Should You Expand by Franchising? by iFranchise Group

Should You Expand by Franchising?

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The Decision to Franchise ◦ ◦ ◦ ◦

How Franchising Works Alternatives Quality Control Legal Aspects of Franchising

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Marketing Your Franchise

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Selling Your Franchise

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Creating a Successful Franchise Strategy

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Questions and Discussion

◦ Structural Decisions ◦ Financial ◦ Organizational Development

We are going to try to cover a great deal of information, so we are asking that you hold your questions until the end of the session unless they are on a particular slide. © 2021 iFranchise Group. All Rights Reserved.

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Three Years in a Row Voted the #1 Franchise Consulting Firm in North America in an Independent Survey of over 750 Franchisors More hands-on experience than any other firm ◦ ◦ ◦

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Consultants with over 700 years of franchise experience 98 out of the top 200 franchise companies Offices in Chicago, Dallas, Los Angeles, Boca Raton, 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 different franchise companies

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The ability to bring more resources ◦ ◦

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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

Faster completion Ability to provide assistance in several areas simultaneously

Breadth across four functional areas ◦ ◦ ◦ ◦

Strategic planning Quality control Marketing Organizational development

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Franchise experience in 50+ countries

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Numerous awards and publications

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Considering franchising your business?

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Franchising less than one year?

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Franchising more than one year?

We are happy to send you a copy of this presentation, so you can limit your note taking if you so desire.

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FTC rule 436 cites three elements that legally define a franchise: 1.

The use of a common trademark

The exercise of control or provision of assistance

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

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Some state definitions vary, but are similar

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Do not have to use the “f-word”

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Franchisee typically pays ◦ Franchise fee average about $25,000 to $35,000 ◦ Royalty range between 4% and10% ◦ Advertising range between 1% and 2% ◦ Franchisor will often sell product to the franchisee

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Franchisor typically provides ◦ Initial training ◦ Operations manual and systems ◦ Ongoing supervision and support ◦ Other support services

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What are your goals? BE SPECIFIC!

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What is your risk tolerance?

◦ Certain levels of profits ◦ Sell company for a specific amount

◦ 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

Year 1 Starting Capital

Year 2

Year 3

Year 4

Year 5

$250,000

$200,000

$250,000

$300,000

($150,000)

($300,000)

$50,000

$100,000

$150,000

$200,000

$100,000

Cash Flow

$100,000

$150,000

$200,000

$250,000

$350,000

Value @ 7x CF

$700,000

$1,050,000

$1,400,000

$1,750,000

$2,450,000

# Opened Capital invested New Cash Flow Existing Cash Flow Units – EOY

Terminal Value

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

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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

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Cannot get there from here

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Alternatives: ◦ ◦ ◦ ◦

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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

10 10

Year 4

Year 5

$850,000

$1,250,000

$1,500,000

($2,250,000)

($1,050,000)

($750,000)

($1,200,000)

($1,500,000)

$750,000

$1,100,000

$1,350,000

$1,750,000

$100,000

Cash Flow

$100,000

$850,000

$1,200,000

$1,450,000

$1,850,000

Terminal Value

$2,750,000 in free cash flow by Year Six = $19,250,000 valuation. Divide by two to account for 50% ownership = $9.6 million selling price. AGAIN, ONLY IF NO INCREMENTAL OVERHEAD IS NEEDED TO SUPPORT

Starting Capital # Opened Capital invested New Cash Flow Existing Cash Flow Units – EOY

Year 1

Year 2

Year 3

$3,250,000

$1,100,000

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With an influx of a little over $3 million ◦ ◦ ◦ ◦

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Problem: Realistic valuations ◦ ◦ ◦ ◦ ◦ ◦ ◦

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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 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

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Leverage Capital

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Speed of Growth

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Motivated management

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Reduced risk

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Few operational concerns

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Higher quality

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Organizational leverage

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◦ Franchise unit will usually generate less profit than a profitable unit ◦ But far more profit than an unprofitable company-owned operation

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Must “share profits”

