Franchising v alternatives (jan 2015)

Alternatives to Franchising

About the iFranchise Group •

More hands-on experience than any other firm – – –

•

27 consultants with over 500 years of franchise experience Our consultants have worked with 98 out of the top 200 franchise companies worldwide Offices: Chicago, Los Angeles, Dallas, Dubai, Jeddah

More “senior level” experience –

Former CEOs, CFOs, EVPs of two dozen major 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

Experience with start-up and established franchise programs

Breadth across four functional areas – – – –

Strategic Planning Quality Control Marketing Implementation and Organizational Development

•

More Data = Better Data (track 200,000+ leads)

•

Franchise Dynamics – – – – –

•

Nation’s premier franchise sales outsourcing firm Sold about 2,000 franchises since 2010 making it “top 10” each year 25 sales and marketing professionals who have collectively sold over 7,000 franchises 400 additional years of franchise experience Former Senior Executives at Cendant, Chem-Dry, The Dwyer Group, LINE-X, Management Recruiters International, Ponderosa, TCBY, Ziebart, and other national brands.

TopFire Media – – –

Nation’s first fully integrated media firm -- SEO, PPC, Social, Blogging, PR, and Mobile 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)

Copyright, The iFranchise Group, 2015. All rights reserved.

The iFranchise Group

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The iFranchise Group provides a fully integrated approach to the development and refinement of franchise businesses…

Franchise Strategy Development

Quality Control, Documentation & Training

Franchise Marketing Assistance

Franchise Implementation Services

•

Franchise Feasibility

•

Operations Manuals

•

Franchise Marketing Plans

•

Franchise Sales Training

•

Competitive Benchmarking

•

Systems and Forms

•

•

Franchise Structure

•

Quality Control Procedures

Implementation Consulting and Coaching

•

Primary Research on Targeted Franchisee Candidates

•

•

Franchise Brochures and other print collateral materials

Franchise Sales Outsourcing

•

PR, SEO, PPC, & Social Media

•

Territory Analysis and Determination

•

Coordination with outside counsel on the development of legal documents

•

Strategic Implementation Plans

•

Financial analysis and fee optimization

•

Business Plans for Capital Formation

• •

Training Programs and Training Aids Training Videos and other Intranet training applications

•

Franchise Promotional Videos

•

Company Audits and Best Practices Benchmarking

•

Operational audits and best practices

•

Franchise Ad Design

•

Due Diligence

•

•

Learning Management Systems

•

Website development

Expert Witness and Litigation Support

•

Website optimization

•

Franchisee Council Development

•

Franchise sales and marketing audits

•

Compliance Audits

•

International Expansion

Fully-Coordinated Approach Across Disciplines Copyright, The iFranchise Group, 2015. All rights reserved.

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But the vast majority of our services are directly applicable to nonfranchised channels of distribution…

Quality Control, Documentation & Training

Strategy Development

Marketing Assistance

Implementation Services

•

Feasibility Studies

•

Operations Manuals

•

Channel Partner Marketing Plans

•

Biz Op Sales Training

•

Competitive Benchmarking

•

Systems and Forms

•

•

Financial Structure

•

Quality Control Procedures

Implementation Consulting and Coaching

•

Primary Research on Targeted Channel Partner Candidates

•

•

Business Op Brochures and other print collateral materials

Biz Op Sales Outsourcing

•

PR, SEO, PPC, & Social Media

•

Territory Analysis and Determination

•

Coordination with outside counsel on the development of legal documents

•

•

•

Strategic Implementation Plans Financial analysis and fee optimization

• •

Training Programs and Training Aids Training Videos and other Intranet training applications

•

Business Op Promotional Videos

•

Company Audits and Best Practices Benchmarking

•

Operational audits and best practices

•

Business Op Ad Design

•

Due Diligence

•

•

Learning Management Systems

•

Website development

Expert Witness and Litigation Support

•

Website optimization

•

Dealer Council Development

•

Business Op sales and marketing audits

•

Compliance Audits

•

International Expansion

Business Plans for Capital Formation

Fully-Coordinated Approach Across Disciplines Copyright, The iFranchise Group, 2015. All rights reserved.

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Definition of Franchising Copyright, The iFranchise Group, 2006 All rights reserved

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What Is Franchising?

• FTC rule 436 cites three elements that legally define a franchise: – The use of a common trademark – The provision of assistance to (or exercise of control over) the franchisee – 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”

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How Franchising Works • Franchisee typically pays – – – – –

Franchise fee average about $25,000 - $35,000 Royalty range between 4% - 10% Advertising range between 1% and 2% Franchisor will often sell product to the franchisee Franchisee makes the entire investment in operations

• Franchisor typically provides – – – – –

Initial training Operations manual and systems Ongoing supervision and support Other support services Trademark & Trademark Maintenance

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Franchising Versus Company-Owned Growth

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Franchise Vs. Company-owned Pros -- Cons

• • • • • • •

Leverage Capital Speed of Growth Motivated management Reduced risk Few operational concerns Higher quality Organizational leverage

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• 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

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The Litigation Trade Off: Franchising Versus Company-Owned Growth Liability Type

Well-Executed Franchising

Franchise Contract Liability

Company-Owned Growth

X

Employment Liability

X

Property Lease Liability

X

Equipment Lease Liability

X

Workers Comp Liability

X

Slip and Fall Liability

X

Vicarious Liability Can require third party to insure you against liability Can insure against internally

Usually not*

You always have liability for your agents

Yes – franchisee

No

Yes

Yes

* Not responsible for acts of an independent contractor (franchisee) relative to third parties. Exceptions are when a) you create an agency and/or b) if you are negligent.

