Restaurant Financing

2023 was marked by several high-profile bankruptcies among restaurant brands and franchisees. That trend bled into the start of 2024, when a multi-unit Popeyes’ operator filed for Chapter 11 protections.

But does this mean restaurant bankruptcies will pile up in 2024?

Chris Desiderio, counsel in Nixon Peabody’s corporate restructuring and bankruptcy group, doesn’t think so. He said recent headline-grabbing filings aren’t representative of a broader move toward bankruptcy, like the trend in retail throughout recent years.

“They've been fairly isolated cases, rather than the industry norm,” Desiderio said in March 2024. Many firms have been able to solve issues, like temporary covenant defaults caused by sales shortfalls, without resorting to the Chapter 11 process, he said.

Desiderio said cost increases may pose a risk. But this risk is unevenly distributed across segments because some diner demographics are more reluctant to accept pricier menus than others.

“Fast casual has the most price-sensitive customer base. So significant shifting of costs will have the highest impact [in that segment],” Desiderio said.

For our first Ask the Expert column, we discussed the issues driving, and constraining, restaurant bankruptcies and how franchisees and franchisors can handle these pressures.

RESTAURANT DIVE: What will 2024 and the first couple quarters of 2025 look like when it comes to franchisee and restaurant bankruptcies and restructuring?

CHRIS DESIDERIO: I think it will remain slow. We're seeing the beginnings of commercial real estate workouts, which obviously will impact what the landlords are doing and the pressure landlords are putting on their lessees.

A lot will depend on return-to-office trends and whether, after the summer of 2024, we have more progress than we did at the end of 2023.

Labor costs have seemed to stabilize for right now, but if the minimum wage increases significantly at any point, that is probably one of the largest overhead costs for an operating franchise, particularly in the restaurant industry. So that'll have to get addressed.

I don't see a tremendous rush to lenders exercising remedies to push in defaults this year.

What sort of conditions do you think would push lenders to take that action?

DESIDERIO: Increased interest rates and the unwillingness of landlords to negotiate.

The biggest things that drive anyone into insolvency or restructuring are liquidity concerns. Folks have been managing around liquidity concerns through negotiations, but to the extent that labor, rent and cost of money go up significantly, [that could impact liquidity]. Those three are the most major concerns.

How should franchisees who are facing cost pressures, but not acute price shocks, approach the next year?

DESIDERIO: Planning and forecasting are incredibly important. Everyone has a tendency to forecast, the problem is you should be tracking your variance from that forecast, which I think franchisees often forget to do. And figure out if you are tracking higher or lower than what you were projecting, and if that is a short-term blip, or if it is a longer-term pattern.

Thinking about restructuring strategies while you still have sufficient cash on hand is important. Folks have a tendency to wait until they're not going to make payroll, or miss a tax payment, to seek restructuring advice. 

It’s a healthy thing to be doing all along. We don't only see our doctors when we have an emergency situation. We have our annual physicals. Reassessing your financial wherewithal on a regular basis is a good thing.

Waiting too long to seek that advice can jeopardize the ability for someone like Nixon Peabody to help. If contracts have terminated, you can't necessarily revive them in bankruptcy. If lines of credit disappear, or IP rights are terminated, they can be very difficult to get back, which leaves very little of a restructuring route. Early interventions are very important.

What can heavily franchised brands, particularly those whose franchisees might face cashflow issues due to traffic declines, do about these issues?

DESIDERIO: The first thing is to ensure that you're maintaining your quality standards, regardless of financial situation. A bad franchisee can do significant and irreparable harm to a larger chain.

It's important to make sure that those standards are maintained regardless of the situation. To the extent a franchisor needs to do some form of interim management help, or provide a lifeline in order to ensure that, I think that's money well spent.

I think franchisors need to make determinations as to whether it's a short-term storm, or a long-term one. There needs to be a calculus of whether it's worth it to continue to invest in struggling franchisees or to potentially shut off rights.

A number of chains are undertaking expensive renovation programs at a time when money is increasingly expensive. Do the benefits of boosted sales from renovated units outweigh the costs of development?

DESIDERIO: We've all seen rebrands that leave consumers confused. And other times a rebrand can reinvigorate a restaurant company and bring something back from the dead. It is a case-by-case scenario. 

Anything that looks tired is going to lose cachet in the market. But there needs to be a realistic evaluation of risk against rewards. Is the renovation going to triple your business? Or is it really a 10% increase?

Those are the factors that hopefully franchisors are considering before they're imposing them on their franchisee base.

How do risks differ between highly fragmented and highly concentrated franchising systems?

DESIDERIO: A smaller franchisee will usually have less experience. They have a lower cost of entry. They may not have experience in management, or with cash flow and projections.

Their ability to access capital is lower. They may not have as much credit available. The value of the collateral they can offer to a lender is less. And you don't realize some economies of scale.

But the risk is lower in that if one or two fails, it's much easier to replace a one-unit or two-unit owner than it is a 100-unit owner.

For a larger franchisee, access to capital is greater, and the experience will be better. You don't just start with 100 units — most of those people have built their way from one or two units.

But franchisors are putting a lot of credit and a lot of their business in someone else's hands [when working with large, multi-unit franchisees]. You have certain controls in place, as a franchisor, to monitor business. But ultimately, if a big franchisee collapses and they represent 10% of your system, it will have a significant financial impact.

