This post continues in a series of posts I am writing on franchise investing. The series of posts initiated with an article I read outlining what private equity investors like about franchising. Today, I want to touch on the  fourth “ingredient” of the Secret Sauce which is whether the franchise has sufficiently long operating history.

Now, it may sound simple on its face to say a franchise must have a sufficiently long operating history. But, I work with many people who are either a) just starting a franchise, or b) looking for the newest idea or trend to get in on the ground floor. So, should you invest in a new franchise? I would say it is definitely a possibility (how about that). But there are some important things to keep in mind:

  1. All things being equal it may be best for a franchisee to invest in an established franchise. But even the most stable franchises get stale. So this isn’t as easy as just picking a franchise that has a sufficiently long operating history.
  2. Even if the business is new to franchising look to see whether the new franchise has a sufficient operating history of multiple corporate locations. In my opinion, if a franchisor has not operated multiple corporate locations, I would be hesitant to invest my capital, whether you are starting the franchise itself or purchasing as a franchisee. A franchisor should prove it has the ability to manage and deal with multiple locations. Having multiple locations brings many complexities for a business owner. You don’t want to be the test case.
  3. For a new idea or concept, what have you done to determine that concept has long-term appeal? Will it have universal appeal across geographies? Is the concept sustainably on trend? Is it a simple concept and something that can be easily replicated?

A new franchise can be a dynamic opportunity under the right circumstances. But do your homework!

 

This post continues in a series of posts I am writing on franchise investing. The series of posts initiated with an article I read outlining what private equity investors like about franchising. Today, I want to touch on the  third “ingredient” of the Secret Sauce which is whether the product or service has universal appeal across geographies.

The private equity pros from Clearlight described it this way:

Some products or services may be relatively more embraced in certain geographies than others. A good example might be a food concept that is cherished in one part of the country but is not portable to other markets based on regional dietary preferences. So, investors will look for systems that are thriving within their original markets as well as new markets that they’ve entered. Example: Have you ever been to a part of the country that doesn’t have a McDonald’s?

If you are investing in a new franchise it may be difficult to determine whether the product or service has universal appeal. That’s why I think most professional investors will tell you to invest in franchises that have experience and history of franchising in multiple geographies. But if you do that, isn’t it entirely possible you will miss out on the opportunity?

The answer to that is that you could absolutely could miss out on the opportunity! But is it better to lose your money or miss out on an opportunity? You’ll need to determine your ability to take on risk. If I am throwing almost all of my net worth into a franchise opportunity perhaps it isn’t the best idea to invest in a delicacy from Louisiana in Iowa. But…if I have an appetite for risk and a healthy bankroll, then perhaps it’s a little easier investing in a concept like Raising Cane’s which as far as I can tell has been a rousing success in Iowa (with it’s long lines and awesome chicken fingers). It all depends upon your situation. (Side note: I have read about Raising Cane’s as it started up. Bankers got it wrong with that restaurant on two points. First, selling only chicken fingers can be successful. You don’t need other options. And two, the regional concept has proven to be successful across multiple geographies).

But the only way you will truly know is for the franchise to expand across multiple geographies before you invest. It is okay to wait on a concept to see if it has legs. In Iowa, that usually isn’t a problem because most franchises start elsewhere before coming to Iowa. By the time a franchise is ready to come to Iowa you will often know whether the franchise has universal appeal across geographies or not.

 

This post continues in a series of posts I am writing on franchise investing. The series of posts initiated with an article I read outlining what private equity investors like about franchising. Today, I want to touch on the second “ingredient” of the Secret Sauce which is whether the product or service is “on trend.”

So what does it mean for the product or service to be sustainably “on trend?” According to the private equity pros:

Systems that benefit from sustainable and easy to understand tailwinds are going to be more attractive to private equity investors. Most private equity funds are adept at discerning trends from fads, so if the shiny new product doesn’t appear to have staying power, then they may pass on making an investment.

One of the industries that comes to mind for me when we discuss sustainably “on trend” is the fitness industry. I have probably reviewed just about every fitness craze imaginable in franchising during my career. In Iowa, I have seen a number of franchises pop up over the years and I have seen several disappear during my time in practice. Based upon my experience, I would say the competition in the fitness industry is fierce. Some franchises are sustainably “on trend” while others are simply a fad. Knowing ‘which is which’ can sometimes be difficult.

Specifically, you should look very carefully at the sustainable trends of the franchise concerning the number of outlets.  Carefully study the number of transfers in the franchise and not just the number of closures.  A high number of transfers may be an indication that franchisees in the system are struggling, but unprofitable franchises have not been shut down.  Of course if there is a significant number of closures in the system that is definitely a bad sign.

In evaluating fitness franchises it is also important to determine whether the franchise system offered is unique in some manner and whether the franchisor’s intellectual property is protected. The uniqueness does not always need to be the exercise program itself. It could be a marketing plan or simply the way the exercise program is packaged to consumers. Some of the best franchises in the fitness industry do not necessarily involve the latest exercise craze, but  instead have figured out a way to run the most tried and true exercise programs efficiently and profitably. Ask yourself, “do you see this fitness business standing the test of time for the next 10 years?” If you can’t answer that question affirmatively then it is time to move on!

See also the First Ingredient of Franchise Investing here.

 

 

I recently posted on the Secret Sauce for Franchise Investing. The post features an article outlining what private equity investors like about franchises. Today, I want to touch on the first “ingredient” which is whether the franchise’s product is straight-forward and consistently replicated.