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Analyzing the Company Growth Option • 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

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Analyzing the Company-Owned Alternative Year 1 Starting Capital

Year 2

Year 3

Year 4

Year 5

$250,000

$200,000

$200,000

$250,000

$300,000

1

1

1

1

2

($150,000)

($150,000)

($150,000)

($150,000)

($300,000)

0

$50,000

$100,000

$150,000

$200,000

$100,000

$100,000

$100,000

$100,000

$100,000

3

4

5

6

8

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

Terminal Value

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

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

Raising Equity as an Alternative •

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

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Analyzing the Equity Alternative

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

Year 1

Year 2

Year 3

Year 4

Year 5

$3,250,000

$1,100,000

$850,000

$1,250,000

$1,500,000

15

7

5

8

10

($2,250,000)

($1,050,000)

($750,000)

($1,200,000)

($1,500,000)

0

$750,000

$1,100,000

$1,350,000

$1,750,000

$100,000

$100,000

$100,000

$100,000

$100,000

17

24

29

37

47

$100,000

$850,000

$1,200,000

$1,450,000

$1,850,000

$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

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Equity Raise Considerations • 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

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Franchising as an Alternative To Company Growth

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Goal Driven Modeling Goal

Sell for $10M in 5 Years

Average Selling Price

6.7 times EBIT

Year Five Earnings

$10M/6.7 or about $1.3M

Average Net Royalties

$10,000 per franchise

Need to sell

$1.3M/$10,000 = 130 Franchises

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Goal Driven Planning

Sales

50

30 25 15 10 Year

1

2

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4

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Goal Driven Planning

Hire Franchise Salespeople 50

Sales

30 25 15 10 Year

1

2

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3

4

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Goal Driven Planning

Hire Field Reps Sales

50

30 25 15 10 Year

1

2

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3

4

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Goal Driven Planning

Hire Support Staff Sales

50

30 25 15 10 Year

1

2

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3

4

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Goal Driven Planning

Sales

50

Personnel Marketing Office Space

30

Brochures

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

15 10 Year

1

2

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Third Party Distribution Strategies Copyright, The iFranchise Group, 2013 All rights reserved

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Alternatives to Franchising Name Fee

Name =

Franchise

System

Fee

=

Trademark License

System

Distributor

Name Fee

Name =

Business Opportunity or License

System

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Fee

Dealership

=

Agency Sales Rep

System

Joint Venture

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Can Combine Options Too Name Fee System

Franchise

+ Joint Venture

Equity

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Name

Trademark License

Product

+

System

Distributor/ Dealer

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Advantages and Disadvantages of Alternatives 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.

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Advantages and Disadvantages of Alternatives 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?

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Advantages and Disadvantages of Alternatives 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.

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Advantages and Disadvantages of Alternatives 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.

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Advantages and Disadvantages of Alternatives 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

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

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Franchise & Business Opportunity Legislation Within the US ND

WA

MN

ME

SD

WI

NE

NH

IL

UT

NY

MI

IA

IN

OH RI KY

CA

VA

OK

NC

CT MD

SC TX

Hawaii

LA

AL

GA

FL

Legend: States having no franchise or business opportunity laws States having franchise registration laws States having business opportunity laws States having both franchise registration and business opportunity laws

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Franchise TM License Business Opportunity Dealer/Distributor Sales Rep/Agent Joint Venture

√

√ √ √

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√ √ √ √

aw chi se L NY Fr an

aws Secur

it ies L

aws R ep. L Sales

p Law eal ers hi Fair D

Relat ionsh ip

Laws

. La w s ss Op p Busin e

Fra nc hise L

aws

s

Laws Governing Third Party Relationships

√ √ √ √

Federal & 26 States New York Only 26 States State/Industry Specific

√

35 States

√

State and Federal

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The Non-Franchise Franchise The Uneven World of Exemptions

• • • • • • • •

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

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Developing Your Strategy

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Choosing the Right Growth “Vehicle” • The decision should be goal driven – – – –

Distance Speed Obstacles Risk tolerance

• 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 Copyright, The iFranchise Group, 2015. All rights reserved.

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When is the “right” time to expand?

• Perfecting the business – If you think you have perfected your business, SELL IT! – McDonald’s in 1955

• Quick vs. Slick – More unique, the sooner you should expand • Risk: Someone with a camera and a notepad • First mover advantage • Who was the first . . . ?

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

• What is right for YOU? – – – –

What are your goals?

What are your constraints?

What is happening in the market?

Do you have something unique?

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Additional Information for Making a Decision • Determine if your business is, in fact, franchisable (or if it can be expanded through any third party distribution) • Determine if third-party distribution channels are the best means of expanding your business • Gain an understanding of what is involved in franchising, licensing, etc.

• Understand various cost options (and combinations of options) and how they can be adjusted to meet your growth goals • Please consider our Analysts to be resources to you

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Additional Questions: Please contact one of our Analysts 708-957-2300 or info@ifranchisegroup.com