Buying a Franchise in a New Franchise System
By Andrew Seid, Consultant, MSA Worldwide
When most people think of a “franchise,” they tend to think about McDonald’s, Subway, Marriott, and other brands that have a long, established history. This history and already-established “brand equity” is a major part of what makes becoming a franchise such a good investment.
However, brands need to start somewhere, and just because a brand doesn’t have a long, established history doesn’t mean it can’t or won’t develop into a strong and successful brand.
Many of today’s most successful franchise systems are less than twenty years old. Five Guys, which today has more than 1,400 locations, began offering franchises in 2003; Firehouse Subs, begun by fireman brothers Chris and Robin Sorensen, started franchising in 2005 and today has over 1,000 locations. Certainly, there are also many emerging franchisors that have not grown well or have even failed because either the concept did not resonate with the public, or the franchise system was not properly developed or supported.
With the right concept, franchise growth can be quick – particularly when the concept is satisfying a new or developing consumer market. A lack of history does not always mean a long climb to regional or national brand relevance, but getting into a successful franchise system on the “ground floor” can be an extremely exciting and valuable experience. But understand, before joining a new franchise system, that there may be certain risks associated with emerging brands.
How ‘New’ is ‘New’?
A good rule of thumb is that a franchise system would be considered 'new' if it has been in existence for less than two years and has not opened several locations in more than one market. There are no legal restrictions on how many franchise locations an emerging franchisor should have before they begin to franchise, or how many new franchises they should have open within those first two years.
For the most part, many emerging franchisors generally will award anywhere from one or two to as many as fifteen or twenty franchises in their first few years.
Conservative franchisors may choose to grow slowly as they learn the craft of being a franchisor and begin to build up an internal infrastructure that can support their franchisees and has the skills and personnel to handle increased growth. Becoming a franchisor is a new business for most emerging franchisors – and just as they needed to learn how to manage and grow their original concept, they need to learn how to manage a franchise system.
Some emerging franchisors may have already established a number of company-owned locations, already have the necessary infrastructure in place, are able to support their franchisees, and can grow at a faster pace earlier on. The capabilities and goals of a franchisor will play a big part in the different advantages and disadvantages there are in investing in a new franchise system. However, with emerging franchisors that have caught the eye of the public, the opportunity to grow faster and farther from their home base than they can support is always a troublesome risk for themselves and for their future franchisees.
In addition to not growing faster than the system can support, intelligent geographic growth – so that they can provide support and ensure brand consistency economically – is essential.
Advantages of Investing in an Emerging Franchisor
There are advantages to becoming an early franchisee of an emerging franchisor. Just like any new franchise that is investing their life’s savings into a business, a new franchisor is likely doing the same. Because of that, they will be motivated to prepare their franchise organization in a way that can make them and their franchisees successful.
When MSA Worldwide is working with an emerging franchisor client, even before the decision is made on how the franchise system should be structured, a Threshold Analysis (also called a feasibility analysis) is undertaken to ensure that the management and underlying concept has the ability to grow and manage the franchise system successfully. The Threshold Analysis examines whether the consumer concept will be successful. Essential, however, is how well the brand will be positioned against the established competition for franchises, and whether the likely economics of the franchise relationship, for both the franchisor and each class of franchise, will have the ability achieve the financial success required. Only after that preliminary evaluation is made can the hard work begin of structuring the design and development of an emerging franchise brand.
While a franchise system may be new and likely does not have the level of resources available in a more mature franchise system, it is paramount for any new franchise system that their earliest franchisees are as successful as possible. Any new franchisor will be able to attract new franchises based purely on how exciting the concept may appear. Based on our experience, recruitment of a franchisor’s initial franchisees is relatively simple when the offering is structured properly and the marketing material and recruitment process are designed well.
Once early-adopter franchisees have been recruited and begin to open their businesses, building a successful franchise system rests on the ability of those early franchisees to validate the franchise system for later potential franchisees. Smart franchisors will always ensure that all of their franchisees receive the time, effort, and resources necessary for them to succeed. This is especially true for emerging franchisors, whose ability to attract and recruit new franchisees will rest on the validation of those initially attracted by the promise of the concept and not by the history of the brand’s performance.
Level of Support from the Franchisor
Franchise systems are governed by the Franchise Agreement, which may lead new franchisors to believe that each franchisee should or must be treated equally. But great franchise systems recognize that not every franchise needs or should get the same level of support from their franchisor. Well-run franchisors generally will exceed the level of support for franchisees provided for in the franchise agreements, and within reason provide what is required.
This is especially true for well-managed emerging franchisors where the support provided to franchisees often comes directly from the founders since the system has not yet achieved the resources necessary to engage a large cadre of specialized staff. So long as there are adequate support and resources in a franchise system, obtaining support directly from the system’s founders is frequently cited as one of the major advantages early franchisees have in any franchise system. Franchisors need to provide to franchisees the support required to get them off to a successful start, and then to continue to provide the counseling necessary throughout the term of the relationship. However, it is still up to the franchisee to manage their business; even with the best support provided by any franchisor, success is in the hands of the operator and not the franchisor.
Availability of Markets
There are other advantages a new franchise system may offer.
Because the franchisor has not yet grown, likely most of the markets a new franchisee will be looking at will likely be available to them. There may be greater opportunity to select specific territories that are more desirable, and a multi-unit developer may have the opportunity to acquire entire regions or larger geographic areas than future franchisees. As franchisors move into new territories, they will often look to their earliest franchisees to develop those new territories, and provide them with more time to develop larger areas than future franchisees may be allotted.
