Below Is a Carefully Considered Analysis Discussing the Two Different Investment Interests in Cheddar’s Restaurants
Below is a carefully considered analysis discussing the two different investment interests in Cheddar’s restaurants. Selling StockBrazos Partners should allow Cheddar’s management to purchase some stock. There are multiple benefits for Brazos if they allow management to increase their holding from 10% to 19.9%. The first benefit is that it will keep Cheddar’s managers motivated to maximize returns, given that it is mutually beneficial for all parties involved. The second benefit is that it will incentivize Cheddar’s to continue to outperform management expectations by opening four to five new units per year rather than the two units originally forecasted. However, Brazos needs to be careful not to severely dilute their interest in Cheddar’s. They can make sure that this doesn’t happen by having Aubrey Good, Greg Good, and Doug Rogers only put in $1.4 million into the deal, thus keeping Brazos’ ownership interest at 75%.
Additionally, the appropriate price for this stock needs to be carefully considered. Due to the fact that equity value per share had risen by 6%, assuming an exit at the entry multiple in only nine months since the investment closed, it would seem as if Brazos should increase the stock price by 6%. However, Cheddar’s management exercised their option for 9.9% more of the company at a 4% discount only four months prior. Therefore, Brazos should sell Cheddar’s management some non-transferable stock at a price somewhere between 4% less and 6% more per share. Real Estate SubsidiaryThe real estate subsidiary proposed by Cheddar’s management is a good idea in this case. While a cursory glance at Exhibit 14 indicates that the subsidiary is a worse proposition at only 42.2% returns compared to a leasehold return of 86.1%, there are other factors that need to be considered. Firstly, the 42.2% leverage real estate return does not include any capital appreciation of the real estate, which would likely gross up this return percentage. Secondly, “transaction costs around opening new locations would fall – the subsidiary would be able to buy and hold the land, increasing in value long with the real estate” and “the company would be able to move faster as it was less dependent on outsiders.”[1] Thirdly, real estate ownership would increase company flexibility, as they wouldn’t be tied into long term leases after closing units. Lastly, with the new investment from the subsidiary, Rogers and Greg Good could renew their employment and non-compete agreements, while Aubrey good could be given the opportunity to execute such an agreement.