What are lenders saying about this business environment?

DESIDERIO: There's still a lot of capital available. Although not as cheap as we've been used to for the last decade, historically speaking it's still fairly cheap and fairly accessible.

I don't know if we'll see as much investment in central cities. But city centers, even at their slowest, still offer more foot traffic than a rural area.

What do out-of-court resolutions to defaults look like? What are the means by which these problems are solved?

DESIDERIO: If you have a struggling franchisee, it could be a franchisor taking them back as a company store; it could be providing some line of credit in order to get them back on their feet, or additional support by helping management right the ship.

Keeping franchisors out of bankruptcy is more lender driven. That depends on whether or not lenders are willing to take the IP and operations on the portfolio and whether they think they can receive more value that way than perhaps by just extending loans or modifying covenants in order to carry defaults for some period of time. 

What's going on in commercial real estate? How is weakness in commercial real estate likely to impact struggling franchisees? Are landlords becoming more aggressive with rents, or do commercial tenants have greater leverage now?

DESIDERIO: We're kind of seeing the first phase of this, where the loan to value ratios are significantly out of whack. Commercial real estate could be as low as 50% of the value of what it was when the debt was originally issued. 

On top of that, tenancy rates are low. With balloon payments potentially coming due, it puts pressure on landlords.

It becomes a chicken and egg scenario: Do we lower rent in order to attract tenants and get those vacancy numbers reversed? Or do we hold on for the market to turn around so we can get higher rents?

Landlords for existing tenants have been fairly amenable to negotiations, because keeping a paying tenant in is meaningful. But there continues to be tension because they're trying to keep themselves out of default under their own loan documents. There's only so much leeway they could possibly have.

When customers came in droves to gorge on Ultimate Endless Shrimp at Red Lobster, losses piled up despite a boost in traffic. While many blame the ill-fated promotion for pushing the chain into bankruptcy, its financial decline truly began a decade earlier. 

With a promise of expanding the chain, Golden Gate Capital bought the chain from Darden Restaurants for more than $2.1 billion in 2014. Then, Golden Gate sold the real estate Red Lobster owned for $1.5 billion in a sale-leaseback deal. Suddenly, a company that had not paid rent now had to pony up for a major additional cost, which was expected to increase 2% each year. 

“When that real estate deal took off, that was the beginning of the economics starting to go south,” said Phil Kafarakis, president and CEO of the International Foodservice Manufacturers Association. 

According to Red Lobster’s bankruptcy filings, rent cost the chain over $190 million last year, and $64 million went toward underperforming restaurants. The seafood giant also reported a net loss of $76 million and a dwindling cash portion that shrunk from $100 million to less than $30 million in six months, making its leases unaffordable.  

Back-to-back management changes also rocked the boat. Red Lobster adjusted to new ownership under global seafood supplier Thai Union Group when it acquired 49% of the chain in 2016 from Golden Gate Capital. Seafood Alliance, an investor group led by Thai Union, bought the remaining stake in 2020. Red Lobster also endured a revolving door of CEOs. The chain said it’s looking into potential misdealings with Thai Union, which allegedly pressured the chain to buy its shrimp as part of the Ultimate Endless Shrimp deal. 

It’s not uncommon for an equity holder to also be a restaurant’s supplier, said Jeff Cohen, partner and chair of the Bankruptcy & Restructuring department at Lowenstein Sandler. 

“I think the allegations that [Thai Union] exerted undue influence on [Red Lobster] management’s decisions to require a larger supply from them, and perhaps at above market rates, that’s the problem,” Cohen said. 

It’s unclear if this dispute could lead to a lawsuit. If Red Lobster can find a replacement supplier with competitive prices, then the chain may sue Thai Union over prior behavior, Cohen said. But if Thai Union is critical to Red Lobster’s supply chain and can’t be easily replaced, the situation “screams of a settlement” because protracted litigation would be too expensive and disruptive to the restaurant’s operations, he said. 

“Thai Union has a been a supplier to Red Lobster for more than 30 years, and we intend for that relationship to continue,” a Thai Union Group spokesperson said in an email to Restaurant Dive. “We are confident that a court-supervised process will allow Red Lobster to restructure its financial obligations and realize its long-term potential in a more favorable operating environment. We are aware of the meritless allegations in the Bankruptcy Court pleadings and look forward to a full representation of the facts.”

“If you peel away the soap opera elements of the first-day pleadings, what is clear is that there’s still a business there,” Cohen said. “There’s still a reason for Red Lobster to exist. There clearly are still profitable locations. I just think they need to use a Chapter 11 process to strip the company down to its core profitable locations [and] correct operations, including [operations] related to all Thai Union supply issues.” 

Red Lobster's problems provide some industry warnings

Even though analysts expect more bankruptcies this year, Red Lobster’s downfall isn’t indicative of the overall health of the restaurant sector. 

Kafarakis remains bullish on the industry. Operators are quickly adapting to changing consumer dynamics and operating slimmed-down stores, he said, which helps franchisees manage their real estate, income and growth. 

“I would be concerned if [Red Lobster] said customers haven’t been showing up, numbers are way down, it’s not sustainable, … but they didn’t say any of that,” Cohen said. “They’re saying people came and essentially ate us out of business.”

Red Lobster was overleveraged and management made poor decisions, Cohen said, adding that its bankruptcy is not illustrative of the state of the industry. 

