Interview with James Waskovich: Private Equity Investing in Franchisors & Multi-Unit Businesses

December 20, 2023

Friends,

I am excited to share this “Fireside Chat” I had with James Waskovich, Managing Partner of Princeton Equity Group, at our second annual Ideas & Networking Conference in New York City on September 21st, 2023.

Jim is one of the best investors I know, which began with his successful private investments in franchisors like Massage Envy and European Wax Center (NASDAQ: EWCZ).  More recently, Jim and his partner Doug Kennealey have built Princeton Equity Group into a leading private equity investor in franchisors and multi-unit businesses with $1 billion of assets under management.

I am proud to have been a founding partner and investor in Jim’s original business, Princeton Ventures, and today I am a senior advisor to and investor in Princeton Equity Group.  Jim and I also grew up together, and we have been good friends for nearly 30 years.  There is nothing better than doing business with a good friend, and it is safe to say that I know where the bodies are buried!

I hope you enjoy this chat as much as I did.   Merry Christmas and Happy Holidays!

Best Regards,

William C. Martin

Topics in this Issue of An Entrepreneur’s Perspective:

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Interview with James Waskovich: Private Equity Investing in Franchisors & Multi-Unit Businesses

Thanks for joining us!  To start, could you tell us about your experience at Washington & Lee University.  What was the most important thing you learned there?

In terms of a career, the most important thing I was exposed to at W&L was investment banking.  I went into college thinking I would go to law school and maybe get involved with politics.  Also, growing up in New Jersey, I wondered what people did in those tall buildings in Manhattan.  What do you do to make money on Wall Street?  It was always a mystery.  Back then, we didn’t have the Internet and ways to learn about this.  W&L gave me that liberal arts education and the opportunity to learn more about my areas of interest, including finance.

After school you joined Summit Partners.  Amazing firm.  What was their secret sauce? What did you learn? How did you apply it?

Summit taught me a sense of urgency and how to pick up the phone.  Summit is known for proprietary deal sourcing.  Private equity is a lot about how you want to spend your time.  You can spend all of your time on the front end of the process trying to find the most ideal, perfect deal that is priced extremely attractively.  Or, you can buy whatever is in front of you and spend all of your time trying to make it better.

Summit was really good at the front end of the process.  When I was there, I was one of 24 people who were, as young analysts, pounding away at the phones, trying to find entrepreneurs to back.  We were very conservative with valuation, taking a generalist approach, but usually focused in technology and health care services.  We worked very hard up front.

What we try to do at my firm now, Princeton Equity Group, is to be good at that, but also the value creation piece of the playbook.  Summit was a great education, learning at a young age how to pick up the phone and have a conversation with a decision-maker.

That led you to launch Princeton Ventures, which was the predecessor to Princeton Equity Group.   Can you talk about that business?  I was fortunate to be an investor in a number of those deals and you had tremendous success.  Can you walk us through what you did there?

Princeton Ventures was an independent sponsor.  Back then, they were called fundless sponsors.  My joke is: we had lots of venture, not a lot of capital.  We were out trying to find companies to invest in and originally focused on software investing.  It was taking that Summit playbook and getting deals under LOI and partnering with other sponsors and, in some cases, family offices, that would hopefully show up and add value post-close.  That would free us up to go do the next deal.  Our model allowed us to get carried interest on the capital we raised.  It wasn’t a banking model, but it was a model that relied on that Summit Partners experience.

We were very lucky to get around our first franchisor, Massage Envy, in 2009.  When I first saw Massage Envy, I thought it really looked like a software business.  A franchisor licenses a brand, a playbook, and often a protected territory to a franchisee who will then use its own balance sheet to open and run the business, in exchange for an upfront license fee and an ongoing royalty on gross revenue.  This margin profile is a lot like software.

Massage Envy was a great success.  We made seven times our money in that deal in less than three years.  When that’s your formative experience in an industry, you take note and then you try to do more of it.  We did European Wax Center, Solar Salon Studios, and today we’re invested in over 30 concepts of which 25 are franchised.

Today you have a dedicated fund, can you talk about that?