This is much harder than you may think for franchise operations to attain but it is often the difference between a successful or unsuccessful franchise. Think about McDonald’s for a second. I would argue that McDonald’s success isn’t because their burgers and fries aren’t the best tasting. In fact, I’d argue that many other places have better burgers and fries. However, the key to McDonald’s success has been that their business is straight-forward AND consistently replicated. Each and every time you walk into a McDonald’s you pretty much know what you are going to get in terms of the experience. The food tastes virtually the same, the service is virtually the same, the locations look and feel virtually the same and the price is virtually the same. There usually isn’t much difference among the various locations.

On the other hand, I am familiar with a different restaurant franchise (mostly regional) that has struggled. One of the major reasons this franchise has struggled is because it has been unable to consistently replicate its customer experience system-wide. In fact, some locations even have different recipes for the food and you are never certain how the food will taste from location to location. This causes issues not only for customers but also among the franchisees. Some franchisees are unwilling to give up their recipes for a more systematic approach because they only consider their location rather than the franchise system itself. In the end this franchise will likely never reach its true potential unless the franchisees buy into a common approach and deliver a consistent experience. There is just too much uncertainty from location to location.

The allure of franchising is that the franchisor has a proven system which will help you be successful. But know that all franchise systems are not created equal. Learn about the system and conduct your due diligence on whether the franchise system you are considering consistently replicates its offerings. It could be the difference between success and failure.

For twenty plus years now I have been reviewing franchise opportunities in one form or another. Unlike a lot of franchise lawyers, I represent both sides of the fence. I have helped business people start franchises and I have helped hundreds of franchisees review FDDs before buying franchise opportunities. Many years ago it seemed as though franchisors were afraid of Iowa. Those franchisors thought the Iowa franchise act was too restrictive and too franchisee friendly. But over the years, franchisors could no longer ignore Iowa. The economic success of Des Moines and its metropolitan area have made our community extremely attractive for franchisors from around the country, and with that, a new crop of Iowa franchisors are finding success with the franchise business model as well.

I have written a number of times about makes a good franchise opportunity. Some things I have discussed in the past is whether the franchise is a solid brand? Do people recognize the franchise? And does the franchise have systems in place that make it repeatable and scalable? But recently I have been diving in much further into what makes a particular franchise a good investment. In conducting my research I ran across a terrific article from Clearlight Partners entitled, Franchisors vs. Franchisees: Why Private Equity Likes Both. This article shares why private equity investors now like franchises for the strong investment returns potential.

We can definitely learn a lot from private equity investors. After all, these are the pros of investment. Some private equity firms have developed businesses that are valued in the hundreds of millions, and still others that are in the billions. In other words, these pros tend to know what they are doing. So what does private equity want to see in franchises? According to the article, private equity investors consider the following:

  1. Product or service that is straight-forward and can be consistently replicated;
  2. Product or service that is sustainably “on trend”;
  3. Universal appeal across geographies;
  4. Sufficiently long operating history;
  5. Critical mass of units;
  6. Good unit economics;
  7. Successful franchisees;
  8. Runway for future growth.

The article also goes into further detail to explain each consideration and also provides a detailed discussion regarding unit economics which I found helpful. Overall, its one of the better articles I have read on franchise investment. I strongly urge you to give it a read whether you are thinking about starting a franchise or becoming a franchisee.

I read an excellent article from the Franchise King, Joel Libava, that he wrote for the SBA website on what it takes to franchise your business. His article highlights various points including:

  • Validating the idea
  • Duplication
  • Creating a system
  • Legalities
  • Marketing and sales

We also had some Twitter discussion regarding the fees and royalties that are paid to franchises. It really goes without saying, for a franchise concept to work you need to have profit margins that are large enough for the franchisee to make a good living, pay employees AND pay royalties and fees to the franchisor. But I think sometimes this is missed with certain franchise concepts. When my clients start franchises I encourage them to turn franchisees into raving fans of the concept and the business model. Make franchisees profitable. Do everything you can to make franchisees successful and the franchise will in turn be successful.

For the last 40 years, Entrepreneur Magazine has released its Franchise 500 List, ranking the “best” Franchises in America. They rank them based on Five Pillars: Costs & Fees, Size & Growth, Support, Brand Strength, and Financial Strength & Stability. The giants at the top aren’t much of a surprise, with McDonald’s, Dunkin’, and Taco Bell all in the top 5. Many other big names are also scattered on the list. The Franchise 500 gives information on investment costs, and many other things you can expect if you decide to purchase a franchise for a specific company. If you are interested in purchasing a franchise, this list can be a great asset. However, it shouldn’t be your only resource, and most certainly does not tell the whole story.

Continue Reading Looking for a Franchise? Don’t Just Rely on the Franchise 500 and other Lists

There have been a series of changes over the past year in federal regulations that impact your old LLC operating agreement. Since I see on a regular basis operating agreements that do not incorporate the changes in the regulations, I thought I would mention a key change in this post. With the new regulations there is no longer a “tax matters partner” which you will see in most operating agreements. Instead, the LLC (partnership) must designate a Partnership Representative (the “PR”) who does not need to be a partner. The PR is similar to, but is different from, the tax matters partner. Formerly, the LLC/partnership was required to designate a tax matters partner to act as a liaison between the partnership and the IRS. That tax matters partner was required to be a general partner and could be an individual or an entity. The tax matters partner had the authority to bind the partnership, but not to bind other partners in the partnership. Also, a partner that was not the tax matters partner had rights during an examination, including certain notification rights and the right to participate in the proceeding.

Continue Reading Review Your Old LLC Operating Agreement: No More Tax Matters Partner