“I don’t think this is a sign of an industry wide thing to come,” Cohen said. “I think it’s a specific situation.” 

Red Lobster does provide some warning signs, however. 

“Companies are getting to the point where they have to perform without either the benefit of low interest rates or the benefit of COVID dollars that they don’t have to pay back,”  said Victor Sahn, partner in bankruptcy and reorganization at Greenspoon Marder.

Bankruptcies will likely hit companies of all sizes, but more likely middle- and large-chains since small restaurants would likely close their doors and liquidate, Sahn said. 

Why bankruptcy was necessary

Prior to filing for bankruptcy, Red Lobster tried to restructure out of court in which its prepetition term loan lenders would own 80% of the company and Thai Union would have a minority stake, but those negotiations were unsuccessful, according to court filings.

Red Lobster was receiving incremental loans of $20 million in incremental working capital, but Thai Union ceased providing capital to Red Lobster earlier this year. Without support from Thai Union, Red Lobster’s lenders no longer would make loans out of court, per court filings.

“With no meaningful ability to raise fresh capital, it became evident that the Company needed to consider a chapter 11 process,” CEO Jonathan Tibus said in court documents. “As a result, the Debtors determined that a comprehensive operational restructuring and value maximizing sale inside of a chapter 11 process would likely be the best possible alternative under the circumstances.”

Red Lobster will come out of bankruptcy with fewer locations, leaner operations and a new owner, per court filings. 

Red Lobster also could be looking for ways to trim its menu, assessing its core offering, because the broader the menu, the more suppliers and vendors a chain needs, said Kevin Clancy, global director of CohnReznick advisory's restructuring and dispute resolution practice.

But nothing would be surprising about how Red Lobster looks in the aftermath, Cohen said. Typically during an assessment of a retailer or restaurant chain, locations are put into three buckets: highly profitable locations, bubble locations and unprofitable locations, Cohen said.

A lot will go into what Red Lobster considers at each location, including where the location is and what kind of business it gets. Is it in an office location where lunch traffic has essentially dried up or in a mall location? If it has multiple landlords for several locations, then that would be easier to negotiate leases than having one location at a time, Clancy said. 

The bankruptcy process will allow the company to reject a lease, and the landlord would then make a claim within the bankruptcy, Clancy said. Other times, the debtor will try to renegotiate their leases, which can come in handy if a landlord doesn’t feel like it will find someone better to fill the space.

Cohen expects there could be more closures as Red Lobster assesses bubble locations, which could be as many as 100 or more locations. After that second wave of closures, the company would be left with hundreds of highly profitable locations that could succeed with operational changes and cost-savings measures, he said. 

As a leaner company, it’s possible that Red Lobster could attract interest from large restaurant portfolio companies, like its previous owner Darden, Cohen said. 

It also could attract the interest in Landry’s, which has acquired chains such as Houlihan’s and The Palm out of bankruptcy in the past. Landry’s also owns much of its supply chain so it would be easier to replace a supplier like Thai Union.

“It would not surprise me if one of those large restaurant conglomerates expressed interest,” Cohen said. “It’s just a matter of where the existing lenders are willing to let go of the company and at what price.” 

For Sahn, an outside buyer is a possibility but unlikely. Prior to its bankruptcy, Red Lobster hired an investment banker to market the chain for sale, but no one was willing to buy at a price to satisfy the secured debt owed on the assets.

“The chances are slim to none because they’ve already marketed the assets,” Sahn said. “And the result of that marketing was not successful. That’s why they’re proposing that the lender act as the buyer. I think that’s what they thought would happen all along.”

It’s most likely that the secured lender will convert its debt into equity and become the sole owner of the company, Sahn said. 

“This is really similar to a lot of cases that have gotten filed in the last five to 10 years where there’s a pre-baked business solution that has been worked out, documented and agreed upon before the bankruptcy is filed,” Sahn said. “The purpose of the bankruptcy is just to effectuate the business plan that they’ve already put tougher and finalized, or nearly finalized before the filing itself took place.”

In 2023, several large QSR franchisees declared bankruptcy. While each of these bankruptcies had unique causes, they provide a window into a set of common industry problems: rising input costs, including labor and food costs; difficulty raising capital to fund expansions or remodels needed to drive new sales; evermore expensive debt service; and static or falling consumer traffic.

In 2024, the environment remains perilous for operators, and experts say restaurant franchisee bankruptcy filings are probably far from over.

“All of those pressures that the franchisees are citing as causing problems with their operating economic models show really no sign of slackening their impact as you move into 2024,” said Eric Danner, a partner in CohnReznick’s restructuring and dispute resolution practice. 

Ab Igram, executive director of the Tariq Farid Franchise Institute at Babson College, said those problems were likely to be serious only for over-leveraged operators. 

“For the most part, it depends on the individual operator, what markets they're in, how well they've maintained their units,” Igram said. “If the economy continues to improve, that bodes well for franchisees heading into 2024.”

Core problems remain

Danner noted that factors driving higher costs haven’t changed. Unemployment iwas still low at the start of 2024, contributing to labor market tightness that forces employers to compete for workers. This dynamic may be driving wage growth above inflation on a broad basis.

While good news for workers, wage growth may eat into the cashflow franchisees need to meet the covenants on loans, which puts pressure on operators’ balance sheets, said Kevin Clancy, global director in CohnReznick’s restructuring and dispute resolution practice.

