Matt Perelman & Alex Sloane - The Art of Franchise Investing

Patrick O'Shaughnessy hosts Matt Perlman and Alex Sloan, co-founders of Garnet Station Partners (GSP), who share their journey from buying 23 Burger King restaurants to leading a private equity firm specializing in franchise and consumer services. They discuss their investment philosophy, emphasizing disciplined capital management, the importance of aligning with franchisors, and leveraging technology to optimize operations. They recount lessons from a failed auto services investment, highlight the significance of maintaining culture, and stress the value of building strong relationships with entrepreneurs and investors to drive consistent returns.

• Garnet Station Partners, co-founded by Matt Perlman and Alex Sloan in 2014, focuses on franchise and consumer services industries.
• The firm started with the acquisition of 23 Burger King restaurants and has since expanded to 26 other multi-unit businesses.
• GSP is recognized as a leader in its field and was praised by Mark Lasry as the next generation of private equity investors.

"Matt and Alex started the firm in 2014 as MBA students when they bought 23 Burger King restaurants. Since then they've invested in 26 other multi-unit businesses from gyms to car washes to funeral homes."

• GSP's initial success and growth strategy involved acquiring and scaling businesses through a combination of management talent, data, and capital investment.
• The company has been working on a print publication to explore and share insights on unique business and investing strategies.

"We explore GSP's playbook for creating value, the power of Matt and Alex's partnership, and their approach to scaling businesses for successful exits."

• The initial plan involved purchasing KFC franchises, but they faced rejection due to financial and experience requirements.
• This setback led them to approach brands directly, resulting in Burger King approving them as franchisees.

"We got a letter in the mail from KFC telling us we were rejected as KFC franchisees. The reasons they gave were one, we had no money, two, we had no restaurant experience, and three, we were in college and therefore too young to be KFC franchisees."

• GSP's strategy involved aligning with franchisors and leveraging their support to identify and acquire underperforming franchises.

"Rather than looking for a deal and then seeking approval, we said let's go to the brands themselves, let's tell them our stories, let's see if any of them will approve us as franchisees."

• GSP's partnership with Ray Meeks, a seasoned Burger King franchisee, was instrumental in their early success.
• They lived with Ray to understand the business and implemented a value-creation playbook that included adding technology, data, and management talent.

"Matt and I spent the summer between our first and second year of business school living with Ray and his wife Cass in Henderson, diligencing the business."

• Their approach focused on remodeling, new unit development, and M&A to grow the business from 23 locations to a significant public company.

"We added management talent, we added data capital, a capital allocation plan and grew that business from those 23 locations to what is today the largest Burger King franchisees."

• Franchise businesses involve a partnership where franchisees typically earn two-thirds of the profit, while franchisors earn one-third through royalties.
• GSP learned to navigate the differing incentives between franchisees and franchisors, focusing on driving bottom-line growth.

"It's important to give some of the background of what those businesses look like in terms of the partnership between franchisee and franchisor."

• They emphasized the importance of aligning with franchisors and leveraging their support for remodeling and new unit development.

"The relationship between the franchisor and the franchisee was extremely important... We went in and said we want to be your best partner."

• GSP focused on scale as a strategy to mitigate risks and enhance stability across different geographies and markets.
• Scale allowed them to manage risks associated with individual unit performance and external factors like traffic changes.

"Alex and I have focused on scale as it relates to both franchisee roll-ups and overall roll-ups."

• They leveraged technology to improve operational efficiency and reduce variance in performance across units.

"It's really hard to take a million and a half sales per box unit and make it 2 million. But if that million and a half dollar box is generating 11% and we can see that the food cost variance and the labor matrix is off by 300 base points, we feel really good that through technology... you can really narrow that G over a three to six month period."

• Access to extensive data across the franchise system allowed GSP to make informed investment decisions.
• Franchise deals involve tri-party negotiations between buyer, seller, and franchisor, where franchisors can offer incentives that benefit all parties.

"In the world of franchising, you have so much data... you could make a much more educated underwrite about the impact of that remodel dollar."

• They utilized data to analyze P&Ls across the system, providing insights into potential remodel returns and operational improvements.

"We were able to access effectively the 7,500 other Burger King franchisees, P and LS. And we could look at them historically and we could also see... what was the trade area, where was the Walmart, what were the demographics."

