Josh Brown - What Makes a Franchise Valuable?
In this week’s episode, Ed had the opportunity to interview his long term referral partner, Josh Brown. Josh is, in the world of franchising, a pool of knowledge. If you are a franchisee or franchisor or planning to become one, you will definitely benefit from this conversation about the franchise world. Enjoy!
1:12 – Who is Josh Brown
2:33 – Franchising Versus Non-franchising: Which Is More Stable
5:30 – HealthCare and the So Many Franchisors
8:30 – Good Marketing And Bad Operations
10:00 – Franchising: Lifestyle or Legacy
13:56 – Independent Operation and Number of Units
16:51 – Breach of Contract and Cross Default Provision
18:50 – Where is the Value in Franchising Housed
26:25 – How to Know if a Business is a Good Candidate for Franchise
30:10 – Private Equity Groups
36:26 – Availability of Right Space and Location
42:15 – When to Contact Josh Brown
44:12 – Josh’s Advice that Would Impact Business Value
45:43 – The Employee Challenge is Real
48:04 – Connect with Josh Brown
Learn More From This Podcast
Who is Josh Brown
Josh Brown is a franchise lawyer who has been in practice for almost 14 years with about 10 years in the franchise space. He is based in Indiana but does franchise work all over the country.
About six years ago, Josh started his weekly franchise podcast called Franchise Euphoria. It is a platform where franchisors and franchisees from all over the world can share their stories, their challenges, and the obstacles they’ve overcome, all to provide good and free valuable information for people who are in and around franchising.
The combination of his law practice, managing the podcast, and everything else is what keeps Josh busy.
Franchising vs Non-franchising: Which Is More Stable
Franchising and unemployment have historically been positively correlated. When employment rises, people look to the franchise system as a means of buying a stable job. But, in this robust economy that we have, it seems that there are more and more franchises but not as many buyers going after the new franchise startups, but instead, are favoring more towards resale.
People have, in their minds, this notion that franchising is a more stable industry than just going out and opening up your own shingle. In a certain context, it may be, but statistically speaking, you have a very likelihood of failure in a franchise just as you do in a non-franchise business.
One of the things we are seeing in terms of people who are buying franchises looking towards other franchise systems to buy on a resale as opposed to just buying something anew.
It’s a couple of things.
First and foremost, there are so many offerings out there now. Franchises used to be relegated mostly in restaurants and few other service areas. Now, everywhere in our economy has been franchised. There’s not an area that hasn’t been franchised. And so, it’s hard for people to discern and sift through all these different opportunities and think about what they can do to start fresh.
It’s much easier for somebody to go into a business that’s already up and going, especially if they have a good corporate background in operations or management or a combination thereof.
If you could go and find a franchise business that’s not being run properly and you can identify the one or two things that you need to do to tweak it, you have a much better opportunity for success.
Taking over a business that’s up and going, with a customer list, and already in a location, means you have a lot of variables, that you still have when you buy a franchise, that you can NOT deal with if you’re looking at a resale.
And there’s more and more of them out there over the years. It’s sort of a culmination that there are more opportunities for people who go in and find a good resale that might meet their qualifications and experience.
HealthCare And The So Many Franchisors
We are seeing so many new franchises popping up all the time. Like in healthcare, what’s the difference between these 15 different same service providers. Why are we seeing so many new franchises?
The number to look at is not the franchisors that are starting, but the ones that are around five years later. That’s the tell-tale.
The statistics in franchising will tell you that aside from restaurants, healthcare-related franchises are the fastest-growing.
A lot of folks have a false sense of what it takes to franchise. People who have been in business for a few months and already want to franchise. In their own mind, they think franchising means slapping some systems and selling it to a bunch of people.
But, it’s not that easy at all.
What’s different is that it’s not that it’s easier to franchise, but that it’s easier to LEARN about franchising – because of the Internet. You can go online and learn more about those opportunities now that information is more readily available. This leads to people who have natural entrepreneurial tendencies to think, “Oh! I can do this.”
The challenge is that you have to look at what’s around after five years after launching because there is a significant drop in franchise companies that opened versus those that are still in existence five years later.
Good Marketing And Bad Operations
Just because a franchisor has the uncanny ability to buy clicks and be at the top of the search, that does not necessarily make the opportunity a great one. It just means they are good at marketing, but marketing is only one aspect to address.
If you have franchise and non-franchise and you have great marketing, but you have operations that can’t support your marketing, you have a disaster brewing. That’s what happens in franchising, except, it can be worse than a non-franchise business because in a non-franchise business if you have great marketing and you have a bad operation, then internally you have to make those tweaks.
