The investing strategy in the franchising and multi-unit retail sector

Mike Esposito shares his journey from a 30-year career at Goldman Sachs to co-founding Franchise Equity Partners, highlighting their differentiated approach to private equity through franchising and multi-unit retail investing.

⏱️ Key Timestamps

00:00 – Introduction
00:30 – Career background and transition to PE
01:45 – Pitfalls of “me-too” PE strategies
03:13 – Leaving Goldman Sachs during COVID
04:41 – Advisory vs ownership mindset
05:36 – Why franchising & multi-unit retail
07:00 – Barriers limiting PE in franchising
08:26 – Unique LP structure with HPS
11:17 – First non-franchise deal (European car wash platform)
13:42 – Why Europe offered better value than the US
16:06 – Minority vs majority investing strategy
17:04 – “Minority, passive, permanent” model
19:28 – Importance of backing the right people
22:24 – Power of a focused investment strategy
24:27 – Using data science for investment insights
26:23 – Contact details

🔑 Key Takeaways

• Focused strategies outperform crowded PE trades
• Franchising offers a large, undercapitalised opportunity
• Minority investing unlocks access to restricted sectors
• Long-term alignment appeals to family-owned businesses
• Europe can offer stronger fundamentals vs overheated US markets
• Data and analytics are key to gaining an edge

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🔗 Connect with Alex Rawlings on LinkedIn https://www.linkedin.com/in/alexrawlings/

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Transcript

00:00
Welcome back to the Raw Selection Private Equity Podcast. Joining us today is Mike Esposito, co-managing partner at Franchise Equity Partners. Today is going to take us on a journey from Mike leaving Goldman Sachs to setting up the private equity firm to where they are with their first investment  outside of the franchise world and also their first investment  into  Europe.  The investing strategy  of the franchising

00:30
and  multi-unit retail sector.  Let's dive in.  Mike, if you could give us a brief insight into you, I've been in the finance industry for most of my adult life, probably since I've been right out of college, actually even before college.  So I'm probably now a 40-year veteran of it, mostly in the investment banking world at Goldman Sachs. But recently started this private equity firm and actually enjoying it more than I've enjoyed anything in a long, time.

00:57
So go ahead, Mike. What is it that makes you enjoy it more than anything in a long, time? What do you love about it? Well, it's been great. We've built a firm really from nothing. We joke about the couple of employees we had back in 2021 and now we've got 35 professionals. We barely had a strategy firm. We now have a fully baked strategy, fully baked point of view.

01:20
And so that journey has been just a lot of fun. know, technically my name is not on the door. My partner, Scott Romanoff's name is not on the door, but  every day we get out of bed and we feel like it is. And so it's exciting, but it's also a lot of pressure to make them work. What's one mistake that you see private equity firms, all portfolio companies making, and what would you suggest to correct?

01:45
Well, I think that there's a lot of  me too-ness to the private equity world. A lot of copycat, I guess, put it that way, strategies, people piling into common themes, common trades. You know, one simple example is residential services.  You know, over the last five years, there's been just a huge amount of money piling into that  from countless firms. And, you know, it tends to bid up the assets quite a bit to

02:15
return levels that may or may not make sense. And so one of the things I like about what we do is we've got a very distinct and defined strategy. know, sometimes we will pile into some of those crowded trades, but hopefully we try to find more interesting proprietary opportunities outside of the crowded trades. Small marks. We've done a lot of work in the residential services, HVAC, fire life and safety, kind of boarders commercial rather than resi.

02:43
But yeah,  it's been a hotbed for activity from private equity as everybody's trying to get into that space. So before we dive into kind of your firm and where you've been, I know that you kind of took the transition from Goldman Sachs to private equity. Just talk about the kind of difference there and moving into the private equity industry from  the well  not known, unfamiliar term and name of Goldman Sachs. Yeah. So I was at Goldman Sachs for almost 30 years and loved it. Had a great career.

03:13
It was a fantastic place to grow up. You learn a lot about businesses, but more importantly, you learn how to build a business. learn how to manage people.  learn how to create a strategy.  And it's in a very collaborative team oriented environment. I  loved Goldman Sachs. When I left, I actually thought I was just going to retire.  And it was right when COVID was hitting in 2020. And I spent a reasonable amount of time on the beach, not doing a lot, but with my kids, which was great.