Because franchisee debt generally has cash flow or profitability requirements, issues with margins or cash flow due to supply shocks, labor shortages or other disruptions can push operators into covenant default, Clancy said. Those shocks can be as minor as a particularly harsh winter, which cuts into traffic in some regions, he said.

Danner said there’s been a general move away from “term debt that has a lot of loan covenants towards asset-based facilities that have fewer covenants but often carry a higher cost of money.” Those loans may be less onerous in terms of the performance metrics borrowers have to meet to avoid technical default, but that relative flexibility comes with a higher price tag.

In general, the cost of borrowing has risen as interest rates have increased since 2021, in proportion with the Federal Reserve’s interest rate increases.

“I've seen our client's borrowing costs go up by two to three times,” Danner said. “That's significant, especially when you're talking about borrowing a large principal balance on which to fund an acquisition or significant renovations.”

Part of the trouble fast food franchisees face stems from the success experienced by the QSR segment between 2020 and 2021. QSRs, Danner said, outperformed the rest of the industry during this time, making them attractive for investors and lenders who were skittish about other restaurant segments.

“As people bought into the franchise world during COVID, the bulk of that was predominantly borrowed money. And that's kind of coming home to roost,” Danner said. The spiraling cost of debt service since then has funneled operating profits away from reinvestments in remodeling, new technology and core operations and toward debt repayment. 

Clancy said that there are likely to be more bankruptcy filings in the casual dining and full-service restaurant sectors as well, as the consumer rush toward experiential dining following COVID-19 restrictions returns to a normal level.

Danner said full-service and fine dining in urban centers may also see a number of bankruptcies if business traffic and office attendance in central business districts remains depressed.

The weakest franchisees may be gone already

Mark Wasilefsky, head of franchise finance at TD Bank, said that while many franchisees are still heavily leveraged, there’s reason to think the worst may be over, given the specific troubles faced by franchisees who went bankrupt in 2023.

Among the major franchisees to go belly up in 2023, two were owned by the same founder, whose death left the companies leaderless. One, a McDonald’s franchisee, went bankrupt to minimize liabilities after the company hired a sex offender as a manager who then allegedly sexually assaulted a minor employed at the restaurant. Starboard Group, the major Wendy’s franchisee that filed for Chapter 11 in November 2023, had problems with residual debt from failed efforts to penetrate the Brazilian market. And Meridian Restaurant Unlimited, one of Burger King’s operators, had pursued a strategy of acquiring underperforming stores in the hopes of turning them around. Other bankrupt franchisees were heavily indebted.

“There were some folks that went way out on the leverage spectrum [in 2021],” Wasilefsky said. “Probably hoping that that kind of performance and those margins were going to continue, no one saw interest rate or commodity and wage inflation coming in like it did.”

“I don't think all those deals have washed through,” Wasilefsky said. But those operators that have held on until now have had time to pay down debt and may be near a position to refinance, depending on loan terms.

“There certainly has been a certain amount of weeding out the weakest that's taken place in ‘22 and ‘23,” Danner said.

While many macroeconomic statistics showed a relatively healthy environment in the U.S. at the start of 2024 — low unemployment, slowing inflation, steady growth — QSR traffic has fallen since 2022 and value moves by brands may not fix it. 

“A lot of these bankruptcies had other issues going on,” Wasilefsky said. “I don't see a lot more of the large ones happening unless there's exogenous issues.”

There may still be exogenous shocks to the market: Ansar Allah, an Islamist movement based in northern Yemen, imposed a partial blockade in the Red Sea in late 2023 in an effort to stop what the group described as crimes committed by Israel during the invasion of Gaza. Ansar Allah also aims to pressure Israel to ensure prompt delivery of food and water in the besieged Gaza strip, where the United Nations estimated more than half a million people were starving at the start of 2024. According to the Financial Times, shipping costs surged as a result of the blockade, which could push up oil prices as well and worsen inflation.

TGI Fridays is about to embark on a new era. In April 2024, it announced that it entered into a roughly $220 million deal to be acquired by its largest franchisee, Hostmore. Once complete, TGI Fridays will become a public company on the London Stock Exchange. This isn’t the first time TGI Fridays has tried to make its public debut. In 2019, it attempted to go public in the U.S. through a SPAC, but that deal fell apart. 

Joining a public market is a huge milestone, and a lot has gone into setting up the American restaurant chain and U.K. franchisee for combination. Hostmore has undergone significant cost reductions, while TGI Fridays closed three dozen underperforming stores earlier this year. 

Check out four things to know about the impending deal and how the new, combined company will function.

TGI Fridays has a long history in the U.K. 

TGI Fridays has operated in the United Kingdom since 1986 under master franchisee Whitbread. In 2007, Whitbread sold its business to a joint venture called TGI Fridays U.K. Limited, which bought 30 out of its 45 restaurants. The joint venture was between TGI Fridays owner Carlson Restaurant Group and private equity Group ABN AMRO Capital. Carlson owned both TGI Fridays in the U.S. and U.K. for seven years. 

In 2014, TriArtisan Capital, along with Sentinel Capital Partners, bought the U.S. TGI Fridays business from Carlson for a reported $800 million, while private equity firm Electra Partners bought the U.K. business for over $155 million. Electra then took TGI Fridays’ U.K. business public under the name Hostmore in 2021. 