Negotiability of the Franchise Agreement
Likely the biggest advantage for prospective franchisees looking at emerging franchisors is the possibility of negotiating certain terms in the Franchise Agreements. As they begin to offer franchises, emerging franchisors may be less averse to negotiating some of the terms of their Franchise Agreement – simply because many potential franchisees will see their offering as somewhat more risky than more established franchise brands.
Whether single or multi-unit, franchisees today are often more sophisticated than they once were. There is an abundance of information available to all potential franchisees and today, some of the best candidates for emerging franchisors already own locations in other franchise systems. This frequently means that new franchise systems looking to award franchises to the best possible franchisees may be more willing to negotiate terms of the Franchise Agreement than more mature franchisors.
While the hallmark of franchising is “standardization,” it is not unusual for a new franchisor to discuss changes to a Franchise Agreement, especially when those changes do not impact other franchisees. Some of the areas where negotiations frequently take place are in the initial franchise fee, royalty, territorial rights, training, terms of the development agreement, personal guarantees, etc. Don't expect every new franchisor to be willing to negotiate major terms of their franchise offering with you, but don't be trapped into thinking that they won’t. In advising our emerging franchisors, we counsel them to significantly limit changes made for any franchisee. However, negotiations will be dependent on what the franchisee is bringing to the table in experience, resources, and growth opportunities. In modern franchising each candidate is considered individually; but care still needs to be taken in what negotiated changes will be made, as some of those changes will need to be disclosed in future franchise offering documents and therefore often become the floor for discussions with future franchisees.
There is a level of camaraderie evident in most new franchise systems between the franchisor and the early franchisees. While a franchise system is not a “partnership,” there certainly is a shared trust and experience among new franchisors and their earliest franchisees, because of the additional risk and the history they both share as the brand becomes further developed. That feeling of growing together can lead to very fruitful and long-lasting business and personal relationships. Often times a franchisor’s first ‘Company Convention’ will be with the first few franchisees meeting over lunch in the franchisor’s first corporate location, or even at the franchisor’s home over the dining room table. The idea of getting in on the “ground floor” can be very exciting and rewarding. But, new does not always mean better – it's essential that you understand the benefits as well as the risks.
Disadvantages of Joining a New Franchise System
I like emerging brands because they are exciting and often can bring to market the ability to be more nimble than larger, more mature brands. However, there are several risks to consider before investing in any new franchise system.
The first risk to consider is that the brand you are investing in has little existing brand equity or cultural awareness for you to use as leverage for your own success. You will be contributing to building the brand equity of the franchise system through the success of your own business. When joining an established franchisor, the number one benefit most franchisees cite is the franchisor’s established history of success, both in terms of public awareness and in the financial performance of their existing locations. Much of that success will be based on the operating procedures, methods and resources they can apply to their franchise systems. It requires a leap of faith to believe that a new franchisor will be able to establish these elements. This means that it is even more important for you, as you review any emerging brand, to properly evaluate not just the offering and the consumer’s potential long-term desire for the system’s products and services, but also to understand whether the management of the franchise system has a history of success and whether the franchisor has the resources to support the system during its growth phase. Don't assume that because of a franchisor has received approval by one of the states that requires registration of the offering, that this is any indication that the franchisor is experienced, adequately capitalized, or has any of the necessary attributes for success. That is not the purpose of any regulatory review.
Secondly, because the emerging franchisor may lack an established business record, it may be harder for potential franchisees to obtain the proper funding. Lenders to the franchise marketplace typically base their lending decisions partly on the record of how well the existing franchisees in any franchise system have performed. Even though there are many sources of lending available to new franchisees, without a record of success it can often be difficult for some franchisees (particularly those with no prior business record of their own) to obtain the necessary funding they will require directly from lenders.
Thirdly, because the brand may not be well known in your area, it may take a new franchisee longer to become established in their market. This is not uncommon; you should recognize that it could mean a longer period of time before you achieve the revenue levels achieved in other areas where the brand is better known. New franchisees in new markets with emerging franchisors often need to take a longer and more patient course to their financial success.
Do Your Research!
It is certainly more difficult to properly assess the viability of a new franchise system, chiefly because it is ‘new’. Even if there are existing franchisees in the system to look to for validation, they likely have not been in business a long time and, as with any new business owner, still have excitement about the potential for their own businesses, even if not yet successful themselves. These may be hurdles, but they are not unconquerable.
Look at the personal history of the franchisor’s management and whether they have a history of success or failure in other business ventures. Section 2 of the Franchise Disclosure Document (FDD) will list the executives of the franchise system and describe their business experience; sections 3 and 4 will provide you information on litigation and bankruptcy. Research on the web the franchise management’s prior business history, and make sure to interview the franchisor on their qualifications and history just as much as they are evaluating yours.
MSA’s website provides a free publication called Making the Franchise Decision, at http://www.msaworldwide.com/franchising-resources/making-the-franchise-decision/. This workbook is an essential tool to help you evaluate any franchise system. You should also seek the support of an experienced franchisee lawyer to help you evaluate and eventually assist you in negotiating possible changes to the franchise offering.
Investing in a new franchise system can be a major risk – but it can also be extremely rewarding. Do your due diligence and get into a franchise system you can trust and believe in.
"I wish I had been the first franchisee of McDonald’s or Five Guys or any number of successful franchise systems!" We have all heard, at some time, someone say that phrase. However, there are many new franchise systems starting up every day that people will say the same thing about in the future. Emerging brands have risks, certainly, but if you carefully make your selection, they are some of the best investments available in franchising, at any time.