Buying a Franchise

Buying a Franchise

An old proverb reminds us that if you are searching for a jewel, it too often may be hiding in plain sight! Most searchers discount the opportunity to become the CEO/owner of a franchise for a variety of reasons, including size, limited growth, low margins, restricted flexibility, and “status.” According to Statista, in 2019, there were approximately 780,000 franchise “establishments” in the US with an economic output of about $787.5 billion and with 8.43 million people working for them—certainly not an insignificant niche.

In a survey of 187 Entrepreneurship through Acquisition (EtA) businesses purchased by Harvard Business School graduates in the past decade, 19 (or 10%) purchased franchise operations—10 immediately upon graduation and 9 mid-career (See Blog Post: Searching Mid-Career). All were self-funded, paying an average earnings before interest, taxes, depreciation, and amortization (EBITDA) multiple of 4.2x with a range of 2.7x to 5.5x. The median seller note was 20% of the purchase price with 15.5% outside equity and the remainder financed by bank debt. Of these franchises, 55% were single-unit operations, and five ranged between 13 and 23 units. Employee count ranged from 8 to 300. Searchers took a median of 12 months from search launch to close with a range of 6 to 35 months. One additional searcher/CEO decided to “build” rather than “buy” a territory for seven car wash facilities.

Why choose a franchisee to acquire?

Omar Simmons, at Exaltare Capital, who now owns more than 100 Planet Fitness operations, said that “franchises are good businesses at a decent price with solid growth prospects. They have low-valuation multiples, offer ‘buy and build’ opportunities for growth, and we can create and leverage a sophistication with our capital advantage.” Richard Bi, at Paul Davis, found that “Brand awareness and operational support offered by a franchise network make the business more stable. Franchises usually come with some form of exclusivity, most commonly territorial protection, which has real intrinsic value that’s independent of how well or poorly you run your business. I found that debt and raising equity relatively easier. I didn’t start my search looking for a franchise. To the contrary, my initial strategy was actually to avoid franchises with the only exception of day care.”

There is some general disdain for franchise businesses as cited by Tyler Tuggle at Home Instead: “Some searchers seem to disregard franchises outright because of a perceived stigma. At the right price, a good business is a good business even if it is a franchise. They come with a built-in marketing strategy and reputation.” Jon Sheedy, who bought a restoration business in Indiana, had similar reservations: “I was actually looking to avoid buying a franchise, but the one I found was too compelling to pass up. Belonging to a franchise system provides the scale necessary to sign national-level agreements to become a sole provider with our payers. Being in a franchise helped with issues post-acquisition as there were dozens of helpful people I could reach out to with questions in the network.”

Ian Cahn-fuller at Massage Envy also speculated about image perceptions: “Franchising gets a bad rap as boring and noncreative. Searchers might not appreciate that building a franchise business, especially a high-growth platform, is like building any other business and that you may be able to move faster and truly focus on scaling.” Another searcher observed, “It is an area overlooked by other acquirers, with a lower entry multiple, and as long as the franchiser is on board, growth through acquisition is straightforward.” Patrick Dunagan, who has an Anytime Fitness franchise, found that “Preexisting processes and controls enable transition time after closing to be very smooth.” A searcher/CEO who acquired a multilocation tax preparation business found that “The proven business model is attractive to lenders and can make up for a perceived lack of searcher experience. Franchise brokers can be extremely helpful with price setting and sourcing. Also, specialized franchise lawyers understand the nuances of the state franchise laws that protect franchisees.”

Contrasting franchises with other search businesses 

Richard Bi at Paul Davis cautioned, “During the entire pre-closing phase, view and treat the deal as a true three-way negotiation process with the seller, yourself, and the franchiser (not two-way like most search deals are). There could be several requirements around who can be equity owners, amount or types of financing allowed, personal guarantees, etc. that could kill your deal on arrival. Approach the franchiser the same way you would approach sellers: with humility, respect, and sincerity. Protecting their franchise’s brand is of paramount importance. Franchise laws make it really hard to get rid of ‘bad’ franchisees once they’re in, so all franchisers desire to maintain tight control over who they allow into their network. The larger and more established brands, in particular, view the process as a job interview—and rightfully so.”

