Momentum Podcast: 215

Should You Buy A Franchise?

by Alex Charfen

Introduction

I'm going to share my answer to this question because it comes up all the time. In fact, today I got a text message from a friend of mine from … a guy that I know from high school who said, “What's your opinion on franchises?” I get this question from people who are experienced entrepreneurs and from people who are just starting out. I want to share my opinion on franchises, but I think, in order for you to understand where my opinion comes from, let me share my experience because Cadey and I have invested millions of dollars in our lives, tens of millions of dollars, and we've made really crazy returns on almost everything.

Episode Description

Should you Buy a Franchise? This is one of those questions that I get from entrepreneurs at every level. What exactly are you buying? Cadey and I have had experiences here and we’ve seen the outcomes.

Full Audio Transcript

I'm Alex Charfen, and this is the Momentum Podcast, made for empire builders, game changers, trailblazers, shot takers, record breakers, world makers, and creators of all kinds, those among us who can't turn it off and don't know why anyone would want to. We challenge complacency, destroy apathy, and we are obsessed with creating momentum so we can roll over bureaucracy and make our greatest contribution. Sure, we pay attention to their rules, but only so that we can bend them, break them, then rewrite them around our own will.

We don't accept our destiny. We define it. We don't understand defeat because you only lose if you stop, and we don't know how. While the rest of the world strives for average and clings desperately to the status quo, we are the minority, the few who are willing to hallucinate there could be a better future and, instead of just daydreaming of what could be, we endure the vulnerability and exposure it takes to make it real. We are the evolutionary hunters, clearly the most important people in the world because entrepreneurs are the only source of consistent positive human evolution, and we always will be.

Should you buy a franchise? I'm going to share my answer to this question because it comes up all the time. In fact, today I got a text message from a friend of mine from ... a guy that I know from high school who said, "What's your opinion on franchises?" I get this question from people who are experienced entrepreneurs and from people who are just starting out. I want to share my opinion on franchises, but I think, in order for you to understand where my opinion comes from, let me share my experience because Cadey and I have invested millions of dollars in our lives, tens of millions of dollars, and we've made really crazy returns on almost everything.

There was a point where we were bankrupt but, after that, we've done exceptionally well, and we've averaged ... I mean we've beaten any market out there on all of our investments except for the two that involved franchises, and one was pretty extraordinary. In fact, it got the highest offer by anyone in the history of Shark Tank. It was a franchise chain called How Do You Roll? here in Austin, and a friend of mine owned it. Cadey and I decided to invest in the corporate office of the franchise. It was a pretty big investment for us. We bought a percentage of the company, and it was the corporate franchise location or, sorry, the corporate franchisor, so it was ... they were in the business of selling franchises.

I made a critical miss when we made this investment, critical. We went to one location, and it went really well. We had a really good experience. I also really liked the owner, and I liked him, but I didn't go to more than one location. There was three in Austin, and that was a mistake because what I realized, after we were already invested, was that they hadn't really perfected the business model. They'd gotten close, and each new iteration was a little bit better, but they hadn't really found a model that worked. In a franchise, you are buying the concept, the model, the whole thing. That's what you're paying for, and so what happened was, Cadey and I, we ended up losing everything in that investment because they actually ... Here's what happened. They hadn't perfected the model.

Every couple of stores, they were making tweaks and changes, and adding things, and then trying to go back and retrofit things in, and then things ... It was as dramatic as they didn't really have warm food, and then they started wanting to heat food, so they had to retrofit food heaters into all of the stores because, at the beginning, it was just sushi rolls. It was a sushi roll you could walk up and order like Subway.

When they went on Shark Tank, they got a huge deal. It was over $1 million of an offer. That's where I learned the reality behind offers on Shark Tank is that the people on Shark Tank can pretty much make any offer they want, and there wasn't any real required follow through. I can't remember which person made the offer, but they didn't ... I mean I was an investor. We were getting the play-by-play. There wasn't a lot of follow-up on the biggest offer ever made on Shark Tank to date. I mean there's been bigger ones now, but nothing really ever came out of it.