03:42
But I played golf, I fished, I boat it.  It was a nice couple of months, but about six, eight weeks into it, I realized I needed to do something, something new, something different.  And looked at a lot of different types of opportunities. I was a financial services banker at Goldman Sachs. So I ran the global financial institutions group. And so the natural thing probably to do would be to work in some sort of financial services oriented job.

04:11
like FinTech or something else. But I started thinking about developing this concept, the Franchise Equity Partners, along with another former Goldman partner. And it got really exciting, which I can come on to in terms of just the white space opportunity that we saw. But  now that we've done it, it's great. And as much as I like Goldman Sachs, this has been really fun. It's been much more entrepreneurial. And I would say probably the single biggest difference when you're on the advisory side of the world,

04:41
You do everything you can to put yourself in the client's shoes  and think about the recommendations you're making  and the consequences of those recommendations in terms of what it does to strategy, particularly in the M &A world. um But it's a whole other level when you actually own the outcome  and you have to live with that outcome for the next several years, if not longer.  And the level of scrutiny, the  level of analysis is even that much higher that I've found.

05:11
At the end of the day, there's risk that you do and take in that, and there's also risk mitigation that you do and take in that. And I think that is probably the single biggest thing in difference that I see between the two roles. I've enjoyed it quite a bit, but it's definitely a difference. So you guys decided and focused on the multi-unit retail and the franchise sector.

05:36
What you said, you didn't quite have a plan at the start. You just mentioned that Goldman gave you the plan of a strategy. So sounds like that probably came pretty quickly once you'd made your decision. But what made you focus on that particular niche? Yeah. So  as you said, our primary focus is on franchising and multi-unit retail.  And what we started to realize as we got into this is that it's a vast, vast world in franchising.

06:02
you have very significant part of not only the US economy, but the global economy.  the notion is simple. The notion is that  certain firms are really good at building brands  and the heavy intensity of the brick and mortar associated with those brands is oftentimes best managed by local entrepreneurs. And it's kind of the best world, the best of both worlds where you have the ability to have a scaled brand, lots of advertising, marketing.

06:31
a focused menu in the case of restaurants, a  focused delivery and service model, but at the same time, you get these scrappy entrepreneurs in the local market. And so the model itself  is one that's vast across the economy. What was very interesting to us was that there weren't that many firms, private equity firms or institutional capital going after that market.  And I think there's probably several reasons, I'd highlight probably two that are

07:00
are the biggest differentiators. think first and foremost, brands are very particular about who owns their distribution. And they don't always like private equity. They don't always like the idea of businesses getting levered up to the hilt, businesses getting flipped every five years,  and ultimately the long time owners, oftentimes families, getting kicked out of the business. And so  our go-to-market  as a franchisee,

07:27
is to be very brand friendly. We look for brands that we can partner with. But I think that's one big constraint on private equity. And then the second big constraint  is a lot of private equity firms don't like to cede control of the model to somebody else.  And as a franchisee, you have to be comfortable that you're a taker of the business model.  And quite frankly, there's not always a ton you can do to influence the business model, whether that be marketing  or

07:56
the delivery format, the look of the stores or pricing, to some extent, even pricing strategies. And so as a result, there isn't much private equity in these different industries. And that for us created a really exciting opportunity to kind of rove around them and find unique opportunities. something else unique is your LP structure. I don't think that was kind of set from the start, but it's a little bit different from the traditional. Talk to us about...

08:26
how that came about and obviously what it looks like. Yeah. So our structure is different. We've got  one primary partner, which is HPS Investment Partners.  They're now a subsidiary of BlackRock. They're a large alternative asset management firm. They manage over $250 billion in assets and they've been an absolutely fantastic partner. In addition to providing us capital, they've provided great insight and help  on deals and sourcing.

08:56
So they've been a fantastic partner. When we launched the firm, we debated heavily about how to do that.  And  the fundamental debate was between doing something relatively small with our own capital and friends and family, or doing something much more scaled.  And we decided ultimately that there are trade-offs. Obviously when you do something scaled, you can do something where you can  afford a better team.

