Should You Expand by Franchising?

ShouldYouExpandby Franchising?

 Voted #1 Franchise Consulting Firm in North America in an Independent Survey of over 900 Franchisors for the fourth year in a row

 More hands-on experience than any other firm

◦ Consultants with over 800 years of franchise experience

◦ 98 out of the top 200 franchise companies

◦ Offices in Chicago, Dallas, Los Angeles, Miami-Fort Lauderdale, Atlanta, Toronto, Dubai, UAE & Riyadh

 More “senior level” experience

◦ Hands-on experience at start-up and established franchisors

◦ Former CEOs, CFOs, EVPs of more than 50 franchise companies

 Adia (now Adecco), Armstrong Tile, Auntie Anne’s, Dunkin Donuts, LINE-X, Pearle Vision, McDonald’s, PIP Printing, Schlotzsky’s, Snap-on Tools, Snelling & Snelling, and other national brands

 The ability to bring more resources

◦ Faster completion

◦ Ability to provide assistance in several areas simultaneously

 Breadth across four functional areas

◦ Strategic planning

◦ Quality control

◦ Marketing

◦ Organizational development

 Franchise experience in 50+ countries

 Numerous awards and publications

 TopFire Media

◦ Nation’s first fully integrated media firm SEO, PPC, Social Media, Blogging, PR, and Website Design and Development

◦ Both brand/consumer focused and franchise lead generation

◦ Recent honors and awards:

 Best new agency (Ragan & PR Daily Ace Awards)

 Best Website Finalist (PR News)

 Best Media Relations Campaign Finalist (PR News)

2013-2023 iFranchise Group.

 FTC rule 436 cites three elements that legally define a franchise:

1. The use of a common trademark

2. The exercise of control or provision of assistance

3. The collection of fees, royalties, mark-ups or other monies from the franchisees

 If you have all three elements, you are a franchise, regardless of what you call it

Some state definitions vary, but are similar

Do not have to use the “f-word”

 Franchisee typically pays

◦ Franchise fee average about $25,000 to $45,000

◦ Royalty range between 4% and10%

◦ Advertising range between 1% and 2%

◦ Franchisor will often sell product to the franchisee

Franchisor typically provides

◦ Initial training

◦ Operations manual and systems

◦ Ongoing supervision and support

◦ Other support services

 What are your goals? BE SPECIFIC!

◦ Certain levels of profits

◦ Sell company for a specific amount

 What is your risk tolerance?

◦ How much are you willing to invest and re-invest?

◦ What other resources do you have to bring to bear?

Conduct Cash Flow Analysis to See if You Can Reach Your Goals

◦ Example:

 Goal = Sell company for $10 million at the end of five years

 Two units in operation

 Total Equity Investment in New Operation = $150,000

 Total available capital = $200,000

 Existing Free Cash Flow for Reinvestment = $100,000/year

 Units Break Even in First Year

 After that, Free Cash Flow from New Units = $50,000/year/each

$450,000 in free cash flow by Year Six = $3,150,000 valuation ONLY IF NO INCREMENTAL OVERHEAD IS NEEDED TO SUPPORT

 This Example

◦ Would need to open 27 company units

◦ That would take about 12 years of reinvesting everything

◦ Total Investment = $4 million over that time frame

 Cannot get there from here

 Alternatives:

◦ Change Goal

◦ Change Time Frame

◦ Change Assumptions (structure, capital devoted, leverage, etc.)

◦ Raise equity to grow faster 

If you are raising equity, factor in dilution

◦ If you will give up 50% of the company, you need to grow twice as big

◦ Run the numbers again

AGAIN, ONLY IF NO INCREMENTAL OVERHEAD IS NEEDED TO SUPPORT

 With an influx of a little over $3 million

◦ Can jump-start growth and leverage off of that growth

◦ Will need to get to about 50 – 54 units

◦ Total investment $7.5 - $8 million

◦ But you are using investor money

 Problem: Realistic valuations

◦ Valuing the existing business – (4X – 7X EBITDA)

◦ Year One Business Value = $700,000

◦ Business Value after Equity = $3.7 million

◦ Sophisticated investor would want 81% ($3M/$3.7M)

◦ Would need to find an investor who would invest $3M for 50%

◦ Might try numbers again at $5 million and a 20% stake???