Hostmore has been undergoing its own turnaround strategy

Hostmore saw its costs increase over the past few years due to the creation of a multi-branded platform, new store openings and its public debut, per the company’s 2022 annual report. It completed an initial review of its fixed cost base and found £1.8 million ($2.2 million) in savings, which included staff cuts. These reductions were expected to save the company £1.2 million ($1.5 million) during fiscal 2023, although it has yet to file its fiscal 2023 report. 

As part of its capital allocation policy, Hostmore deferred new store openings until at least fiscal 2025, which would save it £15 million ($18.7 million) during that period. The savings will be used to repay the company’s loans and borrowings, according to the company’s annual results for 2022. 

The combined company will continue to pursue Hostmore’s revised capital allocation policy framework with a priority toward reducing debt and improving shareholder returns. The combined company will have “significantly enhanced scale and committed long-term funding,” Hostmore said in a regulatory filing about the transaction.  

“Hostmore has made good progress in executing its turnaround strategy over the past year by reducing costs, revising our capital allocation policy to focus on debt repayment and shareholder distributions, and pursuing high ROI organic growth initiatives,” Hostmore chairman Stephen Welker said in a regulatory filing about the merger. 

TGI Fridays also has been working on reducing its debt, including refinancing with new lenders, which is expected to be completed on or before the transaction closes. 

C-suite management from both companies will remain in place

Hostmore’s CEO Julie McEwan and CFO Matthew Bibby will remain in their positions under the U.K. business at the combined group. Bibby will also add the title of head of investor relations to his responsibilities. TGI Fridays’ current CEO Weldon Spangler and CFO Nik Rupp will remain in their same positions under the new company. 

The combined company’s board will consist of a mix of chairpeople from both companies.  Rohit Manocha, co-founder of TriArtisan and chairman of TGI Fridays, will become non-executive chairman of the board following the retirement of current Hostmore chair Stephen Welker, who is expected to step down during the 2025 Annual General Meeting. Other non-executive directors will include:

• David Lis, current Hostmore senior independent director
• Andrew Blurton, current Hostmore audit and risk committee chair
• Helena Feltham, current Hostmore remuneration committee chair
• Anil Yadav, TriArtisan investor in TGI Fridays and a significant franchisee
• Two other representatives nominated by TGI Fridays

Off-premise will continue to be a key growth pillar for the combined company

TGI Fridays’ off-premise business made up about 25% of sales in 2023, with about 40% of those sales coming through the chain’s proprietary channels, which include its website. 

The chain also has ongoing partnerships with third-party delivery platforms. Off-premise is expected to provide “a potential new growth lever through increasing customer numbers and margin enhancement,” Hostmore said in its regulatory filing about the transaction. 

Hostmore also owns a fast casual dining brand, Fridays and Go, that emphasizes off-premise with order kiosks, mobile ordering and delivery. Its website indicates that there is only one such location in Dundee, Scotland, at this time. Hostmore said it has also been working on improving its loyalty app and email database to help increase repeat customer visits, as well.

From Jack in the Box to California Pizza Kitchen, major restaurant brands have spent the last few years pushing for growth via franchising and signing multi-unit deals. It’s not just legacy chains that are accelerating franchise expansion. Many midsize chains, such as Modern Market Eatery and Dog Haus, struck deals in the past few years with operators big and small to create robust pipelines. 

New and existing franchisees will face challenges due to high costs that are squeezing margins and pressure to deploy technology that caters to modern consumer needs, experts said. But the prospect of operating a restaurant still holds a lot of excitement for those entering the field. 

“Franchising is growing as fast as it’s ever grown right now,” said Mark Siebert, CEO and founder of consultancy iFranchise Group. “We’re just seeing a lot of people getting into business for themselves.”

While new business applications remained steady in the past decade in accommodation and foodservice with about 20,000 monthly new business applications, that number has been elevated since mid-2020. The segment reported roughly 30,000 new business applications per month by mid-2020 and have since remained above 20,000 monthly applications, according to U.S. Census Bureau Business Formation Statistics.

Although experienced restaurant business owners and operators understand how difficult it is to run a restaurant, some new entrants view these businesses as a fun way to score guaranteed cash flow from day one, Siebert said — a goal that is far from guaranteed. 

“There’s excitement to the restaurant business that there isn’t to mowing people’s lawns or being a janitorial service person,” Siebert said. 

In some ways, that excitement is warranted. Consumer demand to eat out remains high. In the middle of the week, when business tends to be slow, desirable restaurants are still really busy, said Greensfelder franchising attorney Lenny Vines. 

New franchisees and longtime operators will face a host of challenges this year. Fierce competition for real estate and high technology costs, for example, will threaten franchisees’ profitability, experts said. 

“This is a very, very, very difficult business,” Vines said. “Don’t think that this is going to be a cakewalk. Be prepared to really work hard.” 

Big chains seek multi-unit franchisees

It’s already harder for aspiring single-unit operators to break into restaurant franchising, at least with the big players. In the last five years, well-capitalized groups — often backed by private equity — have bought large blocks of restaurants, said John Ramsay, vice president of franchise sales at Noodles & Company.

Legacy brands are capitalizing on this shift. It’s easier for franchisors to help a large operator group expand from 50 to 60 units versus finding and training 10 individual franchisees, Ramsay said. Many restaurant chains with complex operations don’t want to sell locations to mom-and-pop franchisees anyway, Siebert said, because they prefer the experience of multi-unit foodservice operators.