09:23
which hopefully mitigates some of the investment risk. You can look for bigger companies which have more systems, process, better talent in place, which again, mitigates investment risk. And you can kind of get to a next level more quickly. The big issue is that you give up some degree of control. Ultimately, we decided to go the scaled route. And what we did was we ended up talking to probably 25 large

09:53
institutional investors about seeding us.  We went to sovereign wealth funds, we went to high net worth family offices,  we went to  pension funds, we went to other alternative asset managers. So we went to about 25 different firms where we had relationships.  And ultimately through that process, partnered with HPS. was a firm we knew well. Scott Kapnick who runs it happens to be not only a good friend, but he was

10:21
our bosses at Goldman Sachs probably 25 years ago.  So it was a good relationship. When I left Goldman, I became an operating partner at HPS. So was a pretty  intimate relationship with them. And as I said, they turned out to be a fantastic partner now four years into it. Sorry to interrupt. Just a quick mention of a long-standing partnership with Grata. As you all probably know, the private equity scene is constantly evolving. And DealFlow is moving now to proprietary and data-driven

10:52
Grata provides you with the data and information of over 7 million private companies. So if you're looking to improve your proprietary deal flow and improve the data access, then reach out to Grata today. Now back to the podcast. So contrary to your name, Franchise Equity Partners, you just completed your first non-franchise deal. I believe it was over in Europe and...

11:17
some of this a little bit more popular as you referenced in the residential services, which was to my surprise, the third, fourth person we've had on the podcast that's actually acquired  a car wash, which I'm still amused at, but  it seems particularly popular. What's the difference that you've had there between a franchise deal versus a  non-franchise deal? Yeah. So, you know, maybe taking a step back  and talking about that for a second, they'll come on specifically to IMA, which is the car wash deal that you're referring to.

11:46
You know, when we think at the end of the day, we're experts in franchise and we think we're experts now in multi-unit retail.  And multi-unit retail can be franchise, could be company owned, could be a franchise or system. You know, we kind of look across that whole spectrum.  And for us, a lot of it has to do with, you know, where is the better value play? You know,  you mentioned residential services.  We actually do own a residential services platform. It's part of...

12:15
Neighborly, which is a large multi-branded residential services platform owned by KKR. We own a big franchisee in that system called, it's called Precision Door. It's the biggest repair of garage doors in the country. And for us, when we thought about residential services, we played off the idea that to do it in a company owned model, we were probably going to pay mid teens EBITDA. Whereas in the franchised model, as a franchisee,

12:44
We were paying high single digit EBITDA multiples. And we liked that value differential and didn't think you were getting paid enough or a return in the company owned system. Now to Carwash. We looked at a lot of Carwash companies in the U S. Yeah. There was this tremendous bubble that happened  in Carwash  in the late 2000 teens, a huge amount of building,  very low barriers to entry, uh money pouring in.

13:14
people buying land, sale lease backing the assets. It was a lot of financial engineering. And every one we looked at, we probably looked at 10 of them in the US, we didn't get very comfortable with the return profile of these companies and the moats around their business. We bought IMOTE, which is the largest car wash company in Europe, 720 stores. They operate in 10 countries across Europe, nine in Europe, one is Australia.

13:42
But we love the business. was owned by Driven Brands, which is the public company based in Atlanta. Driven, I think by their own admission,  didn't invest significantly in the business. And we thought that there was a lot of low-hanging fruit to  take growth to another level. What's interesting about the business in Europe  is the barriers to entry are much higher than what you have in the United States. And so you have regulation.

14:12
that  countries have which limit the builds of car wash. Certain countries like Germany, you can't even wash a car at home. So that was helpful. Return on new builds in  Europe are not ideal, not great. And so there's not a lot of new car washes coming in market.  And as we looked at different opportunities to do that, the company owned model

14:41
and the multiple at which we paid, which was again, call it mid single digit-ish EBITDA multiples, we thought was very, very compelling. um Underloved asset,  and we've got a value creation plan now for it that we think is going to unlock a lot of value and turn it more into a growth company. So we're excited about that. It's our first deal in Europe. It's one of our largest deals, and it is our first deal as a company on model.