◦ At some point, just not realistic

 Capital availability even with realistic valuations

◦ Limited in today’s marketplace

◦ Control an issue

 Leverage Capital

 Speed of Growth

 Motivated management

 Reduced risk

 Few operational concerns

 Higher quality

 Organizational leverage



Must “share profits”

◦ Franchise unit will usually generate less profit than a profitable unit

◦ But far more profit than an unprofitable company-owned operation

 Less Control



Good relations with franchisees take work 

MYTH: Litigation

Goal Sell for $10M in 5 Years

Average Selling 6.7 times EBIT

Name Fee Trademark License =

Advantages

Less Regulation - Still a Franchise in NY

Disadvantages

•Lower fees

•Do you have strong name?

•No control over brand

Often, this alternative is eliminated because the company does not have adequate brand strength, and, even if they did, they would risk losing their trademark if they did not exercise control. Moreover, it is important to note that the “control” element of the franchise definition is very easy to trigger.

System

Fee Business Opportunity orLicense =

Advantages

•Less Regulation?

- More at the state level

Disadvantages

•Lower fees

•Do you have strong name?

•No control

•Create competition

•Poor image

This can be a viable option for some, but the loss of the branding element is an issue that should be carefully considered. For example, what would happen to your licensed channel if a branded channel were to be introduced by your competitors? Will you have national accounts? Or a desire to create consumer brand loyalty?

Dealership or Distributorship = Name System

Advantages Disadvantages

•Less Regulation

•Easier to sell

•ABSOLUTELY NO FEES

•Support provided for “free”

•Must have product to sell

•No revenues from service

•Products can be “stepchild”

•Dealer defections to: - better products - cheaper alternatives

Dedicated dealerships can have many of the same advantages as franchising. The biggest disadvantages are the need to pay for services out of the wholesale margins. CAUTION: Can create an inadvertent franchise after the fact, as happened with Mitsubishi v. To- Am.

Agency or SalesRep = Name System

Advantages

•Less Regulation

•Easier to sell

Disadvantages

•ABSOLUTELY NO FEES

•Support provided for “free”

•Must have product /service

•Turnover is high

•Increased training costs

A “top-down” flow of revenues will avoid franchise laws. Again, be aware of the creation of an inadvertent franchise.

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All Rights Reserved.

• GeneralPartnerships

• LimitedPartnerships

• Corporations

• L.L.C.s

Advantages

•Less Regulation

•Easier to sell

•May make more $

•ABSOLUTELY NO FEES

•Negotiated each agreement

•Marriage vs. Parent

•Majority end in “Divorce”

•Fiduciary Duty

•Accounting difficulties

•Underreporting

•No profit = no distributions

•Exit barriers

•Liability

•LOSS

On a one-off basis, this can be reasonable means of expansion, but is perhaps the worst vehicle when more aggressive growth is planned.

Franchise Legislation Within the US 2023

Legend:

States having no franchise or business opportunity laws

States having franchise registration laws only States having business opportunity laws

States having both franchise registration and business opportunity laws

Notes:

• Within Indiana, Michigan and Wisconsin, registration is effective immediately upon the application being filed. Oregon regulates franchises but no filing is required there.

• Florida, Nebraska, Kentucky, Utah and Texas require a simple exemption filing. Once that is filed, a franchisor can begin to offer franchises.

• Georgia and South Carolina provide an exemption if the franchisor has filed a State trademark registration.

• Connecticut, Maine, South Carolina and North Carolina provide an exemption if the franchisor has obtained a Federal registration of its trademark

• Six States require registration of advertising prior to use. (CA, MD, MN, NY, ND, WA)

• New York, Oklahoma and Rhode Island require the FDD be provided to a prospective franchisee at the earlier of (i) the 1st personal meeting held to discuss the franchise or (ii) 10 business days before any agreements are signed or any monies paid (including fully refundable deposits).

• Michigan and Oregon require the FDD be provided to a prospective franchisee 10 business days before any agreements are signed or any monies paid (including fully refundable deposits).