Much is the same with seller prospecting, but Tyler Tuggle at Home Instead pointed out, “There is a similar level of stress and worry about operations, P&L, hiring and firing. Yet, the franchisee network offers industry knowledge and support not available in standalone businesses.” Ian Cahn-Fuller at Massage Envy said, “You are building a business within a business and can move faster by leveraging tools, operational playbooks, marketing plans, etc. from the franchiser. However, you have less control as the franchiser ultimately owns the brand and business model.” One searcher/CEO observed, “We are bound by a franchise agreement which may limit geography and nature of services, but in our case, we can set up our own processes and approach to sales/execution, which matters a lot to us. Although we can target 10x growth, we are unlikely to achieve 100x without broadening our services outside the franchised network.”

Jon Sheedy, with the restoration business, noted, “The similarities are that I am still my own boss, make all of the decisions, and am ultimately responsible for all of the successes and failures my company has. Also, I have help if I need it. If I get a job that is too large to handle with only my employees, then I can call the franchiser in for surge capacity that allows us to accept any size job. I don’t have to think about designing or maintaining a website, marketing materials, employee uniforms, training materials, etc. Essentially I am paying 7% of revenue for them to handle all of these functions, which may actually be cheaper than doing them all myself and frees me up to think about everything else I have to deal with on a day-to-day basis.”

Zack Belzberg at Dodds Doors in Canada, examined franchises deeply before searching, but concluded the following: “For me, buying a small business was about working for myself and being in total control. What I value in the franchisee model is the ability to scale quickly. However, I was concerned that I would ultimately be answering to someone who could influence my decisions.”

Other business models include branded dealerships or distributors that are like franchises. Sunny Kanneganti, at Mobile Sweep, purchased a business with a strong “affiliation” network, but not a franchise: “The 1-800-SWEEPER number has been a nice but not pivotal marketing phone line. They do a yearly conference where owners do a lot of cross-learning/sharing and are more open than in the trade conferences we participate in. They also publish a yearly benchmark study with everyone’s QuickBooks files aggregated that I feel is immensely helpful.”

What is the reaction from lenders and investors?

“Low purchase price multiples, industry tailwinds, and opportunity for growth were attractive to my bank,” explained Tyler Tuggle at Home Instead. Jon Sheedy reported, “My investors were delighted to see significant opportunity to roll out new service offerings developed by franchisor but not yet active in my territory.” Lenders are apt to be more favorable as Omar Simmons found with Planet Fitness: “Many brands have strength that allow a franchisee to get better terms than a similar business would without the benefit of a national company behind it.”

Richard Bi at Paul Davis noted, “Banks will also look at past performances of other franchisees in the same network as an important factor in their approval process. The SBA tracks historical default rates and charge-offs by franchisee. Today, SBA loans are very attractive for both the business and the real estate. There is a third-party data services FranData that help lenders assess the franchise network’s health. Also, some lenders are also more willing to look past a searcher’s lack of prior experience in the industry if the business is a franchise.”

Challenges and opportunities unique to franchises

One searcher/CEO observed, “Getting the deal closed was hard; I had a very difficult seller. Luckily the franchise wanted him out of the picture as well, and they provided encouragement for him to go through with the deal.” Ian Cahn-Fuller at Massage Envy said, “Operating is the biggest challenge, even in a franchise system! Executing your operational plans and driving accountability throughout the organization is hard and hands-on work.”

Another franchise CEO reflected, “Closing required an amendment to the franchise agreement; I wanted an ‘evergreen’ clause added, which meant there was one more stakeholder and subsequent concern in getting across the finish line. There has also been one more stakeholder to satisfy and monitor while running the business, which is an additional risk. On the other hand, the franchiser welcomed the idea of high growth targets and more sophisticated ownership and management than with their other operators.” Omar Simmons at Planet Fitness added, “We were their first institutionally owned franchise, and they had to get comfortable with no personal guarantees.”