15:08
more more shocked to all of that, that you're not allowed to your car in Germany. I mean, I'm based in the UK and I've never heard that before, but equally, why would I know that? But I'm sure there's an environmental thing around that somewhere, but that is a little bit of uh shocker for me  to say the least. Do you know why they're not allowed? Or are you just happy with the regulations? Well, just think it's, know, people are concerned about the water runoff and the chemicals that would be in the car washing. You people don't want that to kind of leach onto the lawn and get into the water table.

15:38
Yeah. I suppose when you think about some of the stuff that they put some, there's a thing called, we've got something called Demon Wheels as a brand over here and you just literally spray on your wheel and it cleans off. I always think what on earth is in that to do such a thing? And then is it being cleaned out of the other ends and then turn into tap water? But it's a very, probably a different podcast and not one on the private equity one. So something else for you, unique for you guys is the,  you guys are completing both minority and majority deals, which you would see in different strategies outside of private equity, but not as common.

16:06
one private equity firm to talk to. So what again inspired you to do so and what have you found are the benefits of uh that strategy? Yeah, so we broadly speaking have very flexible capital and broadly speaking have two primary investing styles. One is traditional control investments like many private equity firms, but then the second is a minority stake strategy. And we probably have done half our deals as a minority stake and half our deals as control investments. um

16:36
The minority stake strategy we often refer to as minority passive and permanent. We take a minority equity stake less than 50%. We are relatively passive. You know, we have 10 to 12 consent rights over significant things like related party transactions, not taking debt beyond a certain leverage ratio, some limits on capital expenditures. So there's a handful of things that we seek protections on.

17:04
So it's minority, it's passive, and then we can invest for a very, long period of time permanently. And we created that strategy really to help us get into franchise systems where there's no private equity. And as we were testing the idea, we found that that strategy, minority, passive, and permanent, resonated quite a bit with brand owners. So for example, we are really the only private equity in the auto dealership business in the United States. We own three platforms.

17:34
We own 42 car dealerships. In that case,  are minority stake investors. In one of our investments, we have a 45 % stake. We have a 40 % stake in a second, and we have a 33 % stake in the third investment.  And as we  market this capital to the OEMs, we found that the OEMs took a lot of comfort that they were still going to be dealing with the same family that's owned these businesses for multiple generations.

18:02
And it's what's allowed us to get into that, allowed us to get into beer distribution again, where there's no private equity in beer distribution.  And it's allowed us to get into some other franchise systems. So we think that it's attractive to the brand owners. And then also obviously for families and investing in family owned businesses, which a lot of what we do is family owned businesses, know, families like that too. know, these families are multiple generations, oftentimes three.

18:32
or maybe even four generations into the business. And the last thing they want to do is bring on a short-term partner that's going to force them to flip the business in a few years. And so we find that minority passive permanent style works really well for these family-owned franchise-related businesses. appreciate with the larger companies, the risk factor of key man risk and who you're investing with.

19:00
in essence, what you're doing when it comes to minority. I mean, know some majority firms have some real problems with who they've bought. And I know that that sits heavily at low middle market, small cap type transactions. You guys are a bit up the tree than that. But how much  additional due diligence do you have to do on the leadership team? Because you're not just going, hey, hey John, this has been in your family for a thousand years. We're going to move you out now. You're not quite what we want to do. There's a lot of politics internally for that. So.

19:28
What do you guys happen to do in addition to what you would  do anyway, but in majority deal, but when you're ority, you're  getting married and you don't know each other yet. So what are you doing around that? It's interesting.  A lot of people will say that even in control investing, the private equity firm can be beholden to the management team. Because any good management team  is going to have a really strong point of view, good strategy, good strong point of view.

19:57
want to make sure they get paid for it. And so,  even in control investing, management teams matter. But to your point, when you're a minority shareholder and relatively passive, it matters that much more. And I would say that the single biggest difference for us between control and this minority investing  is in the minority investing, we generally don't have the right to fire a CEO.

20:25
And that's a significant thing. And we're basically ceding control of that to our majority partner. So for us,  the due diligence around that  is infinitely more important on people. Any other is the obvious thing, like you can do background checks and check the person out. You can obviously see their financial performance and how they're doing to run the business. But I would say the single most important thing beyond

20:55
the traditional work is getting comfortable that our partner wants a partner. And so we spend a lot of time with the team and with the family and with the CEO to make sure that, you know, we're going to have a seat at the table. You know, at the end of the day, they control the business. And at the end of the day, we don't really have the right to tell them what to do, but we like situations where we are at the table in a strategic way. And so we spend a lot of time upfront.

