What Makes for a Good Franchise Investment?

Christopher Conner  |

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Franchising is a widespread industry today: Literally any market segment has significant brands and businesses which have utilized the franchise expansion model to grow their distribution networks and expand into new markets. If you invest in businesses or own businesses, franchising needs to be understood in order to know whether to invest in a business model associated with the franchise concept. I have invested in franchises and in non-franchised businesses. There is no “better or worse” version, and in some cases, franchised businesses can make more or less sense for a particular transaction or business opportunity.

First, it is critical to understand the differences in what it means to be a business owner vs. a franchise owner. Franchise ownership has been described as “entrepreneur-light,” and is designed for one of two primary groups of candidates. The first candidate franchising was designed for is the new entrepreneur who has never owned a business in the past and wants the blueprint, guidance and mentorship that comes with a franchise relationship. For this candidate, the documentation, proven methodology, franchise marketing systems and operations models carry great value to this buyer to minimize the failure rate and increase the odds of making it in a new business. The second category of investor that franchising was designed for is the multi-unit franchise owner. This investor typically is looking for franchise models that have scaled exceptionally well and offer the opportunity to grow within the network. There are cases where extremely adept franchisees have in some cases opened hundreds or even thousands of units of a particular franchise brand. For this type of investor, franchising offers the value of scale, structured systems and large scale brand recognition that comes with uniform standards and well-defined strategic marketing initiatives. If you fit into one of these categories, franchising deserves a hard look, if you have trouble following rules and defined rules of the franchise, probably doesn’t make a lot of sense.

Second, the quality of the franchisor makes all the difference in the world in how strong the return on investment is from your franchise investment. Good franchise systems have a leadership team that is in some ways selfless and absolutely puts the needs and interests of the entire network ahead of their own. Franchisors must disclose financials. From an investor’s standpoint, you have an opportunity to review the health and current standing of the organization in addition to doing some analytical reasoning and calculating average unit volume based on royalty collections, unit turnover and other key variables that can help you make a better investment decision. Great franchise investors are accustomed to interviewing a wide range of franchisors and spending the time, money and effort to figure out not only which model makes the best investment, but also leadership behind the franchisor. In some cases, great leadership in a franchise system can make more of an impact on the success of the franchise than the model itself (Compare the success of Subway vs. the failure of Quizno’s). Get to know the people behind the franchise and who will in essence be your partner should you move forward with a franchise investment.

Third, look at the hard numbers of a franchise investment and understand what the value is you get in return. The question when considering a franchise should always be whether the business can be started on your own and whether the investment in the franchise adds enough value to warrant the cost. Franchises have fees in place that you will pay for the life of the business relationship. You should verify that the value to be received exceeds the investment you pay. Good franchise systems have found ways to leverage scale. You will want to see these aspects inherent in a franchise that you are considering purchasing. Does the franchisor offer franchisees benefits from a buying standpoint in discounted inventory and supply costs? Have they negotiated using the buying power of the franchise and do they pass along these discounts to the franchisees? Does the franchisor market using the economies of scale through a well-managed marketing fund and regional cooperative franchise marketing systems? These are strategic advantages to a franchise over a standard business start-up and will be apparent when reviewing an FDD of any given franchise model. The numbers and documentation don’t lie, but I always recommend making the calls and speaking with franchisees who are already in the network. Another value of the franchise concept is that a franchisor must, by law, disclose the franchisees who are in the system AND the franchisees who have left or been terminated from the system. What better references could there be to make a good investment decision than people who have already invested in the franchise you are considering?

The franchises we have invested in had positive answers to these questions, and there was a business case to working through a franchise company as opposed to going it alone. Regardless of the industry, odds are good that there are franchise systems that work within that market and have the franchise alternative to that business model. Good due diligence and proper research can help you make a strong business decision as to whether franchising offers a better ROI.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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