• Many states also have State Relationship Laws that impact issues such as franchise termination or non-renewal. Your franchise legal counsel can advise you on relevant issues involving these states.

• Check with your franchise legal counsel for additional details and updates which are available.

 Fractional Franchises (Two years and 20%)

 Large Investment (Over $1M excluding R/E)

 Sophisticated Franchisee (Five Yrs. + $5M Net Worth)

 Minimal Payment (pays/commits less than $500/first 6 mos.)

 Leased Departments

 Single Trademark License Exclusion

 Fall under other regulations (PMPA)

 Officers and directors of the franchisee (very specific def.)

 CAUTION: The FTC Exemptions are NOT honored by all states

◦ Patchwork Quilt

◦ Need an attorney to decipher

 Technology-based shared services

◦ Use an app to drive business

◦ Avoid franchising by top-down fee structure

◦ Uber, Lyft, Airbnb

 Certification programs

◦ Certification Mark, not a Trademark

 TM/SM = Source of Product or Service

 CM = Characteristics of a Product or Service

◦ Cannot be used as a TM by the owner of the mark

◦ Must be willing to offer to all who qualify

◦ Cannot have exclusive territories

◦ Can easily stray into a franchise relationship

 The decision should be goal driven

◦ Distance

◦ Speed

◦ Obstacles

◦ Risk tolerance

 A Volvo or a Rocket Ship?

 Don’t have to choose only one vehicle

 Don’t decide to franchise (or whatever)

◦ Instead, decide:

 Do I want to build a third-party distribution channel?

 Do I want that channel to be branded?

 If it is branded, do I want to control quality?

 How do I want to be paid?

 The law (or your lawyer) should never dictate your good business decisions

 The franchisee should make a return on the time they invest

◦ No different than if they were to go out and get a job

◦ Salary should be “market rate”

 The franchisee should make a return on their investment

◦ No different than if they invested in a stock

◦ Return should be commensurate with what they would make if they were to make an investment of similar risk

◦ Ability to sell back their investment at the end of the term

 Franchisees expect that they will need to build their business

◦ Will expect these returns in three years or less

 Annual Cash-on-Cash R.O.I. at the unit level – our criteria

◦ 15% for Owner Operators

◦ 20% for Area Developers (who will support additional overhead)

 Occasional exceptions

Perfecting the business

◦ If you have perfected your business, SELL IT!

◦ If you are standing still, someone is gaining

◦ McDonald’s in 1955

 Quick vs. Slick

◦ If you are going head-to-head with more established competition and your business model is not highly differentiated – be sure to refine first

◦ More unique, the sooner you should franchise

 Risk: Someone with a camera and a notepad

 First mover advantage

 Who was the first . . . ?

 Business plan/strategic direction

 Legal documents and registrations

 Operations manuals

 Training program

 Quality control mechanisms and systems

 Effective marketing plan

 Franchise collateral materials

 Website and web-based marketing

 Advertise  Design and implement a sales strategy

 Staff an organization to implement the plan

 Capital

 You are entering a new business.

 Goals drive your business. Start with support and cost structure.

 What do you need to do to help your franchisees succeed?

 Don’t rely on guesswork: The futureofyourbusinessisat stake.

 Financial analysis is essential.

 Reverse engineer your success.



◦ Often rely on guesswork

◦ Or analysis of what comparable franchisors are offering to make major decisions



“Copycat” is not a strategy – it is a recipe for disaster!

◦ Uniqueness is important to success, whether achieved through the business model, marketing, support, structure, fees, or marketing.

◦ Copying assumes that business economics are the same, support is the same, and that a new franchisor will simply differentiate themselves based on great franchise marketing

◦ But established franchisors often have many advantages not shared by newer franchisors

◦ So the Copycat strategy that is taken by many new franchisors can actually be responsible for their failure

There are certainly a large number of neophyte franchisors who take a “Ready-Fire-Aim” approach

 The impact of a 1% royalty mistake

◦ If a single franchisee generates $500,000 in revenue

◦ 1% = $5,000 off the bottom line

◦ But franchisees will never tell you that they are paying to little and often inertia will keep the royalty where it is at for years