There are good things about going deal-by-deal.  You have a lot more freedom and flexibility than you might in a fund model.  We built this great track record in franchising, and we reached a point where entrepreneurs wanted to work with us, even when there were very large and famous branded consumer investors and consumer funds around.  They viewed us as someone who knew more about franchising than potentially any other investor.

The velocity of opportunities ultimately became too great to continue to go deal-by-deal, and our partnership model started to become less attractive.  We were at a point where we were worried that if we brought other partners into a deal, would they know as much as we knew about the industry?  Would they make the same decisions, and would they help protect the track record that we had developed and felt was valuable?

That was why we set out to raise our first fund.  We launched our fundraise 4-5 weeks before COVID hit.  Great timing!  We set out to raise $250 million for our first fund.  Despite the pandemic, we were able to raise $350 million, which was our hard cap.  We deployed that in less than three years.  We recently finished our fundraise for our second fund this summer, and we were able to raise $575 million, which also met our hard cap.

That’s great.  Congratulations.  Can you talk about some of the businesses you’re focused on in the portfolio today, and how you are able to win deals and how do you add value?

Yes.  At the end of the day, we try to buy businesses that aren’t always for sale, or if they are for sale, ones that are in demand.  The founder of a great business always has options, even when there isn’t an intermediary.  Also, our founders get paid to wait.  Typically, our companies are franchisors and once you’ve perfected the unit economics and you’ve got 100 or more units open, these things become great cash flowing businesses.  Our franchisors tend to be growing at 25%-50%, sometimes doubling EBITDA, when we invest.  These guys can wait another year and maybe double the price they would get.

What we do is convince them that they’re in better hands with us than without us.  We tend to back the original founder who has the skills that are required to go from your first location to your 100th location, this is where we generally get interested.  A very different set of skills are needed to go from 100 to 1,000 locations.  Often when we get around an entrepreneur, they’re starting to lose sight of what’s happening at the unit level.  In the early days, the founder can go to every location and know every franchisee’s name.  By the time we get around them, they’re starting to not know what’s happening.

That’s not a great place to be if you’re going from 100 to 250 to 500 to 1000 units.  Our playbook is centered around getting that franchisor to 1,000 locations reliably faster and with less risk.  What do we do?  We generally build the entire team around the founder.  We typically hire the whole C-suite.  If we raise the sophistication of the team, we can introduce real data into their decision-making and into their governance.  We’ll usually invest in business intelligence, and our goal is to know more about what’s happening in the unit than even the franchisee who owns that unit.  If we know more about what’s going on in the franchisee’s business than the franchisee, we can have a real conversation with that franchisee to change the trajectory of those units.  That’s the Princeton playbook.

There are also other elements of the playbook around franchise sales and development.  For example, remember these are licensing businesses and you’ve got to be good at the business of licensing.  We’ve got a lot of capability around that.  At its core, it’s getting down to the unit level, to the transaction level, and really understanding what’s happening.  Not 45 days in arrears when you look at the financials, but by the minute, what’s happening in the unit.

Oil prices (as of September 21st, 2023) are almost $100, what’s happening by the minute with some of your consumer-oriented businesses?

One of our concepts is Strickland Brothers Ten Minute Oil Change.  We’ve got approximately 180 quick change oil centers.  In that business, we have both franchises, and we have corporate locations.  We own about 100 locations ourselves.  This is a business, in theory, that is very much affected by oil.  We have had countless price increases since we’ve owned it.  Our same-store-sales in that business are actually up over 20% year over year.  EBITDA is up as well.  We’re essentially passing on all of the price increases in labor and oil to consumers, who so far have been able to absorb the higher cost of an essential service for their car.

You don’t see consumers pausing and pulling back on spending at all with $4 gas?

We’re seeing same-store-sales slowing across some of our brands.  A year ago on average, among our high growth brands, our same store sales were in the upper teens.  Now they’re in the upper single digits. We’re still growing, but that growth is coming down and we are seeing an overall weakening of the consumer.

Do you think the resumption of student debt payments will have an impact?