Michael Cianelli, at Tommy Car Wash System, explained that “the franchiser felt that we brought a level of fundraising and potential that the they had not previously seen.” Similarly, Ian Cahn-Fuller at Massage Envy observed, “They were happy to partner with younger, hungrier franchisees who brought a new perspective to their brand.”

Advice for searchers investigating this path

Ian Cahn-Fuller at Massage Envy advised, “Find a way to partner with the franchisor; a strong relationship can make all the difference. Do your homework—speak to as many franchisees and operators in the systems you like as possible. You can never be overprepared before entering a system.” Omar Simmons at Planet Fitness suggested, “Joining a brand can be a bit like joining a family; it can take time to understand the ‘unwritten rules.’”

Another searcher/CEO with multiple fast-food units expressed, “Talk to as many existing franchisees as possible about their experience and level of satisfaction with the brand because that at the end of the day is going to be the primary factor in determining your success. I’d rather be an average operator in a great brand than the best operator in a lousy one, no question!”

One searcher/CEO strongly recommended, “As early as possible, get your hands on the sellers Franchise Disclosure Document (FDD) and Franchise Agreement (FA) to determine if it is assignable and what the differences are between the FA and the ‘current’ version. Many state agencies display disclosures on Franchisers which can be useful: California Site.” Tyler Tuggle at Home Instead advised, “Find out what your royalty fees are paying for. Do they provide marketing, operations support, or a helpful franchisee network? If you’re only getting the brand name, it may not be worth 5%–10% of top-line revenue.”

Richard Bi at Paul Davis, cautioned, “Make sure you’re actually okay owning a franchise with the trade-off of less control/independence for the benefits of being part of a franchise network. The relationship with the franchiser also can be positive and rewarding if you have the right expectations going in and embrace the spirit of partnership. Many franchises have the challenges of a blue-collar workforce. [See Blog Post: Managing a Blue-Collar Workforce.] If you feel going in that it’ll be too difficult and a contentious relationship, you should probably consider just moving on to pursue other opportunities.”

Jon Sheedy with the restoration business offered this suggestion: “Make an informed choice by speaking to a lot of existing franchisees and asking them what issues they have had or heard of with the franchiser. This should be part of your diligence and include litigation history. Understand the long-term goals of the franchiser, and make sure their interests are aligned with yours.”

Patrick Dunagan at Anytime Fitness pointed out, “Franchises are franchises for a reason . . . be really careful you’re not buying yourself just a job. Strength and depth of the existing management is really key to your future growth.” Finally, on a practical note, Michael Cianelli, at Tommy Car Wash System, advised, “Hire a very good franchise attorney to review franchise agreements. The fine print can make or break you! Franchise law is very unique. Get referrals from other searcher/CEOs.”

Conclusion

EtA is all about being flexible and open to unusual options. A franchise has some unique characteristics and provides ways to mitigate your business risk. Ignore the image and status issues and focus on achieving the goal of running a business and putting your entrepreneurial/managerial skills to work creating value. The “magic” of EtA is more about you than the business!! These “jewels” are, indeed, in plain sight! I collaborated with AJ Wasserstein from Yale and Peter Mistretta on this topic with some great additional examples: Exploring Franchisees as a Post-MBA Entrepreneurial Path

Search on!!!

Feel free to share some of your own best practices or experiences in dealing with these issues in written blog comments below. I encourage this dialogue, allowing all to learn from both my own views and the views of others in a virtual learning cycle—so jump right in! Also, I frequently update individual blog posts and add to the Reference Sources and Search Tips sections of the site, so visit the www.jimsteinsharpe.com website regularly.