• Significant variance exists at the unit level across franchise systems, influenced by location and brand strength.
• GSP focused on managing costs in the middle of the P&L to drive consistent performance improvements.

"From the top line, it varies a lot. And a lot of that is based on location and brand strength."

• They employed technology to optimize labor and cost of goods, enhancing margin and operational efficiency.

"A lot of operators will base labor just based on what their anticipated dollar sales is... If you actually double click on that and you can do this pretty easily with technology... it's as localized as is the local high school football team playing tonight."

• GSP's journey highlights the importance of strategic partnerships, data-driven decision-making, and leveraging scale in franchise investments.
• Their approach to franchise consolidation and management has positioned them as leaders in the industry, providing valuable insights for future investors.

"Franchising is a massive part of the US economy... We've spent the last 10, 11 years at every franchise conference, meeting every franchisee, every franchisor out there."

• Labor is crucial for business success, impacting consumer satisfaction and business growth.
• Treating employees well is essential as they are often part of the local community and customer base.
• A virtuous cycle exists where better labor leads to better customer experiences, driving sales growth and allowing for further investment in quality labor.

"Labor is the most important part of these businesses. They're people businesses. And getting labor right is the key not only to the middle of the P and L, but it really is the key to top line, get satisfaction, net promoter score, intent to return."

• This quote emphasizes the centrality of labor to business success, linking employee satisfaction to customer satisfaction and business growth.

• Multi-unit businesses are simple to understand and evaluate based on sales, rent, and margin.
• The firm has extensive experience in assessing these businesses and identifying opportunities for improvement.
• Despite simplicity, some opportunities, like Taco Bell deals, have been consistently missed due to valuation concerns.

"We invest in simple businesses, we're investing in multi-unit businesses throughout the country. They're not particularly difficult to understand."

• Highlights the firm's focus on straightforward business models that are easy to assess and improve.

• Taco Bell is highly regarded in the franchise investment universe due to consistent growth and high margins.
• Effective marketing and operational models contribute to its success.
• The firm has historically missed investing in Taco Bell due to high valuations but recognizes the missed opportunities.

"Taco Bell is the darling of the franchisee investment universe. It only comps positively, meaning same store sales always seem to grow."

• Illustrates Taco Bell's consistent performance and attractiveness as an investment, despite the firm's hesitance due to cost.

• Early investments, like in auto services, provided valuable lessons on the challenges of roll-ups and the importance of experience.
• The firm learned the hard way about the dangers of over-leverage and the need for experienced management.
• These experiences shaped their investment philosophy, emphasizing quality and cautious leverage.

"Our second investment was not a good investment. We lost money on it and it was in some ways it was the best thing that ever happened to us. We call it tuition."

• Reflects on the learning experience from a failed investment, shaping future strategies and philosophies.

• COVID-19 posed significant challenges due to the firm's reliance on foot traffic-dependent businesses.
• Strategic actions included furloughing staff, mothballing businesses, and leveraging government programs.
• The firm successfully navigated the crisis without losing any companies or breaching covenants.

"We had a portfolio that was 100% foot traffic dependent. We don't use a lot of leverage, but when your portfolio goes to revenue zero, any leverage, a dollar of leverage is over."

• Describes the severe impact of COVID-19 on their business model and the strategic response to mitigate losses.

• Early capital was raised through family offices and specific deal presentations rather than blind pools.
• Successful early deals facilitated the transition to a fund structure and attracted institutional investors.
• The firm emphasizes strategic partnerships with founders and transitioning businesses for greater value.

"We were put in business by a number of family offices... It wasn't a blind pool of capital. We were saying, here's the transaction, here's the deal."

• Outlines the initial strategy for raising capital and building investor trust through specific deal offerings.

• The firm invests in diverse categories like food, auto services, and health, focusing on high-quality metrics.
• Key investment criteria include high average unit volume, strong margins, and quick payback periods.
• They prioritize businesses with top consumer satisfaction metrics and fragmented, growing industries.

"Everything we've invested in, every multi-unit business we've invested in over the last few years has been the number one highest average unit volume sales per box in its category."

• Emphasizes the firm's stringent criteria for selecting high-quality multi-unit investment opportunities.

