Raising Capital With Master Franchising:
A New Paradigm For
Launching, Financing and Building Businesses
Copyright ©2005-2008 Richard Pawlowski
Phase Two of the "New Internet Economy" is just beginning and because totally new types of recessions and expansions are also emerging along with it, many investors are rushing to rethink their past investment strategy and existing portfolios. Much of the dot com and tech stuff they originally invested in is now downright ugly and many now realize, they, at that time, were fairly myopic.
However, because some consolidation and growth fundamentals worked well in the past, many of these "old" or "traditional economy strategies" are again starting to make much more sense. One of the best from the past is franchising and perhaps the greatest strategy now for American companies to use to compete with on a global scale. Americans are pros at franchising and as a fundamental growth and consolidation strategy, it holds great promise for keeping entrepreneurs on top of most localized economic changes, anywhere on the globe, quickly and rationally.
Franchising Fundamentals
Franchised businesses succeed more than regular businesses and more than 3 million are spread around the world with 767,483 in the U.S.. They generate more than $ 1.5 TRILLION in sales and a new franchised business is opening somewhere in the U.S. every 16 minutes. More than 18 million people are employed by 15,000 franchises in more than 60 countries and more than 40% of all US retail sales comes from a franchise operation. 94% of franchised business owners are successful and 75% of franchise owners would repeat their franchise again. The average gross income before taxes is $124,290 and the average total investment is $147,570.
With many Fortune 1000 companies unsure about their future, franchises are always adding more jobs and opening new locations, and it's no wonder that franchising is booming globally and ambitious Americans are changing careers and looking for true financial security within the franchising industry.
Franchising Is Now (again) A Perfect System For Consolidating and Growing Businesses
Franchising is a proven organizational strategy and perfect again for consolidating many technology companies which may have had a good idea but for some reason, executed incorrectly and perhaps missed the real world components necessary for "sustained" growth.
The Corporations Commissioner and the Federal Trade Commission (FTC) view franchise ownership as another form of "security" offered by the parent company (the franchisor). It is similar to stock in many respects but it is not the same. Knowing and using the differences correctly is where mega-millions are made in franchising.
The franchisee (typically an operator), can be a multi-owner partnership entity (limited or otherwise), or even another corporation. The parent franchisor can be a partnership entity or corporation as well. The "grant" of a franchise is serious business and requires state approval before any sales are made. The standardized federal offering document is called an FDD (Franchise Disclosure Document) or UFOC (Uniform Franchise Offering Circular) and is accepted in most states. (Hang in there with me and you will understand why so much money is involved with franchising).
Special Secrets For Successful Franchising
A new reality is emerging in the world of franchising and many existing franchisors and most businesses, simply do not understand what is really happening. What you are about to learn is very valuable information and esoteric to a very select group of people on this planet. Please pay very close attention - you are in luck. Your eyeballs are in the right place.
Large amount of money can be raised from selling "rights", licenses, master distributorships and regional/master franchises before a franchise "unit" is even open or operating (of course however, an open or model unit makes the sales much easier). Stock in the parent company (the franchisor) is not diluted because of franchise sales and in fact, the more franchises there are, the more valuable the stock becomes. The stock in the parent franchisor can also be used to acquire or consolidate other companies (more about this coming up).
I've seen smart franchisors start up with very limited, "borrowed" funds (under $10k) that were placed into trust accounts which were then verified by CPAs and then sent to government officials to get startup approval (this isn't the best way to do it but it can be done).
There are currently only 14 states that require approval before any franchise is sold in their state - which is the FDD or UFOC registration. This also means there are 36 others who do not. In other words, if you live in one of the registration states, an out-of-state franchisor must first register in that state. It takes time and some legal work but the reality is, the whole state can be sold to a regional or "master franchisor' first.