What happened was a lot of people came in and wanted to be franchisees, but the problem with the ... and mean it was incredible exposure for the brand. The hardest thing for a franchise to do is to sell people on buying the franchise, and so it got huge exposure. Hundreds of people were interested, but it was ... There wasn't a lot of performing stores. There wasn't a lot of success in the chain because it wasn't perfected, and so that experience, first, it taught me that having a franchise or creating a franchise is incredibly hard because you have to solve everything, not just some things, but everything. You have to solve what is the location? For most franchise deals, you're buying ... maybe it's not location, but you're buying the concept, the business model, like I said, the rules, the process, a supply chain. It's really hard to solve everything in the way that is optimal for someone running the business, and so one of the biggest challenges is exactly that.

If you want to go out and find a franchise that looks new and unique and it might offer higher returns, oftentimes, you're gambling on a concept that hasn't really been completely flushed out, and so if you're thinking about buying into a franchise, I'll add in a little bit of advice of here is that you have to go look for one that has really ... If you're buying into an early-stage franchise where you're under the first 100 locations or people, you have to make sure that a lot of the people who are before you have been very successful because, if a franchise is figuring out its model as it goes along, you're going to have a really hard time succeeding in that system.

That was a tough lesson for us, and it was one that felt so obvious afterwards. I was kicking myself. I had worked with some of the largest franchise organizations in the world. I knew how obsessive they were about down to the square inch of their models, down to where things went and how you said things, and the scripts, and the dialogues. That was a level of obsession that I had seen, and I didn't verify it was there before we made the investment. It showed me how difficult it is to be successful being a franchisor because you have to be able to remote control 100% of the processes in the business with an inexperienced operator. That is not easy, so I'm not a big fan of franchises, and I'm not a big fan of becoming a franchise owner, because I've worked with a lot of the franchise owners, and it is a nightmare.

In fact, the second franchise investment that Cadey and I made was with some people I know in Orlando where we bought into a location of a franchise with a company that was experienced restaurant operators, had done it for years, had tens of millions of dollars in restaurant investments, so we were buying in with a company who ... I mean they, at one point, owned so much of the real estate on I Drive in Orlando it was crazy. We invested with them, so we were trusting their expertise, and they ended up investing in a franchise where the corporate office went bankrupt, and we were on the other side of the coin, so we owned a corporate office that went bankrupt, and then we owned a franchise where the corporate office went bankrupt where it was just one check after another to keep investing in keeping the location alive while it went through lawsuits a branding change. We stopped writing checks because it was one of the worst investments we ever made, and that was a complete loss for us as well.

The experience I have in franchises doesn't make me excited about the franchise model, and so when somebody says, "Should I buy a franchise?" here's the inherent issue in the franchise model is that the most successful franchises out there, the ones that have the highest level of success, charge a rate for both the startup fee and the royalty that is just a decent rate of return. They make it so that you don't end up making a lot of money.

In fact, the franchises most ... and I'm not saying all, but most of the franchises that are out there, especially the ones that are really stable, if you buy a single location, what ends up happening is you become a really well-paid general manager who invested to start up a store that is paying franchise fees and royalty fees back to the corporate office, and there's a reason ... This isn't me bad-mouthing franchises, but the fact is there's a reason why, in every major franchise organization, there is a group of franchisees in almost every ... I can't say every. I don't want to use infinitives, but in almost every there is an anti-franchise home office group in the franchisees because it's so hard to succeed at doing everything in the right way.

Then what happens is, if you do succeed at doing everything in the right way, you have to spend so much money doing it that you end up charging more royalties where you end up charging more up front, and what ends up ... people, really, they end up ... If you're a really successful Subway owner, you're probably making about $100,000 a year, but if you're running the franchise, you're working like a full-time restaurant owner. If you're not, you're paying somebody to do all of the general managership, and it's not going to be done as well as you are doing it, and so you have a single location where you're going to make something, maybe 50, maybe 60, maybe 70,000. I'm sure Subways make more, make less, but I've known a lot of Subway owners, and that's what they've told me they've made.