Subway, which has a long history of working with single-unit franchisees, said in 2022 that it would target more multi-unit operators. In August 2022, Jack in the Box began offering operators discounted royalty rates for their first five years if they agreed to develop at least three units. 

Noodles & Company isn’t seeking first-time franchisees, either. Ramsay said the chain feels larger, long-term franchisees are better equipped to deal with current challenges in the industry, such as the increasing cost of real estate and construction. In 2021, Noodles & Company focused on attracting multi-unit franchisees to expand in the South and Southwest.

However, major restaurant brands’ disinterest in single-unit operators has left room for small brands to add franchising to their growth strategies. Franchising is still a great model for someone locally connected, especially if a restaurant offers a simple, assembly-focused menu that doesn’t require extensive foodservice experience, such a sandwich shop,  Siebert said. 

“There’s always going to be space in the franchisee world for that first timer,” Ramsay said. “If anything, franchising has gotten more sophisticated and better. A lot of these emerging brands have access to better systems than they did in the past.”

A push for profitability

Even if ideal franchising partnerships are formed, profitability will demand creative solutions in 2023, said Tim Doherty, president and CEO of franchise group Doherty Enterprises. The company owns and operates 135 restaurants, including Panera and Applebee’s units in four states.

While Doherty’s restaurants saw strong sales in 2022, profitability was hard won due to inflation’s impact on both wages and food costs, he said. 

“I think that there needs to be an approach with the franchisor and franchisee on making sure we are developing menu items that are both an excellent value for guests, but are also profitable for the restaurant,” he said. 

Applebee’s and Panera have both developed menu items that could be LTOs or long-term menu items, depending on performance and food costs to keep the restaurants profitable, Doherty said. Panera, for example, has added several new menu items within the last few years, most recently adding toasted baguette sandwiches earlier this month. 

“Franchisees are super hyper [aware] about what the margins look like, what are specific brands doing to combat [low margins] and how is that going to impact them in the long term,” Ramsay said. 

Noodles & Company, which had 366 company-owned stores and 93 franchised restaurants as of September 2022, uses data collected across its corporate stores to help predict upcoming trends for franchisees. This can help operators prepare for fluctuations in commodity prices, labor costs, interest rates or lease costs, Ramsay said. The chain has been purchasing kitchen equipment, such as refrigerators, HVAC units, stainless steel tables and other fixtures, for company-owned and franchisee-operated stores. This will allow franchisees to share in the company’s purchasing power, Ramsay said. 

“There’s a level of comfort there that we had a plan in place and actions that we can take and we’re not just going to be reacting to what happens,” Ramsay said. 

Franchisees consider more cost-effective real estate options

As cost concerns grow in the restaurant space, franchisors are developing smaller stores emphasizing off-premise business, which continues to drive a large portion of diner traffic. These smaller stores are more cost-effective to build, experts said, which can create openings for upstart operators. Other restaurant companies are focusing on store conversions to expand, and are using second-hand equipment to save costs. 

Competition for drive-thrus has increased alongside property values, which makes development more challenging, said SG Ellison, president of Diversified Restaurant Group. Those values will stabilize heading into a recession, but with interest rates rising, financing these properties will be difficult. 

However, Ellison said companies with decent cash positions and the ability to grow their balance sheets, or finance their development on their own, will be in a good position to find opportunities that weren’t available in the past few years. 

Diversified Restaurant Group continues to look for places where it can leverage Taco Bell’s Go Mobile store format, as well as drive-thru assets and strong delivery demand, as it plots expansion. Ellison said the Diversified delivery and digital channels have grown more than any of its other channels in the past two years, which has created more opportunities for experimentation. 

 

In 2022, Diversified opened a Taco Bell Go Mobile store format with two separate drive-thru lanes to reduce delivery pickup times. Typically, a Go Mobile store will have two lanes meet to form one lane for the final pickup.  

“We’re continuing to look at design and how we best design the layouts for the digital traffic that’s coming through from an order ahead or delivery,” Ellison said. 

Both Applebee’s and Panera are experimenting with alternative ways to develop new restaurants, which Doherty is taking advantage of. The franchisee is working on building an off-premise-only Applebee’s restaurant in Long Island that won’t have a dining room. Applebee’s also is adding more mobile order pickup windows after an initial test with a separate franchisee in 2021.

Doherty is partnering with Panera to test urban units, as well. The franchisee’s New York City territory includes Brooklyn, Queens, Staten Island and Long Island. 

Brooklyn and Queens are underpenetrated markets for Panera because the chain didn’t have a model for urban or light-urban settings, he said. But Panera has opened two corporate locations in the city, including one in Manhattan, and Doherty plans to test two in Queens to see if Panera’s urban model can work in that borough. 

“There are lots of interesting and unique ways that both the franchisor and franchisee are looking at getting into markets that may be underpenetrated and that’s something I am actively looking at doing for both my brands,” Doherty said. 

Because so many restaurants closed during the COVID-19 pandemic’s early days, Vines said there could still be opportunities for franchisees to open units at a lower rent rate than what had been previously available. There could also be ways to acquire used equipment and fixtures that are in good condition at bargain prices, he said. 

