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Why private equity is good for the restaurant business

The investors have helped push the industry in a positive direction, even if they have some ruthless traits, says RB’s The Bottom Line.
Photograph: Winsight staff

the bottom line

Private equity investors can be maddening. They have limited ownership timelines, which can come with a short-term view of a company’s future.

They sometimes decide that a brand is better off as a cash cow than a brand primed for growth, keeping it alive only to pay off the massive debt, used to fund dividends, that eventually pushes that concept into bankruptcy.

Their cost cuts can be brutal. And they’re frequently too quick to sell off real estate. Often the debt they put on the company’s books keeps that company from making investments needed to remain competitive.

As my colleague Peter Romeo argues against private equity, he will point to all of these issues as evidence of the firms’ risks. And he would be right.

But Peter is also wrong to simply dismiss private equity as bad for the industry. On balance, the investors have been good for restaurants, helping fuel an unprecedented innovation in a long-staid business.

Private equity has provided a necessary source of investment for a restaurant industry that needs it for growth. That has helped many chains avoid debt as they’ve sought to grow in their early years.

And that has pushed the restaurant industry in a positive direction, by fueling the growth of smaller chains with newer ideas when it comes to food, sourcing, technology, service style or even robotics. The growth of these smaller concepts, in turn, have pushed their larger competitors to adapt.

Restaurants are simple concepts. Someone who knows how to prepare a meal can theoretically sell that meal to paying customers. It’s not as if that person needs to code a software program or invent a widget.

But they also need a lot of cash. And because the business is such a simple one to develop, it is competitive—people open restaurants all the time—which can make banks less willing to loan money to a newer restaurant company.

Historically, the restaurant business has not attracted a lot of venture capital, though that has changed in recent years as early-stage investors have pumped money into startup concepts, notably the single-unit robotic restaurant Spyce.

Private equity, however, has stepped in for concepts with four or five units, put money and expertise behind them and helped them to grow without requiring them to go to the bank every few months.

These firms have discovered that the industry offered strong returns and could generate cash. And their interest in the business has unleashed immense growth and helped fuel the fast-casual sector. It has also provided investment for large-scale franchisees at chains such as Applebee’s, KFC, Taco Bell, Burger King and others.

And while they often have short time horizons, not all of them do. Investment firms such as Roark Capital and 3G Capital, among others, have discovered that long-term investments in the business can be considerably rewarding—to the point now that there are a number of investment firms seeking to mimic that strategy.

They can also provide a lifeline for brands that might otherwise struggle, fade away or simply liquidate. That includes firms such as High Bluff Capital, one of those companies that takes a long view of its investments. High Bluff is taking a chance on chains such as Quiznos and Taco Del Mar, betting that it can right the chains’ finances and store base and keep them stable.

Of course, Quiznos in particular is an example of a private equity-driven leveraged buyout hamstringing the company and leaving it unable to deal with the recession and Subway’s $5 footlongs and new toasters, forcing operators to close in droves.

As I said, private equity is far from perfect. But its influence has been a net positive for the restaurant industry.

 

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