ' things like getting all franchise agreements, area developer, and master license agreements, and information about litigation together for review,' he said. 'You can find independent financial advisers for the bids that arrive. Also, you can ask your accounting firm to have ready the kinds of information that an equity firm will want to know.'

The Dwyer Group 'had records in good shape, but we did not have them in electronic format. Next time, we will,' added Duke.

Kevin Adler is associate editor of this newsletter.

Private equity investors eager to purchase franchise operations have brought a new dimension to franchising in the past few years and have the potential to keep franchising invigorated in the future. A panel discussion at the International Franchise Association's Legal Symposium in May explored the motivations of sellers and buyers in private equity deals and the role that legal counsel plays in getting deals done.

'We did not have to sell, but we chose to,' said Dina Dwyer-Owens, CEO and Board Chair of The Dwyer Group (Waco, TX), whose experience selling to The Riverside Company, a private equity firm in San Francisco, was the reference for much of the panel discussion. The Dwyer Group owns 10 franchising businesses with about 800 franchises in the United States and 275 in 15 other countries. It was a public company at the time of the sale, but was in many ways still a classic family-owned and family-run operation, with 66% of the shares held by family members.

In early 2001, the Dwyer Group's Board of Directors decided to solicit strategic investors or buyers, and it met with representatives from about 25 firms. 'We felt that the company's value was not being reflected in our stock price, which was stuck at $4.25/share in a thinly traded stock,' said Dwyer-Owens. 'Family members were seeking liquidity.'

Then 9/11 occurred, and investors backed away for a while. When they started calling again in the summer of 2002, Dwyer quickly found a potential buyer, signed a confidentiality agreement, and entered into negotiations. However, Dwyer's Board decided that the buyer's offer of $5/share was insufficient, and that the Board's fiduciary duty required that it solicit other offers.

'We looked for a good financial return and liquidity for the family, and also a good cultural fit with our organization,' said Dwyer-Owens. The cultural fit was important because it provided franchisees with protections that were not embodied in the franchise agreements. 'For example, our franchise agreement allows us to open a competitive business in a franchisee's market. We are not going to do that; but we were concerned that a new owner-partner might want us to,' said Dwyer-Owens.

Just after the original deal foundered in September 2002, Riverside contacted The Dwyer Group with an unsolicited expression of interest. The culture was an immediate fit, and exclusive negotiations quickly ensued.

'We seek small family-owned firms ' though Dwyer was larger than many that we consider,' said Stuart Baxter, managing partner of Riverside. 'We focus on achieving rapid growth and selling the franchise in five to seven years to a bigger private buyer. We are usually working up the equity investor food chain ' selling our companies to private equity firms when revenue is in the $100 million range.'

Growth was on Dwyer-Owens' mind, too. 'The final element in the decision was to find an owner that had enough resources to help The Dwyer Group continue to grow,' she said.

After a few months of negotiations, an offer price of $6/share was made, and attorneys outlined numerous provisions, including:

• The transaction would be structured as a merger;
• Dwyer would be required to meet certain EBITDA targets;
• The agreement would include a breakup fee; and
• Dwyer gave Riverside an exclusive 90-day negotiating period.

Of equal importance, and reflecting the primacy that both sides placed
on cultural considerations, the agreement required that certain executive officers of Dwyer would enter into employment contracts because Riverside emphasized the importance of continuity in the operation. Also, certain Dwyer officers and family members were required to enter into a voting agreement and to make equity investments not to exceed 30% of the new parent's equity.

When management agreed to become part of the new entity, however, Dwyer's Board saw potential conflicts of interest. Therefore, the Board created a subcommittee without any members who would be stockholders, directors, officers, or employees of the merged Dwyer. This subcommittee engaged separate legal counsel and re-evaluated the offer. Ultimately, the subcommittee negotiated an increase in the offer to $6.75/share.

On May 12, 2003, the parties announced the intended merger; the offer represented a 59% premium above the trading price ($4.25/share) on the prior trading day. It was the first that the franchisees had been told about the plan to sell/merge the company. 'We knew that we would be inundated with calls from concerned franchisees, so we prepared a video and sent it to all franchisees within 24 hours of the announcement,' said Dwyer-Owens. 'It was very well received.'

Despite the price premium and the independent Board committee, the Dwyer Group was sued in the Delaware Court of Chancery, New Castle County, for breach of fiduciary duty. Duke Johnston, vice president and general counsel for Dwyer, described the lawsuit as a 'six-month fishing expedition' with extensive, costly discovery. The lawsuit was dismissed with prejudice.

The Securities and Exchange Commission took its turn slowing down the proceedings, too, and so ultimately it was October 2003 before the transaction could be completed. It was about a year since Riverside had first contacted Dwyer.

Issues to Consider

Panelists described a few additional considerations for franchisors weighing a buyout. Baxter noted that franchise owners must understand that 'investors will seek controlling interest in a firm so that it can impose its strategy. Don't count on being able to sell only 30% of a firm to private equity.'

Dwyer-Owens said that the loss of control was balanced to some degree by the benefits of 'getting out of the quarterly earnings box' that all public companies face. As an example, she noted that Riverside built Dwyer's sales team well beyond the investment that the Board was willing to make ' with excellent results. 'We are now selling 250 units per year, as compared to 80 per year prior to Riverside,' she said.

As another example, Dwyer-Owens said that in the midst of the sale to Riverside, The Dwyer Group had the opportunity to purchase Harmon Glass Company, which was a competitor with its Glass Doctor franchise. 'It was an opportunity to purchase nearly 300 company-owned stores, but our public Board said no. So I presented the idea to Riverside, and they agreed to a letter of intent to purchase,' she said. 'Riverside hired an acquisition team to work in the Harmon acquisition, leaving us to focus on Dwyer. Harmon was more than twice as big as Glass Doctor, and all stores were company-owned. Harmon had $25 million in overhead alone in its head office ' And we pulled it off.'

Speed of Transaction

Contrary to common perceptions, as well as the experience of the Dwyer-Riverside merger, panelists said that private equity deals can be done fairly quickly. Six months from start to finish is not uncommon, said Sean McAvoy, partner with Jones Day (Palo Alto, CA). 'As private equity has matured in the last 10 or 15 years, [parties in transactions] have developed norms and terms of agreements, so deals do not get hung up on those norms and terms,' he said.

The franchisor can improve the process by being organized, Baxter added. 'There is a lot of preparatory work involved ' things like getting all franchise agreements, area developer, and master license agreements, and information about litigation together for review,' he said. 'You can find independent financial advisers for the bids that arrive. Also, you can ask your accounting firm to have ready the kinds of information that an equity firm will want to know.'

The Dwyer Group 'had records in good shape, but we did not have them in electronic format. Next time, we will,' added Duke.

Kevin Adler is associate editor of this newsletter.