Master Franchising = MEGA-BUCKS
MASTER-franchising (also called and confused with regional, multi-unit, area-development and/or sub-franchising) has become extremely successful for smart franchisors and is a special way of raising capital from working investors around the globe. Master franchising will continue to grow on a global scale too, because of general public awareness and legalized standardization. BlockBuster Video, ReMax, Century 2, McDonalds and many others have launched and grown this way. My personal opinion is that master franchising and "conversion" franchising (more about this coming up) are the keys to the global Internet gold mine, especially now because of the boom and bust in Internet companies and because of new caching strategies and digital video technology. Additionally, and very important to note, is that the baby boom generation in America is set to inherit over $10 Trillion (that's a "T") in the next twenty years and they have grown up buying from and participating in franchising.
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Large amount of money can be raised from selling rights, licenses, master distributorships and regional franchises before a franchise unit is even open or operating
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With Master Franchising, the sub-franchisor (region owner), signs an exclusive contract with the parent franchisor to market and manage all the franchises in a larger than normal area. Although the master franchisor is also a franchisee, the master-franchisor has some special duties and obligations to the parent company. The upfront dollars to play in this arena are typically much more than the cost of an individual franchise. In an exact sense, the Master Franchise owner/s can buy franchises at "wholesale" and resell them. Europeans and the Japanese love the U.S. franchising system. This is also perfect for globally franchising incubators. Ultra-wide-vision is especially helpful in Master Franchising.
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Additionally, the baby boom generation in America is set to inherit over $10 trillion in the next twenty years and they have grown up buying from and participating in franchising.
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Master franchises are typically sold based on the amount of population, TV broadcast area and/or political boundaries. Some are also sold on the value of the demographics and zip or area codes.
For example: in the State of California, the Los Angeles area has five (5) typical regions and San Diego and San Francisco have four (4) each. In some cases (depending on the type of business), each region could contain 100 "units". If each franchise unit sold retail for $50,000 each and wholesale for $10,000, the region owner/s would pay 100 X $10,000 or $1 million to the parent for the "exclusive rights" to market and manage in that area. Some smart investors consider this very smart mega-leverage strategy. Stay tuned, it gets better.
If a single unit is opened and a regional franchise "permit" is gained from the state, the parent franchisor could then sell regions first to help capitalize and expand. Remember, this is NOT stock being sold.
For example; if there were 10 regions (master franchises) in the State of California and they sold for $1 million each, the parent could raise $10 million before another unit was even opened. If the parent continued to sell regions globally, the franchise grows rapidly and rewards all who participate.
**Important Note** Seasoned franchisors are always looking for hot new concepts and ideas. From the above example you can understand why it may make sound economic sense to pay a high price for an existing, successful single owner business, then commence franchising. With regional (master franchise) sales first, the concept stands a better, quicker and broader chance of success.
Very often, parent franchisors sell regions/master franchises on favorable terms and are not too concerned about the immediate cash input. There are important reasons for this, because WHO is buying the maser franchise often triggers the sale of many other master franchises and brings in more investors. In other words, the regional buyer can become more important than the seller. The right initial region owners can literally make the franchise work on a global scale.
Factoring Regional Sales
In some cases the parent franchisor "finances" the regional sales with a low down payment and records the balance due as "accounts receivable". This way, it is much easier to get loans and venture capital and perhaps more experienced management. For example; if the region sold for $1 million with 10% down ($100,000) , the remaining balance of $900,000 could be carried and sold to a "factoring" company for $750,000. The cash could then be used to finance even more regional sales, TV advertising and to set the concept firmly in the minds of millions of people. Again, the key ingredient in regional sales is in the signature of the BUYER. It adds value to the franchise concept in a big way.
(SPECIAL NOTE * If you would like private consulting on how to get the right "who" for your master franchises, contact me personally - rp@venturexpo.com ).
The Lions Share Goes To the Region Owner
Big Cash Flows Attract Big Players. The daily cash flow from just 100 operating franchised units can be hefty. When a regional owner commits and starts to market individual franchises, the party starts to rock and roll. The main motivation for everyone (who is participating in the franchise) is to get the daily cash flow up as soon as possible for joint advertising purposes. Ideally speaking, everyone wants to see it happen and are a definite part of each others success. The mental alignment and financial bonding elements that accompany a good network marketing organization (such as Amway) also apply within a good franchise.
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With regional sales first, the concept stands a better, quicker and broader chance of success.
