Invest Like the Best with Patrick O'Shaughnessy: Episode 392 Guests: Matt Perlman & Alex Sloan - The Art of Franchise Investing

Introduction to Guests and Garnet Station Partners (GSP)

Patrick O'Shaughnessy welcomes Matt Perlman and Alex Sloan, the co-founders and managing partners of Garnet Station Partners (GSP), a firm specializing in investing within the trillion-dollar franchise and consumer services industries. Founded in 2014 during their MBA studies, Matt and Alex began their journey by purchasing 23 Burger King restaurants, eventually expanding to 26 multi-unit businesses across various sectors, including gyms, car washes, and funeral homes. Their success earned them recognition as "the next generation of great private equity investors" by Mark Lasry earlier in the year.

Notable Quote:

"GSP is a leader in its field and our conversation is a masterclass on franchise investing."
— Patrick O'Shaughnessy [04:23]

Founding Story and Early Challenges

Matt and Alex recount their unconventional start in franchise investing. Initially rejected by KFC due to insufficient funds and lack of experience, they pivoted to approach other franchisors directly. Their persistence paid off when Burger King granted them the opportunity to buy Ray Meeks' struggling franchise in Henderson, North Carolina. Living with Ray and his wife Cass, they meticulously diligenced the business, implementing management talent, data capital, and strategic capital allocation, transforming the 23-unit operation into the largest Burger King franchisee with over 1,100 stores.

Notable Quote:

"We bought that business in August of '14 and grew it from 23 locations to over 1,100 stores."
— Matt Perlman [07:15]

Investment Philosophy and Approach

GSP's investment thesis centers on franchise consolidation within fragmented, multi-unit consumer services businesses. They emphasize disciplined operations, cost management, and strategic reinvestment. By leveraging technology, data, and experienced management, GSP aims to scale businesses efficiently while maintaining strong franchisor relationships.

Key Points:

• Fragmented Markets: Focus on industries with a high number of units but low market concentration.
• Operational Efficiency: Utilize technology to streamline expenses and optimize labor management.
• Franchisor Alignment: Ensure partnerships with franchisors are mutually beneficial, enhancing brand value and operational support.

Notable Quote:

"We all together have a pretty good sense of where the opportunity is."
— Alex Sloan [10:03]

Managing Through Crises: The COVID-19 Experience

The COVID-19 pandemic posed unprecedented challenges for GSP, with their portfolio heavily reliant on foot traffic. Faced with potential revenue plummets, Matt and Alex took decisive action:

• Operational Shutdowns: Temporarily closed businesses and furloughed employees.
• Liquidity Management: Assisted franchisees in accessing government programs and alternative financing.
• Strategic Acquisitions: Acquired distressed assets at favorable terms, such as Pete’s Hut and Wendy’s franchise debt, capitalizing on market dislocations to generate significant returns.

Despite the turmoil, GSP successfully navigated the crisis without losing any portfolio companies or breaching debt covenants, later benefiting from a rebound in foot traffic and strategic acquisitions.

Notable Quote:

"We didn't lose a single company. We didn't have to put in a dollar of rescue capital."
— Alex Sloan [39:02]

Sourcing and Deal Flow

GSP emphasizes a robust sourcing strategy built on strong relationships and an extensive network within the franchise ecosystem. Their deals often originate from existing portfolio relationships and recommendations from trusted industry contacts. Additionally, their thorough understanding of franchise operations and market dynamics allows them to identify and capitalize on unique investment opportunities.

Key Points:

• Relationship Virality: Leveraging connections from current portfolio companies to source new deals.
• Consistent Track Record: Building credibility through successful past investments, facilitating easier capital raising.
• Strategic Positioning: Acting as preferred partners for franchisees looking to scale or seek institutional support.

Notable Quote:

"Our best deals come from the virality of relationships within the portfolio itself."
— Alex Sloan [89:33]

Capital Structure and Leverage

GSP adopts a conservative approach to leverage, often initiating investments with 100% equity to minimize risk. Learning from early setbacks, such as over-leveraging their auto services investment, they now prioritize maintaining low leverage upfront. Once businesses are stabilized and scaled, GSP judiciously introduces debt to optimize capital efficiency without overburdening operations.

Key Points:

• Low Initial Leverage: Starting with equity to ensure financial stability.
• Gradual Debt Introduction: Adding leverage only after confirming operational robustness.
• Capital Efficiency: Utilizing debt to replace equity costs and support further consolidation.