From a franchise perspective, if you have great marketing and bad operations, it means you have sold a lot of franchises. It means people have invested their hard-earned money in various locations but they are not getting the support or seeing the return of what they invested. If you got people who invested their money but are not happy, you got a real big problem because that is a recipe for a lot of losses.
Franchising: Lifestyle or Legacy
Do business owners in the franchise world do business based on lifestyle, or do they do it based on the legacy? Are they looking at building a true business or are they looking at buying themselves a job?
It’s actually both.
There is a whole lot of people who get into franchising for the lifestyle that they think it’s going to be and for the lifestyle that they are chasing. There’s a lot of people who think, “I want to go buy X franchise and hire workers and I will never be there and I’ll just print money while sitting on a beach somewhere in Hawaii.” It can work out that way but it takes years and years of getting a management team in place, having multiple units open, and just like with any business, it takes a deliberate strategic focus.
There is also a whole bunch of people who get into franchising for the legacy. People who are working in a corporate job their whole career and want to leave something to their kids. People who wanted to do it their whole life but life’s circumstances have come in and prohibited them from doing so, but now they are in a position where they can leave something to their kids.
What’s interesting about it is that most people don’t really know if they get into franchising for lifestyle or legacy right off the bat. You need to probe a little bit.
Independent Operation and Number of Units
Every business, whether it’s a franchise or a non-franchise, the owners have to be present. They may not have to be there 8 hours a day, but they have to be there and they have to be involved.
In terms of the number of units and operation, there are, as a percentage, very few franchise opportunities where owning just one is satisfying. Owning just one will not give you the return you that you could see with owning 2, 3, and so on units. But it depends on the franchise system.
There are so many opportunities, but as a general proposition, in franchising, you need to really pay attention to unit economics before you buy-in. And that will help you determine how much you want to expand with that franchise.
A lot of business owners that we see go into franchising thinking that 1 plus 1 equals three, but gets 1 plus 1 equals a half. They don’t understand that you need to get one working the way it’s supposed to be run and then you add rather than add first then figure out how to make them work together.
In franchising, you have to be careful because a lot of people go in with the idea that they want to be multi-unit operators. They want to either own a bunch or oversee other people owning a bunch. But they have to do it under a schedule that is within a contract. And if everything doesn’t go perfectly, this whole strategy can go up and smoke because it could be a violation of your schedule within your franchise and contract.
Breach of Contract and Cross Default Provision
If you are not able to comply with the terms and conditions of your contract, you are in default of your contact and it then comes down to what the franchisor is going to do. That is why it is important to pay attention to who are the franchisors and to find out what their values are.
Sometimes the franchisor really wants to work with the franchisee and is willing to keep the train going despite the technical violation of the contract.
On the other side of the equation is if the franchisor is not like that and if either one or a variety of reasons they decide they want to put the squeeze on, you can be in a world of hurt because most of these franchise agreements have what’s called a Cross Default Provision.
A cross default provision says, and most of the franchisors have this in their agreement, that “if you are in violation of any of the franchise agreement, you are in violation of all of the franchise agreements and, therefore, we can terminate all of them”. It can be absolutely devastating to a franchisee.
Where is the Value in Franchising Housed
When you are a newbie in the franchise, the value is more heavily focused on the brand, the process, the location, all of these things. Obviously, the brand, the location – these are things that are prevalent throughout the term of the franchise. What becomes highly valuable in the franchise is what the franchisor is providing 2 years into a 10-year deal.
Franchisees always ask themselves this question 2-3 years into a 10-year deal, assuming that all is well: Why am I continuing to pay these royalty, tech fees, and management fees, etc.? As a franchisor, Josh advises his clients to think about the ongoing value.
On an ongoing basis, the system is certainly important to the business but not as important to the franchisee’s mindset because what you find in a lot of these franchises now is that real ongoing value occurs in the POS system, or the software, or the proprietary system that is continuously developed and evolved by the franchisor. And that is something that, to the average franchisee, is tangible enough that they can say, “Oh wow! I really can’t do this without them because they got a whole R&D team that’s focused on the next wave of technology that we are going to need in this franchise.” That is a really important distinguishing characteristic of a good, well-run franchise.
The process and being able to add value to the service or product that you are providing on an ongoing basis seems to be superior to the brand. What’s interesting is, take Subway and the whole Jared Fogle debacle for example, there was a huge hit that the company took because they have become so well-known in the world of everyday American. If you have that, you have a disproportionally negative impact when the brand leader does something that impacts the brand. Ironically, if you are not well-known and something happens like that, you won’t take as big of a hit.