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It is not uncommon for a regular franchisee to buy 5 or 10 franchises from a master franchisor. This way they can be even stronger in a certain area. Where they may have missed being able to buy the whole region, they may still be able to open multiple units. In the California region of REMAX, for example, the owner of the Manhattan Beach franchise bought several other beach cities, near his original franchise, to insure a broader REMAX area for himself.
In the case of USWEB (a web developer in the 90's), the company was originally started as a franchise made up of top-tier web developers and who were given exclusive rights within their cities or regions. The parent franchisor was initially funded with $13 million by Softbank Ventures to consolidate them. Within two years, the parent franchisor was worth over a BILLION dollars!. As the franchise grew however, the parent franchisor bought back the individual franchises with direct stock in the parent (funny money). The original USWEB franchise concept went on from there to acquire and merge with several other companies by using their inflated stock. It is important to also note that late in their execution strategy, they had to backtrack and start an ongoing corporate training and employee recruiting system just for staffing their offices. They also later went out-of-business because they got away from their original franchising mindset and roots (this is my opinion). In other words, the top management got stupidly greedy and wanted to keep all of the profits for themselves. They inflated the overhead (cooked the books?) and when the market turned south, they had to fold.
In the real world, for a franchisee, having standardized accounting, suppliers, management, training and co-op advertising programs are the major reasons to buy a franchise in the first place. For the franchisor, having control and royalty income from hundreds of locations without having to pay the monthly rent and salaries is the main reason why franchisors can expand rapidly. In many respects, master franchising of Internet/technology companies is now a special new way to compete in the future. Remember, franchising is the ultimate form of "decentralized management" and is a perfect and proven way to bring in quality management and working investor/ partners - while holding on to original equity.
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The key ingredient in Master Franchise sales is in the signature of the BUYER.
It adds value to the franchise concept in a big way.
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CO-OP Fund is Imperative
A typical franchise fee to a region owner may only be five (5%) percent of the gross sales, with the parent franchisor only receiving one (1%) percent. The "lions share" of the cash flow goes to the master franchisor but the parent franchisor has ultimate control over policy, trademarks and can sell hundreds of master franchises or regions. For national and international advertising, generally everyone kicks in an additional one-half (1/2 %) percent. This fund can get to be enormous and if used correctly, it becomes the key to security for everyone involved. [Look carefully into the franchising agreements of McDonalds, Century 21, REMAX and BlockBuster and you'll get the big picture].
If a franchise is set up without an ample "CO-OP" advertising fund (budget) or without master/regional sales, growth can be slowed and also difficult to maintain. The two (regional sales and co-op ad budgets) go hand in hand are critical elements that many franchisors fail to implement. In other words, they literally shoot themselves in the foot. Again, non-knowledge is the root cause.
First Refusal Rights
Master Franchisors often have the rights to open and maintain their own locations as well as selling locations to others. This can present a bit of a conflict of interest among the individual franchisees because the master franchisor is also an advantaged competitor of sorts. It is good practice, in some cases to restrict a master franchisor from actual operation of individual franchises unless it is critical to overall success.
The parent also generally retains the "right of first refusal" to purchase an operating unit or region if someone wants to sell to another party. This maintains the strength of the parent and also insures the quality of the concept. All parties linked in a good franchise openly disclose operating profits, new ideas and problems. Both the master franchisor (region owner) and the parent must submit audited financial statements to the state and federal regulators. All cards are on the table.
The Fast Track - Global Conversion or Consolidation Franchising
Conversion franchising is another fast growth key to Master Franchsing. Seasoned franchise investors look for good concepts in the "incubator" phase and then start buying up other existing locations to convert to the main concept. By standardizing the better competition and/or making the weaker stronger in an area, the region owner can also control the impact on the market and make success somewhat "predictable". In other words, rather than waiting for a franchise to sell, it may make sense to expand through both acquisitions and sales. The main growth strategy is to control and focus the advertising budget from hundreds of different, yet similar entrepreneurial companies. It is important to also keep in mind that each franchise unit is still typically owned by an individual entrepreneur that could not compete any other way.