Discussions with Key Stakeholders

Review existing material, forms, & documentation

Develop preliminary outline

Determine gaps in current documentation

Assign responsibility for content creation

Identify Subject Matter Experts for gaps

Interview Subject Matter Experts

Onsite observation of units & documentation

Resolve Best Practices Conflicts

Draft material to cover all identified gaps

Edit all material into common style & “voice”

Revise first draft of Operations Manual based on client input

The FTC rule

◦ Disclosure document with 23 items

◦ Disclosure fourteen days prior to sale

◦ Final Franchise Agreement seven days prior

◦ Financial Performance Representations

◦ Consistency with Franchise Disclosure Document

 State laws

2022)

The Franchise Sales Pipeline

Send

2022)

Time to close can range from 30-90 days or more following the initial face-to-face meeting

Total time to close: often 12-20 weeks

Marketing Cost = $10,086 Average per sale*

Overall Expected Close Rate = 3.4%**

Close Rate for Qualified Leads = 15% (those that meet certain pre-qualifiers)

* Average cost per sale ranged from about $9,000 to over $12,000 in recent years. While not measured separately in the Franchise Update report, Cost Per Sale numbers can be vary for emerging brands, in particular.

** Historically, close rates have hovered between 1.8% and 2%, but higher (3%+) in the last three years; average Cost per Lead (CPL) was $197 in the prior year, with a spike to over $300 in 2020 due to the pandemic. The numbers above are based on the most recent Franchise Update survey.

A good concept

+The Right Message

+Marketing Plan

+Adequate marketing budget

+Good sales technique

= leads

= meetings

= franchise sales

Some studies have indicated the average new franchisor will sell:

 An average of 9, 11, and 13 franchises in their first three years

 Median sales of 4, 5, and 6 sales in their first three years

Franchise Program for Aggressive Growth Approximate Development Activity Schedule

Discovery & Benchmarking

Initial Planning Session

Strategic Planning

Financial Sensitivity Analysis

Franchise Agreement

Disclosure Document

State Registration Process

Operations Manual

Training Programs

Training Videos & LMS Content

Primary Research/Profiling

Franchise Marketing Plan

Develop/Print Brochure

Mini-Brochure

Franchise Sales Video

Website Optimization

Franchise Sales Training & Manual

Franchise Implementation Strategy

Implementation Consulting

Legal Coordination

Strategy

Legal Documents

Quality Control

Franchise Marketing

Organizational Development

The iFranchise Group does not provide legal services but instead works through outside legal counsel

Discovery & Benchmarking

Initial Planning Session

Strategic Planning

Financial Sensitivity Analysis

Franchise Agreement

Disclosure Document

State Registration Process

Operations Manual

Primary Research/Profiling

Franchise Marketing Plan

Develop/Print Brochure

Mini-Brochure

Website Optimization

Franchise Sales Training & Manual

Franchise Implementation Strategy

Implementation Consulting

Franchise

Program for Moderate Growth Approximate Development Activity Schedule

Legal Coordination

Strategy

Legal Documents

Quality Control

Franchise Marketing

Organizational Development

Discovery & Benchmarking

Initial Planning Session

Strategic Planning

Financial Sensitivity Analysis

Franchise Agreement

Disclosure Document

State Registration Process

Operations Manual

Franchise Program for Conservative Growth Approximate Development Activity Schedule

Legal Coordination

Strategy

Legal Documents

Quality Control

We can modify our programs to meet the needs of any company getting into franchising. Our fees can range from $20,000 to $200,000+.

 Consulting and legal costs vary based on franchise company’s situation:

◦ Desired speed of growth influences services needed

◦ Ability to do work internally

 Do not go into franchising undercapitalized

◦ Legal fees: $15,000 to $35,000+

◦ Consulting and Development: $20,000 to $200,000

◦ Organizational expenses: $10,000 to $20,000

◦ Franchise Marketing: $8k - $12k per sale (six months)

◦ Personnel: varies widely

 Can bootstrap growth

 Can spend hundreds of thousands

 Franchising is a means of duplicating success, not creating success

 Thrives by creating win-win situations

 You must be selective

 Franchising is a new and different business

 Is not the right solution for every business

 Provides one of the most powerful business expansion models ever developed