Less Control Good relations with franchisees take work MYTH: Litigation

Goal

Sell for $10M in 5 Years

Average Selling

6.7 times EBIT

Year Five Earnings

$10M/6.7 or about $1.3M

Average Royalties

$30,000 per franchise

Average Net Royalties

$10,000 per franchise

Need to sell

$1.3M/$10,000 = 130 Franchises

15 15

Sales

Hire Franchise Salespeople 50

Sales

Hire Field Reps

Sales

Hire Support Staff Sales

Sales

Personnel Marketing Office Space

Brochures

Cost to get into franchising can range from $50,000 to $200,000+

Name Fee

Name =

Franchise

System

Fee

Trademark License

System Distributor

Name =

Business Opportunity or License

Fee System

Dealership

Agency Sales Rep Joint Venture

Name Fee System

Franchise

+ Joint Venture

Equity

Name

Trademark License

Product

System

Distributor/ Dealer

Name Fee

= Trademark License

Advantages

Disadvantages

Less Regulation - Still a Franchise in NY

•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.

Fee System

Business = Opportunity or License

Advantages

Disadvantages

•Less Regulation? - More at the state level

•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?

Name System

Dealership or = Distributorship

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. © 2021 iFranchise Group. All Rights Reserved.

Name System

Agency or = Sales Rep

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.

Name System

Joint Venture

• • • •

General Partnerships Limited Partnerships Corporations L.L.C.s

Advantages

Disadvantages

•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

P P P

TM License Business Opportunity

P P

Dealer / Distributor

P P P

Sales Rep / Agent Joint Venture

NY Franchise Law

Securities Laws

Sales Rep. Laws

Fair Dealership Laws

Relationship Laws

Business Opp. Laws

Franchise Laws

Franchise

Federal & 26 States

New York Only

26 States State / Industry Specific

35 States

State and Federal

Franchise & Business Opportunity Legislation within the U.S. 2021 Legend:

SD NE

MN IA

ME MI

V A NC

OK TX

N Y

IL IN OH

UT CA

N H

CT MD

SC GA FL

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

Alaska

Hawaii

Notes: •

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

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

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

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

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

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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).

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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).

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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.

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Fractional Franchises (Two years and 20%)

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

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

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

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Leased Departments

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Single Trademark License Exclusion

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Fall under other regulations (PMPA)

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

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CAUTION: The FTC Exemptions are NOT honored by all states

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Technology-based shared services ◦ Use an app to drive business ◦ Avoid franchising by top-down fee structure ◦ Uber, Lyft, Airbnb

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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

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The decision should be goal driven ◦ ◦ ◦ ◦

Distance Speed Obstacles Risk tolerance

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A Volvo or a Rocket Ship?

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Don’t have to choose only one vehicle

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Don’t decide to franchise (or whatever) ◦ Instead, decide:

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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

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Successful prototype Credibility Differentiation “Sizzle” Buyer appeal Value Proposition

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Teachability Adaptability Systemization

R.O.I.?

Sell? } } }

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Affordability Profitability

Market trends Capital Management

Succeed?

Clone?

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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”

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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

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Franchisees expect that they will need to build their business ◦ Will expect these returns in three years or less

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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)

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Occasional exceptions

Cost to Open a New Unit

150,000

Add a Franchise Fee

25,000

Add Working Capital

25,000

Franchisee Estimated Investment

200,000

Estimated Franchisee Revenue Year Three

500,000

Current Profit after Owner’s Compensation

70,000

Adjust Owner’s Compensation

15,000

One-Time Only / Capital Investment

5,000

Tax Minimization Strategies

5,000

Shared Overhead

5,000

Interest and Debt Service

5,000

Depreciation and Amortization

5,000

30,000)

80,000

Subtract Royalties, Fees, & Price Adjustments Estimated Franchisee Profit (adjusted)

$80,000/$200,000 40%

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Perfecting the business

◦ If you have perfected your business, SELL IT! ◦ If you are standing still, someone is gaining ◦ McDonald’s in 1955

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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 . . . ?

Risk of Failure Business Model Risk

Competitive threat

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Business plan/strategic direction

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Legal documents and registrations

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Operations manuals

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Training program

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Quality control mechanisms and systems

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Effective marketing plan

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Franchise collateral materials

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Website and web-based marketing

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Advertise

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Design and implement a sales strategy

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Staff an organization to implement the plan

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Capital

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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?

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Don’t rely on guesswork: The

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Financial analysis is essential.

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Reverse engineer your success.

future of your business is at stake.