Notable Quote:

"We're starting with 100% equity... to make sure that we're de-risked."
— Alex Sloan [60:35]

Culture and Partnerships

A cornerstone of GSP's success is their unwavering focus on maintaining a strong internal culture and fostering meaningful partnerships with franchisees. Both Matt and Alex highlight the importance of mutual respect, alignment of incentives, and preserving the unique cultural aspects of each portfolio company. Their close-knit, lifelong partnership also contributes to a cohesive and resilient organizational culture.

Key Points:

• Core Values: Emphasizing accountability and alignment with LPs (Limited Partners).
• Cultural Preservation: Respecting and enhancing the existing culture within portfolio companies.
• Partner Relationships: Building long-term, trust-based relationships with franchisees and their families.

Notable Quote:

"Our partnership is really special. We value it as much as anything in the world."
— Matt Perlman [62:19]

Risks and Challenges

GSP identifies several key risks in franchise investing, primarily revolving around operational leverage, integration complexities, cultural misalignment, and valuation discrepancies. They stress the importance of thorough due diligence, understanding cyclical market dynamics, and maintaining flexibility to adapt to changing economic conditions.

Key Points:

• Operational Leverage: Balancing cost efficiencies without compromising service quality.
• Integration Challenges: Seamlessly consolidating multiple units while preserving cultural integrity.
• Valuation Risks: Avoiding overpaying and ensuring sustainable cash flow projections.
• Cyclical Vulnerabilities: Preparing for economic downturns and unexpected market shifts.

Notable Quote:

"We've consistently missed Taco Bell deals because they were too high quality and too expensive for us."
— Alex Sloan [28:42]

Innovation in Franchise Operations

GSP leverages technology and innovative financial structuring to enhance operational efficiency and drive growth across their portfolio. This includes adopting advanced labor management systems, optimizing real estate agreements, and implementing strategic marketing initiatives tailored to each brand's strengths.

Key Points:

• Technology Adoption: Utilizing cutting-edge tools for expense management, labor optimization, and real-time operational insights.
• Financial Engineering: Renegotiating leases, implementing sale-leaseback arrangements, and optimizing capital structures to de-risk investments.
• Marketing Strategies: Engaging top-tier marketing experts to bolster brand presence and customer engagement.

Notable Quote:

"It's not inventing new technology. It's adopting what’s out there and implementing it effectively."
— Matt Perlman [73:27]

Exit Strategy and Buyer Relationships

GSP meticulously plans exit strategies from the outset, targeting larger private equity firms as potential buyers who value the operational efficiencies and scalable growth GSP has established. They focus on building high-quality, consistent platforms that are attractive investment opportunities for these institutions.

Key Points:

• SIM (Sales Investment Memo): Crafting detailed exit plans early and aligning all decisions to support eventual sale.
• Buyer Profiles: Targeting substantial private equity firms with significant AUM looking for scalable, professionally managed franchises.
• Consistent Performance: Ensuring portfolio businesses exhibit narrow performance variance and robust growth metrics to appeal to buyers.

Notable Quote:

"Every single decision we make is to ensure when that private equity partner sits around their investment committee table, they're talking about this platform that they have to own."
— Matt Perlman [50:35]

Maintaining Excellence and Future Outlook

GSP remains committed to sustaining their high performance by focusing on culture, disciplined financial practices, and continuous relationship building with both portfolio companies and LPs. They aim to uphold their reputation through consistent value creation, strategic innovation, and maintaining strong operational standards.

Key Points:

• Continuous Improvement: Regularly updating and refining investment strategies based on past learnings and market evolution.
• Strong LP Relationships: Prioritizing transparency, accountability, and proactive communication with investors.
• Long-Term Vision: Planning for sustained growth and relevance in franchise investing over the next five decades.

Notable Quote:

"Our goal is to give investors $3 back for every dollar they invest."
— Matt Perlman [51:25]

Conclusion

Matt Perlman and Alex Sloan of Garnet Station Partners provide a comprehensive look into the art of franchise investing, highlighting the critical elements of disciplined operations, strategic relationships, and innovative financial structuring. Their journey from youthful MBA students to seasoned private equity leaders underscores the importance of resilience, continuous learning, and unwavering commitment to their investment philosophy. For aspiring investors and industry professionals, their insights offer valuable lessons on navigating the complexities of franchise consolidation and achieving sustained success in a competitive market.

Notable Closing Quote:

"We're building a firm to serve as real partner capital to baby boomers and small business owners."
— Matt Perlman [48:12]

This summary encapsulates the key discussions and insights from Episode 392 of "Invest Like the Best," featuring Matt Perlman and Alex Sloan. For a deeper dive, listen to the full episode or visit Join Colossus for more resources.