• The firm takes a thematic approach, ensuring investments align with long-term industry growth and consolidation logic.
• They seek an edge in every deal, often being the first institutional capital for businesses.
• The focus is on professionalizing and growing businesses to maximize value for future sales.

"We have a whole process for how we source deals and every single transaction we look at. We have to have an edge."

• Highlights the strategic methodology in sourcing and executing deals to ensure competitive advantage and future growth potential.

• Success in multi-unit businesses is driven by strong unit-level economics, with a focus on achieving over 20% store-level cash flow.
• Tailwinds in the industry and understanding the end market and payer are crucial for business success.
• Acyclicality in businesses, such as those where the payer is not the ultimate decision-maker, can drive stability and growth.

"I think the things that drive success in a lot of these multi-unit businesses is both obvious statement. The unit level economics I mentioned earlier that we're only investing in concepts that are north of 20% at the store level in terms of store level cash flow."

• Emphasizes the importance of strong unit-level economics as a foundation for success in multi-unit businesses.

"Everyone knows the buffet quote of the management team with a great reputation meets an industry known for difficulty and the industry survives with its reputation intact."

• Highlights the need to align with industry tailwinds and avoid industries with inherent difficulties.

• Building a brand and scaling a new concept is challenging and requires understanding regional consumer preferences.
• Consistent quartile analysis is crucial in evaluating and underwriting growth for new business concepts.
• Regional brands should focus on their core geography rather than expanding to new markets without understanding local dynamics.

"We would say we're not that smart. We love what we do, we think it's very simple. And the US consumer what a consumer likes in Texas may not be what they like in Ohio, may not be what they like in Arizona or in California or in other parts."

• Acknowledges the complexity of scaling a brand due to varying consumer preferences across regions.

"We always say if a brand has customers who have tattoos of that brand on their arms, that's an arb. Authentic restaurant brands type of brand."

• Suggests that strong regional brand loyalty can be a significant asset but doesn't guarantee success in new markets.

• Roll-ups are complex and often fail due to leverage, integration issues, and cultural misalignment.
• Respecting and maintaining the culture of acquired businesses is essential for successful consolidation.
• Financial engineering and understanding the true cash flow of businesses are critical in roll-up strategies.

"One is leverage. Two is integration, not integrating these businesses. Three is a lack of appreciation of culture."

• Identifies the main reasons roll-ups fail, emphasizing the importance of integration and cultural respect.

"People we've found is they fool themselves with this sort of adjusted EBITDA run rate, EBITDA pro forma, EBITDA nonsense."

• Warns against over-relying on adjusted financial metrics that may not reflect actual cash flow realities.

• GSP aims to generate excess return per unit of risk with consistency, targeting a 3x MOIC in five years.
• Conservative leverage use, starting with 100% equity, helps manage risk and maintain low loss ratios.
• The focus is on buying at attractive free cash flow yields and professionalizing businesses to exceed return targets.

"We always say our mission at GSP is to generate excess return per unit of risk and to do it with consistency."

• Outlines the firm's investment philosophy focused on risk-adjusted returns and consistency.

"For most of our consolidations, we're actually starting with 100% equity."

• Highlights the conservative approach to leverage, emphasizing starting with full equity to manage risk.

• The partnership between the speakers is integral to their business success, characterized by shared decision-making.
• Building strong relationships with entrepreneurs and respecting their business culture is key to successful investments.
• Incentive structures are designed to align interests and reward successful outcomes.

"We do everything together. And that makes it really fun. And we really believe in that expression that the lows are so much lower than the highs are high."

• Describes the close partnership and shared experiences as a source of strength and enjoyment.

"We won't hire an asshole. We won't do business with jerks. Life's too short."

• Emphasizes the importance of working with people who align with their values and culture.

• Innovation in technology adoption is crucial for growth in multi-unit businesses, with a focus on best-in-class tech stack implementation.
• Real estate and rent renegotiation are seen as opportunities for value creation and financial engineering.
• Labor management and reducing turnover are critical challenges in operational efficiency.

"Tech adoption is a huge part of that GSP playbook. It's a huge part of that same store sales growth and margin enhancement that we talked about."

• Highlights the role of technology in driving sales growth and improving margins.

"Most people we find look At Retina Fix fixed expense, that's a contract you can renegotiate."

• Suggests viewing rent as a negotiable contract rather than a fixed expense, creating opportunities for value creation.