More brands are considering conversions as well, Dan Rowe, CEO of Fransmart, wrote in an email to Restaurant Dive. In 2021, a Curry Up Now franchisee converted a closed Indian restaurant, which already had most of the necessary equipment in place, into a Curry Up Now within three weeks for roughly $100,000, according to Nation’s Restaurant News. 

By contrast, the restaurant’s franchising site lists startup costs ranging from $392,000 to $1.6 million to open a restaurant from scratch. Nathan’s Famous is providing half off of its franchisee fees to operators willing to convert their existing restaurants to a Nathan’s to take advantage of similar savings. 

In general, a new restaurant could cost a new franchisee $600,000, Rowe said. If that operator makes $1.2 million in sales and $200,000 in profits in the first year, that’s 33% of the way toward making a return on the investment. On the other hand, conversions can cost as little as $200,000, creating a path to profitability as early as year one, Rowe said. 

Technology increasingly critical to operations

Many of the store designs available to new and existing franchisees center on technology that drives sales or cuts costs as chains look to optimize their systems for on-the-go diners. Much of that innovation is designed to streamline off-premise channels and improve the guest and staff experience.

While delivery demand has leveled out for many restaurants, some — such as, Taco Bell — are still capturing growing sales in the channel, Ellison, said. 

“I think there’s still a lot of room for growth in our order-ahead mobile apps as well as delivery,” Ellison said. 

On March 17, 2020, Applebee’s on-premise business made up 87% to 88% of sales, with off-premise only generating 12% to 13% of sales, Doherty said. 

Nearly three years later, off-premise makes up over 25% of sales, Doherty said, adding that he expects off-premise will likely make up 25% to 30% of sales in casual dining going forward. 

“The guest has found a service that they have gotten very comfortable with using … whether it is delivered or it is picked up at the restaurant through our carside to go,” Doherty said.

Siebert said technology has improved restaurant service as more brands adopt integrated software solutions managing orders, loyalty, delivery and third-party apps, which creates more efficiency with the ordering process. 

Doherty Enterprises has been testing food pickup locker systems that keep both staff and delivery workers accountable for maintaining food quality. 

The lockers notify drivers when the food is ready to be collected, Doherty said, which boosts driver efficiency and helps ensure food is delivered hot. This also frees up restaurant staff to help carside pickup customers and improve that experience. Doherty also uses a system that notifies staff where a car has parked so staff can get the food to guests faster. 

Doherty said his company uses a sticky printer to help improve accuracy for off-premise orders. An expediter will take a sticker of each item in the order to help him/her pack that order ensuring that nothing is missing.

“Accuracy is a killer for off-premise business. You can’t recover that the way you can in the restaurant,” Doherty said. 

Noodles & Company has an app for online ordering that also integrates with third-party delivery to take pressure off of franchisees who are processing digital orders. The company’s in-house team manages the technology integration so franchisees can focus on building their employee base and improving retention and training, Ramsay said.  

Technology will continue to be critical to address ongoing customer needs, experts said. 

“Brands that are able to deliver a very positive customer experience through really good interactions with their staff stand to see a lot of success,” Paul Woody, franchising attorney at Greensfelder, said. “Technology is part of the answer, but it’s not the entire answer. Just continuing to have a brand presence that is very positive for customers and is very attractive to customers is going to continue to be really important.” 

Communication is crucial

Franchisors will need to establish transparency with their franchisees to scale successfully amid cost pressures and diner preferences for faster, off-premise-focused service. 

“Franchisors need to be very cognizant of shifts and changes in customer expectations and be prepared to quickly roll out solutions to that to their franchisees,” Woody said. “Of course, franchisees need to be prepared to make those adjustments.” 

Systems that are nimble will have a leg up over the competition, and franchisors that have good relationships with their franchisees and provide them with support will be in better shape, Woody said.

Brands, such as McDonald’s, Jack in the Box and Subway, have experienced discontentment among their franchisee networks in recent years over a multitude of issues, including fees and remodels. McDonald’s updated its franchising guidelines in 2022 to create more clarity and consistency within its system and devoted $250 million over the next five years to help franchisee candidates that may be facing socioeconomic challenges.  

To avoid such issues, Vines said franchisors should test significant restaurant changes in their company-owned stores to show that a new idea works and is worth the expense before requiring it of franchisees. 

One way franchisors can establish transparency is by creating a franchise advisory committee that is a good cross-section of their franchisees and not just the top operators or those with the most experience, Woody said. Wings & Rings created a franchise advisory council in 2018, which has led to the creation of a forum for franchisees to discuss and test initiatives, such as picking a new point-of-sales system. 

Franchisor to franchisee communication also should include electronic communications and/or interactive platforms where operators can get assistance or provide input in real time, he said. 

“If you’ve got franchisees that are either distrustful of their franchisor or franchisors that have not established good communication paths with their franchisees, then they’re going to struggle to basically have the relationship to make those changes,” Woody said. 

Blackstone, via private equity funds it manages, entered into a definitive agreement to buy Tropical Smoothie Cafe from Levine Leichtman Capital Partners, the company said in a press release in April 2024. 

Terms of the transaction were not disclosed, but The Wall Street Journal reports it is worth roughly $2 billion. 

Blackstone said this is the first transaction made using its flagship private equity vehicle, and it plans to continue growing Tropical Smoothie Cafe by investing in menu innovation, operations and marketing.

Levine Leichtman originally bought the chain in 2020 when the company had 870 units. Tropical Smoothie has since grown to over 1,400 units. 