In many cases, good operators of successful competitors are given very favorable franchise purchase terms if they join. Some fiercely hold out, but realize what might happen if they do not act on the opportunity in front of them at the moment. They know the franchisor (or master-franchisor) can offer the area to another who will take the ball and run with it. For example, the Blockbuster Video store chain purchased a 200 store independent that was about to commence franchising. When that deal was finalized much of the older video store competition took special notice.
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By standardizing the better competition and/or making the weaker stronger in an area, the region owner can also control the impact on the market and make success somewhat "predictable". The key is to control and focus the advertising budgets of hundreds of different, yet similar entrepreneurial companies.
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Franchising Business Development Centers (BDCs), EXPOs & Incubators
There are about 15,000 trade shows and 800 incubators and BDCs around the USA. Many of them are struggling and are ripe for a new consolidation strategy that can help their existing exhibitors and "incubatees" (and local businesses) survive and grow. A new and special global franchised EXPO/incubator opportunity is starting to emerge because of the economy, hyper-competition and reality in the market. The problem for regular incubators and BDCs is one of ongoing overhead and typical sole-owner, one-location thinking. Many VCs, EXPO, BDCs and incubator operators are not yet aware of the value in building a global franchise around the "open-to-public" BDC/incubator concept...such as the VenturEXPO.
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Some however, are just starting to "get it". Enfrastructure (www.enfrastructure.com ), although they have recently changed their name to TechSpace, are not a franchise..yet. They originally planned 25 incubators locations which would cater to hi-tech startups and originally attempted to offer laundry and other "concierge" services to their elite incubatees. To some of us, who may be more familiar with the real estate development industry, this strategy isn't anything new and is nothing more than a common perk to get tenants in a down market. Originally, Enfrastructure had some great first-stage investors but because they hung out an elitist banner for themselves, it literally choked the baby in the cradle. In my opinion, this is what ultimately made major problems for them - in a down market - because they are now missing the true value in franchising - which of course, is having local, hard working co-owners with large-scale "branding" plan in place and also NOT assuming all the risks of owning and managing all locations.
International Markets
Global Master Franchising is not a new concept although it is often totally misunderstood, it is now an established business reality simply because it makes good economic sense. Over 600 U.S. franchisors are now doing business abroad and there are some important considerations and special components to international franchising. According to the Hayes Group:
"There are five components to successful international marketing: information, preparation, contacts, follow-up and closing the sale.
The world market is rolling out the red carpet for U.S. franchisors. As people in developed countries acquire more disposable income, they require more good and services. Thus the need for franchises. And, many of the people are entrepreneurial and looking for businesses to own. Thus the market for franchises.
Unless you know the international turf, speak the language of the country, are familiar with its customs and have a grasp of its marketing and sales processes, you are taking a big risk to enter that market independently".
American franchisors have a greater success if they first seek out partnerships or regional type arrangements with local business people who have a greater understanding of their particular market. This can be accomplished fairly easy thru the International Franchise Association, trade missions and expos in many different countries. The U.S. Chamber Of Commerce also has similar trade missions and expos throughout the world. And of course, most new franchise leads are coming from the Internet.
Special New Trends & Opportunities
Phase Two of the Internet is just starting and it's going to be real exciting for franchising. New wireless and broadband technology means millions more independent webcasting channels, more global networks, more worldwide trade expos and more Internet marketing than ever before. Special new incubator and BDC consolidation strategies exist within these exciting technology and marketing sectors and master franchising will be at the very heart of it. This also means special new competitive pressures as well as growth and special new investment opportunities for both VCs, angels, BDCs and incubator operators.
Two of the special franchise companies I am consulting for and participating in are called The VenturEXPO and Net-Theaters.com. This master franchising game plan provides for on-the-street locations additional to broadband webcasting, semi-large screen exhibitions and daily incubation services. For more information on these upcoming technology franchises, please feel free to contact me personally.
Richard Pawlowski is a marketing, franchising and expansion consultant, specializing in franchising and business strategies. He is also president of the VenturEXPO Group and may be reached at: royce@venturexpo.com - 310-831-5625
