FIRST US ROYALTY TRANSACTION
Sponsored content by Diversified Royalty Corp.
STRATUS BUILDING SOLUTIONS
Stratus Building Solutions (“Stratus”) is an independently-owned leading commercial cleaning service franchise company providing comprehensive, environmentally friendly janitorial, building cleaning, and office cleaning services primarily in the United States.
Stratus has achieved scale: system sales of ~$150 million, operating in 68 markets across North America, excellent track record of double digit same-store-sales growth and highly profitable. Stratus also has a clear path to expanding into 85 additional markets in North America and thereafter, internationally.
The profitability of Stratus is expected to ramp up significantly as it more than doubles the number of markets it operates in, and early-stage and underdeveloped markets continue to generate strong double-digit same-store sales growth.
Most entrepreneurs that have scaled their franchisor business, eventually are interested in considering a liquidity event – the Stratus owners were exploring a liquidity event.
Like most other independently-owned franchisors that have achieved scale, profitability and have significant growth opportunities, Stratus has been approached by private equity firms looking to acquire a significant controlling interest.
Private equity funds often pay double digit multiples on run-rate EBITDA. While this seems like a great valuation relative to historical profitability, relative to the expected cash flows of the business from predictable new store growth and continued same-store sales growth, it undervalues the business in many cases (private equity firms state they have earned outsized returns investing in high quality franchisor businesses).
Given its very strong growth profile, selling a significant controlling interest in Stratus was not of interest to the owners.
The owners of Stratus were introduced to a new liquidity event option at the 2022 IFA Convention in San Diego – a franchisor royalty transaction.
A franchisor royalty transaction allowed the owners of Stratus to realize a liquidity event comparable to a private equity transaction while retaining 100% ownership and control of their business.
Stratus received proceeds of $59.4 million and is paying a $6 million royalty, equal to a significant portion of its current cash flow.
Each year, as the Stratus business grows into new markets and becomes more profitable, it may increase its annual royalty, subject to royalty coverage tests, and receive proceeds equal to nine times the royalty increase. This mechanism allows the owners to monetize the vast majority of the economic benefits of continuing to grow Stratus.
Another important benefit of the franchisor royalty transaction is the franchisor-franchisee relations are unaffected as there is no change in ownership or management.
Stratus became the first US franchisor to complete a royalty transaction because they strongly believed in the continued growth potential of the business and the royalty transaction provides a far superior outcome.
WHO CAN DO A ROYALTY TRANSACTION?
A royalty transaction seems almost too good to be true – outright sale-like liquidity, ongoing monetization of new stores and retaining 100% equity ownership. The key element of a successful royalty transaction is the quality of the franchisor: strong store-level economics, history of same-store-sales growth, strong new store growth opportunities and over $4 million of profit.
Franchisors with these characteristics are royaltyable – owners can realize a significant liquidity event while retaining 100% ownership.
While Stratus is the first US franchisor to complete a royalty transaction, many of Canada’s leading franchisors, including A&W Food Services, The Keg Steakhouse, Boston Pizza, Pizza Pizza and Mr Lube, have completed royalty transactions over the past 20 years. Each business realized a significant liquidity event and many multiples of the initial liquidity event over the past 20 years by retaining 100% ownership.