• Managing the labor force is a critical component of business operations, affecting margins and overall success.
• High turnover rates are costly, with retraining expenses ranging from $3,000 to $5,000 per employee.
• Retaining employees through incentives and tech solutions can significantly lower turnover and improve financial outcomes.
• A small improvement in turnover or margins can have a substantial impact on businesses with lower EBITDA margins.

"If you look at the fast food business, for example, industry average is north of 100% turnover. So we're not being unrealistic and saying we're not trying to bring that down to 25, but if the industry average is 130 and we're at 110, that 20 percentage point gap is worth an unbelievable amount of money."

• This quote highlights the significance of even small improvements in turnover rates, which can translate into considerable financial gains.

• The U.S. has an aging car fleet, with an average car age of 11.5 years, creating demand for auto services.
• Businesses that focus on mission-critical services, often covered by insurance, are preferred investments.
• Technological changes, such as EV adoption, are considered in investment strategies, but businesses like tire retail and car wash remain viable.

"We love auto services businesses that take advantage of both the age of the automobile, the car park in the US and the fact that for the majority of the US a car, particularly in 2024, is their largest asset."

• This quote underscores the strategic focus on businesses that cater to essential car services, driven by the aging car fleet in the U.S.

• Health and wellness is a growing sector but poses challenges, such as fad risks and cyclical performance.
• Investments in gyms, specifically Planet Fitness, are favored due to brand strength and market position.
• The focus is on businesses that can withstand market cycles and avoid being a short-lived trend.

"We're very afraid to invest in the next Curves which had X amount of thousands of units and 10, 15, 20 years ago and today obviously does not."

• This quote reflects the caution exercised in investing in businesses that might be subject to trends, emphasizing the need for sustainable models.

• The early education sector is attractive due to secular growth and increasing consumer spending.
• Regulatory and cyclical risks are key considerations, with a focus on businesses with strong customer experiences.
• Avoidance of government payor exposure is a strategic choice to mitigate regulatory risks.

"Setting aside the risks, the secular growth is unparalleled. There's just more people spending more money every month to put their kids into extracurricular programming than there was the same month last year."

• This quote highlights the sector's growth potential, driven by consistent consumer demand for early education services.

• Businesses are scaled to a sweet spot of $15 to $40 million in free cash flow before selling to larger private equity firms.
• Buyers seek consistency, professionalization, and scalability across multiple markets.
• The sellers often stay involved post-sale to ensure continued success and value creation.

"I think in large part what they're looking for is consistency, professionalization and scale across multiple markets."

• This quote explains the attributes that make businesses attractive to larger private equity firms, focusing on stability and growth potential.

• Maintaining a strong company culture is crucial for sustaining success and achieving growth.
• The firm emphasizes core values, accountability, and a challenger culture to drive performance.
• Pricing quality and avoiding overpayment are key strategies for continued success.

"Maintaining that culture for us is the thing we worry most about as we grow, and we're extremely focused on it."

• This quote emphasizes the importance of preserving company culture as a foundation for ongoing success and growth.

• Strong relationships within the portfolio and with founders are vital for sourcing deals.
• The firm aims to be the capital partner of choice, focusing on long-term relationships and reputation.
• A comprehensive understanding of market cycles and history informs investment strategies.

"Our goal is to be the capital partners of choice for founders and business owners around the country."

• This quote highlights the firm's commitment to building strong, lasting relationships with founders and business owners.

• The firm prioritizes liquidity in downside scenarios over maximizing leverage in upside scenarios.
• Entering with low leverage and maintaining financial flexibility are key strategic elements.
• Understanding market cycles and historical context is crucial for informed decision-making.

"Liquidity in downside scenarios is always worth more to you over a longer period of time than max leverage is in an upside scenario."

• This quote encapsulates the firm's cautious approach to capital structure, emphasizing the importance of financial stability.

• The firm maintains a strong, accountable relationship with LPs, viewing them as customers.
• Transparency and alignment of interests are central to the firm's approach to managing LP relationships.
• The firm leverages the experience and guidance of LPs and mentors to enhance decision-making.

"We work for LPs, and one of our core values is accountability."

• This quote reflects the firm's dedication to serving LPs' interests and maintaining a transparent, accountable relationship.