Created: 03/08/2021, Last Revised: 04/12/2023

2 Comments

  1. Barclay Henderson on August 9, 2021 at 11:20 am

    I hold the greatest admiration for those creative types who can invent a new concept for a business venture. But even attempting to do so strikes me as a high-risk proposition and not the best use of my business skills. After 40 years of owning 25 successful Wendy’s, Jiffy Lubes, and Benihana of Tokyo units, I’m very enthusiastic about franchises. They bring inconveniences, reduced margins, and big company frustrations but inventing wheels with an unproven concept is rough.

    • Jim Sharpe on September 9, 2021 at 5:26 pm

      Barclay, great insights from and experienced operator. Appreciate the comment.

      Jim

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Posts – Most Recent

Posts – Contemplating a Search

Posts – Launching a Search

Posts – Conducting your Search

Posts – Being CEO/Owner

Random Quote

45-“Strategic partners” are very important to the business searchers.You want to rely on some trusted providers to support your business, you can’t do everything yourself!(See Blog Post-Strategic Partnerships)

42-Start early on legal documents, they often delay closings while under LOIBoth the searcher and the seller are plowing new ground and it takes a while to comprehend the meaning of all of the legal details .(See Blog Post-Getting to closing)

63 Searchers make promises they can meet to build trust with sellers. It is important to provide incremental opportunities to show that you can be counted on to deliver.(See Blog Post-Building Trust with Sellers)

34 Searchers who get access to employees before closing are more likely to close. Once the seller begins to confide in their employees about the sale of the business and introducing you as the “new owner”, they are more likely to proceed to finalize the transaction than to change their mind at the last minute.(See Blog Post-Getting to Close)

07-You are not a PE firm, don’t act like one!
Potential sellers resonate with your taking over their legacy, a PE firm is simply adding to their portfolio. Make sure your website looks personal and non-intimidating.

04-Fight Seller Fatigue in Due Diligence!
Sellers get worn out in this process. It is highly emotional for them, probably their first time at relinquishing their “baby” to someone else. During LOI stage, make it a practice to communicate with them, in person or by phone, every 2 days.

53-Holding monthly “all-hands” meetings indicates your transparency. Trust employees with what is going on with the business and they will trust you more .(See Blog Post-Communicating with Employees)

06-Use metrics to drive decisions
Track what is most important for your search – getting in front of prospective sellers to make offers to buy their business. Track the number prospects, IOI’s, LOI’s and set goals for yourself! If you measure it, you can improve it.

22-When in conflicts arise, remind professional advisors they work for you.
Inevitably, you will disagree with some advice you are getting. After checking multiple sources, do what feels right to you and move forward. You will have to “live” with your own choices, not the professionals!(See Blog Post-Professional Support)

18-Every day that goes by during Due Diligence raises the chance that you won’t close!
Time is of the essence when it comes to moving from a signed LOI to closing on your business. Seller fatigue sets in as the closing date gets extended and the seller constantly re-evaluates their motivation to sell. Only you can push the process along.(See Blog Post-Due Diligence)

44-Plan ahead, give thought to the small details of how you present yourself as the new owner. The first introduction to the employees of the business has a huge impact so you want every word to be rehearsed!(See Blog Post-Taking over the business)

50-Don’t expect immediate “loyalty”, the previous owner earned it, it takes time. You will need to earn the trust of your employees by your actions, not your words. (See Blog Post-Seller Tranisition)

35-Searcher CEO’s need to be prepared to walk away from volume orders if margins will decline. It takes a forward thinking CEO to seek out higher margin, value added opportunities to grow profits, not revenue.(See Blog Post-Wearing the sales hat)

09-Learn from others – read case histories
Over 40 case histories have been written about funded and self funded searchers in a variety of industries and historical settings. Each have great “lessons learned” and are worth the $10 cost to read them. Searchers are learners!

39-The business seller is “hiring” you to run their business. The owner trusts you enough to turnover the “legacy” of their business to you. (See Blog Post-Searcher Profile)

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