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There are certainly a large number of neophyte franchisors who take a “Ready-Fire-Aim” approach ◦ Often rely on guesswork ◦ Or analysis of what comparable franchisors are offering to make major decisions

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“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

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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 too little and often inertia will keep the royalty where it is at for years Lost revenue from a single franchise

Times 100 franchises opened Times 20 years Lost enterprise value at 10x earnings Total Loss

$5,000

$500,000 $10,000,000 $5,000,000 $15,000,000

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

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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

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State laws

The Franchise Sales Pipeline Public Relations Example CPL = $250

Print Advertising Example CPL = $150

Trade Shows Example CPL = $100

Direct Marketing Example CPL = $75

Internet/ Digital Leads Example CPL =$50 - $150

Brokers Cost Per Sale = $20K - $35K

Referrals/ Unsolicited CPL = $0

Lead Generation Time Varies by Media

Send Marketing Materials, Prequalify, Schedule Meetings

Average CPL: $312** Median CPL: $75

Meet With 3 – 10% of Leads Convert 15% - 20% of Completed CIRFs to Sales (Franchise Update reported 23.5% in 2020)

Initial Meetings with Candidates Further Qualify

Follow-up meetings, assist with business plan & secure financing

Average 45 – 90 Days Lead to Meeting 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 (Franchise Update reported 18 weeks in 2020)

Close 65% - 75% of Discovery Days (Franchise Update reported an average of 73.4% in 2020)

Award Franchise

Marketing Cost = $12,138, Average per sale* $9,650 Median per sale* Overall Expected Close Rate = 3.5% Close Rate for Qualified Leads = 13.5%**

Average cost per sale was $10,500 in 2019; and $8,984 in 2018. While not measured separately in the Franchise Update report, Cost Per Sale numbers can be even higher for emerging brands based on anecdotal evidence. ** Historically, close rates in past years have hovered between 1.8% and 2%; average Cost per Lead (CPL) was between $126 and $213 in the previous two years. The numbers above are based on the most recent Franchise Update survey, and are influenced by a number of factors in 2020, including COVID-19.

Source: Franchise Update.

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 © 2021 iFranchise Group. All Rights Reserved.

Franchise Program for Aggressive Growth Approximate Development Activity Schedule MO 1

MO 2

MO 3

MO 4

MO 5

MO 6

MO 7

MO 8

MO 9

MO 10

MO 11

MO 12

Discovery & Benchmarking Initial Planning Session Strategic Planning Financial Sensitivity Analysis Franchise Agreement

Legal Coordination

Strategy Legal Documents Quality Control Franchise Marketing Organizational Development

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

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

Franchise Program for Moderate Growth Approximate Development Activity Schedule MO 1

MO 2

MO 3

MO 4

MO 5

MO 6

MO 7

MO 8

MO 9

MO 10

MO 11

MO 12

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

Legal Coordination

Strategy Legal Documents Quality Control Franchise Marketing Organizational Development

Franchise Program for Conservative Growth Approximate Development Activity Schedule MO 1

MO 2

MO 3

MO 4

MO 5

MO 6

MO 7

MO 8

MO 9

MO 10

Discovery & Benchmarking Initial Planning Session Strategic Planning Financial Sensitivity Analysis

Legal Coordination

Strategy Legal Documents Quality Control

Franchise Agreement Disclosure Document State Registration Process Operations Manual

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+.

MO 11

MO 12

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Consulting and legal costs vary based on franchise company’s situation: ◦ Desired speed of growth influences services needed ◦ Ability to do work internally

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Do not go into franchising undercapitalized ◦ Legal fees: $15,000 to $35,000+ ◦ Consulting and Development: $40,000 to $200,000 ◦ Organizational expenses: $10,000 to $25,000 ◦ Franchise Marketing: $8k - $10k per sale (six months) ◦ Personnel: varies widely Can bootstrap growth Can spend hundreds of thousands

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Franchising is a means of duplicating success, not creating success

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Thrives by creating win-win situations

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You must be selective

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Franchising is a new and different business

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Is not the right solution for every business

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Provides one of the most powerful business expansion models ever developed

www.ifranchisegroup.com 708-957-2300

If you would like a copy of this presentation or a complimentary book, please provide us with your business card.