Last week, Fat Brands announced that it acquired the fast-casual franchise Elevation Burger for $10 million.
The actual price is far more complicated. Deal terms, according to federal securities filings this week, reveal an agreement with a combination of loans, seller financing, stock conversions, incentives, clawbacks and shockingly little cash that could result in a wide range of actual outcomes.
The agreement provides a revealing look at the restaurant industry’s bargain bin, where small and midsize chains can frequently struggle to find buyers. When losses mount and loans come due, they can get desperate for buyers.
As a result, a generation of investors have emerged to take advantage of this market to build multichain operating companies for pennies on the dollar. And the market has yielded some unusual deals.
Fat Brands recognized this market a couple of years ago when the owner of Fatburger decided to start collecting franchised brands, using any form of financing it could find.
It sold stock and went public in 2017 through a small-scale initial public offering. It acquired Ponderosa and Bonanza and later Hurricane Grill and then Yalla Mediterranean. It also had a deal in 2017 to buy The Counter, which was ultimately sold to MTY Group.
The company has also struggled to get financing, and earlier this year took a $20 million loan from Sardar Biglari, the CEO of Steak ‘n Shake owner Biglari Holdings, at a 20% interest rate.
Hans Hess founded Elevation Burger in 2002. The chain, based in Arlington, Va., promises higher-end burgers and makes its fries with olive oil. It was part of a generation of so-called better-burger chains.
The chain peaked at about 60 locations in 2013, based on franchise disclosure documents, but currently operates 44 locations worldwide. Domestic system sales declined 6% last year, according to data from Restaurant Business sister company Technomic.
The chain has struggled amid a boom in the fast-casual burger segment in the face of a handful of stronger competitors such as Five Guys and Shake Shack.
Technically, Fat Brands is paying just $50,000 up front to buy Elevation Burger.
Fat will also pay up to $2.5 million in cash to Hess if Elevation Burger exceeds certain royalty revenue targets. But there is also a $2 million clawback if revenues don’t meet certain expectations.
Most of the purchase price, $7.5 million, is coming in the form of seller financing, meaning Hess is allowing Fatburger to make payments for the bulk of the purchase price. The loan will carry a 6% interest.
Seller financing is relatively uncommon in restaurant deals because sellers usually want their buyers to have established financing. Seller’s notes are also usually unsecured, meaning it is far back in line to get repaid in a bankruptcy proceeding.
It happens when buyers can’t get traditional financing and sellers really want to make a deal happen. Companies use seller financing “to satisfy an immediate need” for cash, said John Gordon, a restaurant consultant out of San Diego.
What’s particularly unusual here is how much Hess is financing: at least 75% of the deal’s value.
Several other elements make this deal unusual. Fat Brands is providing Hess with a $2.3 million loan at the same 6% rate. That loan can be used to offset the $7.5 million seller financing, meaning that in reality Fat Brands is paying $2.35 million up front and financing $5.2 million.
The risk for Hess is that Fat Brands collapses and lands in bankruptcy court, where it could potentially be on the hook for that $2.3 million while not receiving the $7.5 million in seller financing that may not be repaid.
“It shows you how upside-down some of these younger brands can get in order to get a leg forward,” Gordon said.
To make that up-front payment and loan, by the way, Fat Brands borrowed another $3.5 million from Biglari.
There are potential benefits for Hess, however, and not just limited to that $2.5 million in cash down the line.
First, Elevation would receive the right to buy 46,875 shares at $8 per share. Fat Brands is trading at just over $4 per share and hasn’t been above $8 since October. Thus, if the stock were to go to $10 per share, Elevation could exercise its warrant, sell the stock, and pocket the difference.
Hess could also convert the $7.5 million in sellers financing into Fat Brands stock at $12 per share.
That could make the deal potentially more valuable than $10 million if Fat’s stock were to surge to, say, $15 per share.
It would make Hess a major shareholder in Fat Brands, though the agreement contains a provision that keeps Fat Brands CEO Andy Wiederhorn’s Fog Cutter Capital the company’s dominant shareholder.
All of that is iffy, of course. It’s much easier to say that Fat Brands paid $10.05 million for Elevation Burger and be done with it. But the truth is far more interesting.