I think it will, though we have not yet seen it. I think the student loan issue is going to have a big impact for boutique fitness- and millennial focused-concepts where millennials have really driven a lot of the growth historically.

Let’s zoom out.  A lot has changed, both with interest rates and valuations as a whole.  What are you seeing on the deal side in the marketplace?  Cost of capital, deal velocity, how much is going on out there? Bid ask spreads?

2022 was a slow year for deal flow.  I would say the first half of this year was slow.  That’s changing.  The amount of inbound activity we’re getting from investment bankers has picked up a lot.  You’re starting to see higher quality assets come to market and lenders are very much open for business.

Is that because the entrepreneurs have reset valuation expectations?

For high-quality assets, valuations haven’t come down that much.  In our world, maybe a very high-quality franchisor, lower middle market, let’s call it $20-30 million of EBITDA to $40-50 million of EBITDA.  That’s a business that, pre-COVID, would have been trading for low 20x’s EBITDA, maybe high teens.  Let’s call that on average 20x.  That business is probably trading for around 17x today.  Most of that delta is strictly related to the cost of debt.  We’re getting a little less debt in our deals, but we’re still getting debt.  We’re still getting leverage.  It’s still covenant light.  There’s still no amortization.

Are they bank lenders or are they non-bank?

Non-bank, private credit lenders.

No pull back there?

It’s full steam ahead.  In fact, we’ve seen spreads come down probably 100 to 150 basis points this year.  The quotes we’re getting, we’re trying to get something done now, it’s SOFR plus 600 for five turns of leverage.  That’s around 11-12% given where rates are today.

What’s the typical amount of leverage you’re putting on deals?

4.5x – 5x, bigger guys will go higher than that.  There are still ways to get to 6x.  We’re doing a refinancing now with a very aggressive lender.  Pricing is more like SOFR plus 850 or 875.  We’re going to get six full terms of debt with a total leverage covenant of 6.75x.  Very, very friendly, but expensive.

At what point is equity better than debt when you’re starting to pay mid-teens on stuff?

Equity is always better, right?  This is a little bit of the pitch to the entrepreneur.  If you were an entrepreneur and thinking, “Hey, I could fund my business with debt, or I could take some chips off the table with debt.”  Well, with interest rates where they are today, accepting equity from value-added investors who are going to help you grow your business seems a lot more attractive.  That’s part of our pitch now.

The Trump tax bill, one of the things it did was cap deductibility of interest, I think at 40% of EBITDA or some metric. Is that an issue for you or do you have enough basis step up?

It’s not a huge issue for us, in part because we’re generally investing in LLCs and due to our fund structure.  If we owned a lot of C-Corps, that would obviously be a different story.

Have you seen any fall-out from the Silicon Valley Bank collapse?

We have a Silicon Valley Bank subscription line.  This allows us to defer and smooth out our capital calls.  Silicon Valley Bank understands our business very well and are willing to bank smaller funds.  When this crisis hit, we went out and we talked to everyone who could provide a subscription line and most people were absolutely not interested.  Only smaller, regional banks were interested.   We ended up staying with Silicon Valley Bank for Fund 2. They’ve been wonderful partners and have committed to working with us post-crisis.

Multiples on invested capital have been steadily falling in private equity for a long time.  That’s not surprising, there’s tons of capital in the industry and higher valuations, but IRRs have held up and that’s how some investors have defended their private equity allocations.  With higher rates, a slower pace of refinances, the higher cost of subscription line funding, etc., aren’t IRRs the next thing to fall?

Speaking globally outside of our strategies, where we’ve got some mitigants, yes, how could they not come down?  We also had this great period as interest rates came down, multiples expanded.

One thing offsetting that is liquidity.  I think historically for LPs, private equity was an illiquid asset class.  The growth of the secondaries market means that even if you think about the return coming down, liquidity has gone up.  I don’t know if that’s an offset in the calculus for an LP.  Returns come down, but I’m not locked in for ten years anymore.

Is there actual real liquidity in the secondary markets?

Yes.  They’re very large.

I’m curious how you think about allocating capital between franchises and company-owned stores.  It seems like a slippery slope. 