“Tropical Smoothie Cafe has had an impressive growth trajectory consistently building on its loyal customer base as it has scaled nationwide,” Peter Wallace, a senior managing director in Blackstone’s private equity business, said in the press release. “We believe our capital and resources will help position Tropical Smoothie Cafe for continued success and innovation for the benefit of its guests and franchisees.”

Blackstone tends to invest in franchised businesses that can grow without significant investment, according to The Wall Street Journal, which originally reported on the pending deal Wednesday.

Tropical Smoothie Cafe CEO Charles Watson said in a separate press release from LLCP that the fast casual chain benefited from its prior parent company’s “management-centric approach” as it grew its footprint. 

Part of Tropical Smoothie Cafe’s development has focused on menu innovation. In January 2024, the restaurant brand added bowls to its permanent menu, marking the first major change to its offerings in six years. The company also is doubling down on franchising, securing partnerships with multi-unit operators.

This deal comes just over a week after TGI Fridays agreed to be acquired by a U.K. franchisee for $220 million. The transaction also will take Fridays public on the London Stock Exchange. Jersey Mike’s and Bob Evans are rumored to be seeking sales. Earlier in 2024, Tijuana Flats gained new owners through a bankruptcy, and Benihana’s parent company sold to One Group Hospitality.

From closing thousands of units to franchisee troubles and low store-level average unit volumes, Subway has had a tough couple of years. But the chain’s future could look a lot different, especially for operators, now that Roark Capital has agreed to buy it.

While it’s difficult to determine what exactly this will mean for Subway’s franchisees, on a high level, this could be positive, said Ab Igram, executive director of Babson College’s Tariq Farid Franchise Institute. 

“Roark … is an experienced private equity investor, not only in franchising, but in restaurants and large brands,” Igram said. “I would see that as a good sign that there is interest and a view of the potential of the brand by … a smart investor.” 

Subway’s ongoing growth strategies, which include menu changes, redesigns across its system, a focus on multi-unit franchisees and domestic and international unit growth, will continue under Roark. The new parent company could provide Subway with additional knowledge and expertise on how to grow chains, especially because Roark also owns Focus Brands and Inspire Brands and can draw from its strategies for those companies. 

Growth opportunities for Subway

Roark’s experience with large acquisitions and franchised brands could make this ownership transition a net positive for Subway, and it’s unlikely management will change, Igram said. 

“Roark’s previous experience with franchising and outlet expansion through their investment in other restaurant groups will likely lead to a large expansion of Subway outlets, with a focus on international markets,” Dorothy Calba, senior research manager at Euromonitor International, wrote in an email to Restaurant Dive. 

Subway has also made some good progress on turning itself around, Igram said.

“Subway has since 2021 been turning sales around by looking to focus on quality perception and investing in marketing,” Calba said. “This sale should help this investment and push forward quality initiatives like the nationwide rollout of in-house meat slicers.”

In 2022, Subway accounted for over 14% of sales within the global bakery products limited service restaurant segment, according to Euromonitor International. In the U.S., Subway captured 19% of sales in the sector last year, securing the top position in the segment. In 2022, Subway had over 37,000 units. The bakery products limited service sector is also growing in general, reaching $54 billion in sales — an uptick of 14% compared to 2017, Euromonitor said.

Subway’s traffic also improved in 2023, according to data from Placer.ai. In the first six out of seven months of the year, monthly traffic was positive year-over-year, even though it lagged behind pre-pandemic levels. In July 2023, traffic was up 0.4% year-over-year, but was still down 18.5% compared to four years ago. 

Sandwich competition is still fierce

Even though Subway is the largest sub sandwich chain in the U.S., competition has been growing since the mid-2010s as more companies enter the segment, Calba said. Rival restaurant companies have been expanding faster and posting higher sales per outlet, as well, she said. 

“When you look at some of the other brands in that space, whether it be Jersey Mike’s or others, I think [Subway management] would need to explore and look at how they can improve their average unit volumes for their locations and drive more revenue in the store, which bodes well for [Subway]  franchisees if they’re operating at good margins,” Igram said. 

Subway’s average unit volumes are estimated to be less than $500,000, according to Reuters. Comparatively, Jersey Mike’s and Firehouse Subs have AUVs of over $1.1 million and $900,000, respectively. Subway’s AUVs have never surpassed $500,000 within the last decade either, according to Restaurant Business. The company has also struggled with unit growth for years, closing nearly 5,000 restaurants from 2017 to 2021.

Subway has been pushing for more growth, signing a 4,000-unit deal in China over the next 20 years. 

“[Subway] continues to talk about store openings, so that's something to keep an eye on, whether that’s internationally or in the United States, but they’ve indicated a desire to open more units,” Igram said. 

The pace of that growth, especially in the U.S., could depend on improved four-wall economics. Even with Subway moving toward adding more multi-unit operators to its system, existing franchisees may be waiting to see if there is a good return on their investment to open new stores.  In 2023, the company shifted 230 units to five multi-unit owners, who will remodel stores and open new units in the future. 

“It’s a dance to figure out if it’s worthwhile to open new stores,” Igram said. 

Despite challenges with unit-level profitability, Subway’s North American same-store sales were up 9.3% during the first half of the year.

“Sales for Subway have been very solid so far in 2023 and this sale is promising in terms of their future growth,” Calba said.