21:25
talking about that, what that looks like.  We do have  monthly financial calls, we have quarterly board meetings. When there's some problem or some opportunity like an acquisition, there's very, very frequent interaction with these companies. And I would say generally speaking, when we're going through that process, we find people that do want partners.  so, knock on wood so far,  we've been fortunate in that our partners have engaged with us in a really, really serious way.

21:55
So at the end of the day, while we don't have that power to fire the CEO, we have a very collaborative relationship with them where we hopefully can influence things in a positive way. I'm never surprised by most people's answers. Usually it comes down to dealing with reasonable people and having heavy communication that usually gets to the end of the path. I know it's never that simple, but certainly starts with that strategy with most difficult, challenging scenarios. So what do you read?

22:24
my Budgie Watch, what you listen to, that would recommend that anybody else checks out.

22:31
Well, I think one of the things that we're benefited by is having a focus strategy. And I guess I didn't mention, like when we launched the firm, one of the things we definitely focused on was having something more focused because there's enough great private equity firms in the world, the thought that we were going to somehow come in in 2021 and have an angle or an edge.

22:58
relative to any other mid-market private deputy firm was kind of absurd.  so having  a focused strategy, I think helps a lot because it really trains the mind that every day you get out of bed, you know exactly what you're looking for. And every day our team gets out of bed, they know exactly what we're looking for. And every day advisors and brokers  and accountants and lawyers get out of bed, they now know what we're looking for. And so I do think like having a

23:28
area of focus, whether it's by industry, by type of product,  I think that makes a really big difference.  I just think the world is so competitive today and  private equity is flush with capital.  I just think having that focus strategy makes a huge difference. so  because we have a focus strategy,  we've  set ourselves up to get below from those industries that we focus on.

23:58
focus on restaurants, auto dealers, heavy equipment dealers, beverage distributors, and other consumer business services. So, you know, there's whole cottage industries around each of those subsegments, whether it be conferences, whether it be investment bankers, whether it be, you know, media assets. And so I think, you know, we're very much plugged into all of those things for each of those different sectors.  And, you know, because we've got that focus, we've also been able to

24:27
afford and invest in a data science effort around those different industry groups. And the amount of information we build a glean from kind of the general information out there is pretty phenomenal. I'll give you a couple of examples. One thing we do is we do a lot of data scraping. So we scrape restaurant prices, quick service restaurant prices for about 30 brands in the United States. And so...

24:56
When we're looking at an acquisition of a franchisee, we can see very quickly how they're priced relative to the competition in the local market. It gives us a sense for whether there's opportunity to take price or they've been too forward leaning on that.  We can also see sort of nationally how brands price in different demographic markets.  And  literally can kind of, we call it wisdom of the crowds, a uh term from Freakonomics.

25:24
But basically what it says is that  a high income market in the United States, for example, Beverly Hills, California,  they'll have probably the top 1 % in terms of pricing versus a low income market ah somewhere,  wherever. We can see how the brand prices across those different demographic markets. And then again, when we're comparing a company that we're looking at buying, we can see how they price across those demographic markets to sit.

25:53
see whether there's opportunity again to take price or whether they've taken too much price. So that's an example.  You know, we've gotten, we've gotten really good at like ingesting information. when we get  in the auto dealer world, we get oftentimes 40, 50 statements. basically can now machine read them. So our data science effort has been really a value added. And again, I think it's been very helpful that we've been focused on these different segments so we can build true expertise around it.

26:23
data brings that out certainly. If anybody wishes to reach out to you post this podcast, Mike, how best do they get in touch, please? Yeah, anytime. can reach out at mike.esposito at fvp-us.com. thank you very much for coming onto the podcast. Give it as an insight into the worlds of franchise investing and multi-unit retail investing and how you guys have built the strategy from Goldman Sachs, working out what you're to do.

26:52
and now to present day with your first  deal outside of franchise. So thank you very much. I really enjoyed the podcast. Thank you, Alex. Really appreciate it. And thank you very much for all of our listeners tuning in yet again to the Private XU podcast. Till the next time, keep smashing it.