Yes, a lot of franchisors mix in company-owned EBITDA.

When we think about corporate locations or doing a corporate-owned only model, and we’ve done that, there’s a continuum of unit economics.  There are zones on that continuum where the economics are so good, they’re so juicy, that you want to own the entire pie.  I love franchising because as a franchisor, we get a piece of the pie.  I think we get the best piece, right?  The piece off the top.  If you are in a not-so-great of a concept, maybe the franchisor is taking all of the pie anyway.

In our world, where we back the concepts with the best unit economics in America, we’re maybe getting 20% of that pie because the four wall margins for the franchisee are so great that they’re able to keep most of it.  But yes, there are times where we look at this and we say, wow, the cost of entry here, the complexity, the returns, they’re so great.  We want to own them all.

Q&A: I was going to ask you a question about crisis management.  In terms of these franchisees, when they go through bumpy roads, which they often do.

We owned a lot of businesses back in COVID.  The challenge with franchisees is that they are emotional.  They are probably a lot like individual investors.  In your world, however emotional we all are, they’re potentially even more emotional.  The biggest thing we did during COVID was to try to take the emotion out of it.  To do that, it’s really communication.  The biggest problem you have in franchising is, the minute things get a little bit difficult, the franchisee pulls back on engagement.  They disengage from the concept, and a big thing they stop doing is unit level marketing.  A lot of our playbook is around how do we get them to keep spending money driving customers into the unit?  That’s part of what we did.

Q&A: What are the demographics for a typical franchisee?

One of the neat things about franchising is, and we see this across our concepts, we have great diversity in our owners.  One of the things we do is go to every franchisee convention.  Each of our concepts will have an annual event and it is a mix.  There are some concepts that skew a little bit older, some skew a little younger, some skew more female, some skew more male.  The reality is there’s a tremendous amount of diversity. It’s always been diverse.  It is one of the great things about this industry.

Awesome. Thank you. 

Thanks, Billy.

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Bill Martin Featured on CNBC’s Art of the Trade

CNBC’s Yun Li sits down with Bill Martin who “famously shorted Silicon Valley Bank before its collapse last March.  His lucrative bet had a lot to do with his entrepreneurial background and his connections on the West Coast.”

https://twitter.com/YunLi626/status/1721563663604089313?s=20

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Favorite Books & Media

Byron Wien’s 20 Life Lessons

In remembrance of Byron Wien who recently passed (I never missed one of his year-end lists), this is a great list of life and career wisdom.  “Try to be different”, “write handwritten thank you notes”, “always mentor someone younger”, “try to do something out of your comfort zone every year”, “travel extensively,” and more.  This is worth a quick read – Byron will be missed!

https://pws.blackstone.com/education-insights/article/byron-wiens-20-life-lessons/

 

Dwarkesh Podcast: Richard Rhodes – Making of Atomic Bomb, AI, WW2, Oppenheimer & Abolishing Nukes

From one of my new favorite podcasts, this lengthy interview with Richard Rhodes, the author of The Making of the Atomic Bomb, is chock full of trivia and nuggets about the race for the atomic bomb, the geopolitical aftermath of its usage in Japan, and the entire cold war era.  While not the cheeriest of topics, there’s a lot of interesting info in this podcast for those who like history.

https://podcasts.apple.com/us/podcast/richard-rhodes-making-of-atomic-bomb-ai-ww2/id1516093381?i=1000614123147

 

Gambler – Secrets from a Life at Risk, by Billy Walters

A light, gossipy read, Billy Walters’ book is filled with interesting stories and anecdotes about the world of gambling, sports betting, and golf.  The book contains a long list of characters, including some of Las Vegas’ most colorful characters, including Billy Binion and a variety of famous mobsters, as well as figures like Phil Mickelson, Michael Jordan and others.  It also contains a lot of information on the ins-and-outs of sports betting, including how the sports book price odds, how good sports betters size their positions, and how the professionals try to capitalize on the tendencies of retail betters.

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A Selection of Recent Tweets from @RagingVentures:

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Fortuna Audaces Iuvat – Fortune Favors the Bold!

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