How to Know if a Business is a Good Candidate for Franchise
As a general proposition, if you got a brick-and-mortar type of business that has a retail component to it, you need to have at least a couple of locations up and running. You need to have a model promenade. What’s nice about having at least two locations up and going is that now you have experienced what it’s like to run multiple locations simultaneously.
You need to make sure that you have your systems and processes together. You have to make sure that you have your protected mark – registered your name, logos, etc. You got to have a really good operations manual that not only tells people how to run the business but also tells them about the business and trains them well into the business. At the end of the day, you have to have a good strategy for how you want to grow.
Franchising your business is a long-term strategy. You are utilizing other people’s money to grow your business. And if you are going to do that, you should think long and hard about what those people look like, who they are, where they are located, where you should not go, where is your market limited, or is it limited at all. These are all things that have nothing to do with the legal structuring of your business but have everything to do with the opportunity for success after you franchise.
Private Equity Groups
Historically, Private Equity Groups buy a good business (not necessarily a floundering one) and add gas to it, fix its processes, and take off from there. There’s a lot of private equity groups that are targeting groups of franchisees or the franchisors themselves.
Private Equity is looking for one thing only, and that is RETURN. What they see in franchises is an opportunity of a return on a larger scale level. An opportunity to, say, buy into a system that already has 250 locations, tweak some things and take it from 250 to 600 while increasing the economy of each one by X% and, therefore, generate a return of Y.
We see private equity firms that have had success with one transaction like that, and now they think that every transaction is like that. That could be a mistake. Just because you’ve done it on one franchise doesn’t mean you can do it with every franchise system. There is culture or soul to a franchise. And if you go in, as often happens to a PE firm, and change everything, sometimes you kill the “golden goose”. Sometimes you kill the thing that makes it special or you take something that once was special and destroys it.
Steak ‘n Shake is a brand that’s been around for a long long time. And to say that it is going through some changes right now would be an understatement. There is an argument that the individual or group that took over Steak ‘n Shake didn’t have a good sense of its culture and its soul.
Availability of Right Space and Location
According to FRANdata, there are almost 16,000 unopened franchise locations due to a lack of suitable space. It has become much harder to find the right kind of availability. You can find land but you can’t find the right zoning. In a good economy, like we are in right now, the demand is there. And the challenge for some of the franchisors is that most of the franchise agreements give a period of time to go and secure the real estate that you need for your franchise.
So if you are a franchisee, you need to have a good idea of where you want your business to be before you pay the franchise fee. And on the risk version standpoint, if you see that there are a hundred locations signed but not opened, you have to start wondering why.
The Franchise Disclosure Document (FDD) that are regulated under Federal Law and many different state laws has tables that will show you how many are opened, how many have been signed but are not opened, how many are corporate locations, and how many are franchise locations. There’s a lot that you can take from those numbers. And those are great questions to then go back during a discovery day with the franchisor. You want to know how long it took from the time they signed to the time they opened. And how long in the process are these folks, who have not opened, been looking for a location. Those can tell you how efficient the franchisor’s operations and assistance team. It can tell you how much assistance they can give you to find properties.
When to Contact Josh Brown
On the franchisee side, if you get to a point where you’re down to one or two franchises that you’re interested in, that’s a good time to call Josh. Certainly, before you go to a discovery day, if possible, but definitely before you sign anything.
On the franchisor side, if you are contemplating going the franchise route, that is a great time to call Josh. Josh works with people and educates them about franchising, licensing, things that they can do and not do during that process, referrals, and walks them through a whole lot of aspects. If you are a franchisor, it’s better to contact Josh sooner rather than later.
Josh’s Advice that Would Impact Business Value
You have to have great people that are fully invested and will keep things going. You got to be in business and in a market that has the potential for the age that we’re living in. Business owners can see what they’re doing today, but if they can see where this thing is going ten years from now, that would really increase their business value. Place a higher value on businesses that you think will go prime in the next 10-15 years, or prime for an opportunity to be purchased within the next 10-15.
The Employee Challenge is Real
We are in such a tight market right now that finding good employees and retaining them is a real challenge. But you can’t just let that be an excuse. You have to come up with better and more creative ways to satisfy your employees. If you offer better opportunities in the same space people are going to come to you.
People leaving is not just about money. It’s about the environment, the benefits, the lifestyle. For most millennials, having the flexibility for their lifestyle can make a difference.
Connect with Josh Brown
The best way to connect with Josh is by emailing him at josh@IndyFranchiseLaw.com.
You can also search iTunes for his podcast Franchise Euphoria.
And more information about Josh can be found on his LinkedIn profile