When you look at most of the really successful franchises, the structures are such that you're investing a lot to make a return on your investment because they're that good of a bet, and so if you're investing ina smaller one, you have to be really careful, and so here are some things that you should think about if you are thinking about it. By the way, I don't know. I can't tell anyone I know, "Don't go start a business," but be really careful if you're going to get into a franchise, if you're going to give someone money for their business model.

Here's what you need to think about. Go look. Look for it. Do they have a proven track record with the early investors and franchises? Talk to a few of them. Find out if they're making money. Find out if they're happy with the corporate office. Find out if they would do it again. You want to know. Then, next, look at the business model for the franchise. Is it simple? Is it easy to understand? Is it easy for the customer to understand? You should know that before you get into whatever franchise model it is. That's universal. It doesn't matter what type of franchise model it is. When you're looking at franchises, look at how much recurring business is there? How many times are people buying? Can you create a following with it? Because where you can win is if you have a really exceptional location of one of the successful franchise places or one of the successful franchise chains.

If you run a locations that is exceptional where people treat people really, really well, where you train your team well, where you create a culture around really taking care of the client, if you create exceptional outcomes in a franchise location, you can win, but you have to know you might also be limited by the size of the model and the way that the franchise works, and so make certain, if you're going to invest in a franchise, that you're investing in a model that's proven to work over and over again, because what's going to happen is you're going to pay that franchise system for everything they've figured out so far.

Let's be really clear on what you're buying. You are paying them for everything they've figured out so far. The reason I mention Subway, not that I would ever eat at a Subway, but the reason I mention Subway is that they are a really successful franchise system, but they also are one of those systems where the owners feel somewhat capped or not ... I can't speak on the behalf of the owners. The owners I've spoken to feel somewhat capped by the amount of revenue that they can make in a location.

If you look at any successful franchise organization, here's one of the biggest challenges they face. They're trying to solve a bunch of problems in a whole bunch of different areas, like geographic areas, in different types of real estate, in different types of places, where, a lot of times, it's hard to do that, and so you want to make sure that you feel like whatever they're doing has a really high chance of success where you are or where you're going to put your franchise because, often, there's concepts that work really well in one place and fall completely flat in another and, until there's a track record, it's hard for you to know.

If you're thinking about doing something in the franchise world, ask yourself the hard questions. Have the tough conversations. Look at the numbers and make sure that you're making not something that ... not a decision that feels good, but a decision that makes financial sense to you, because here's what you're going to do. You're going to invest your money and a huge amount of your time in almost all cases. There are some franchises where you can hire a general manager and send them and have ... You don't really invest your time, but that is few and far between. A lot of franchise models allow for managers and allow for people to help you, but the challenge is, at the beginning, you're going to be doing a lot of it, and a lot of locations start quickly, some start slowly, some have a really hard time getting off the ground.

When you look at the average franchise organization, there's a lot of them that are opening locations, and they're losing locations, so one of the things you want to make sure you understand from any franchise organization you're talking to is how many of their locations are profitable? What is the highest revenue? What's the average revenue? If they're not willing to tell you how much each location that they have is making, or what the average revenue is, or how many of them are profitable, you need to be suspect of their numbers, so be cautious.

Like I said, it's hard for me to say to someone, "You shouldn't try and run this business," but you have to understand that if you buy a franchise, you're buying all of it and, in most cases, legally, you can't give up any of it. Something as simple as putting a television in a Subway restaurant ... You can't put a television in a Subway. They're not allowed, or maybe they are now, but it's either one or the other. When you look at most franchise tenants and covenants and the way that you have to run the location or the way that you have to run your business, in most cases, entrepreneurs have a really hard time with that level of constraint.

It's interesting. McDonald's recruits farmers, or used to recruit farmers to buy locations because farmers were willing to follow the process down to the letter because that's how you run a farm. Most entrepreneurs would rather build the process or create the innovation than just run someone else's process to get a paycheck. Even in a successful franchise organization, what ends up happening is you start feeling like you're ... If you have one location, you're like a very well-paid general manager. If you have multiple locations, you're like a very well-paid regional manager until you can hire one. Then, until you have multiple regions, you're like a well-paid, I guess, vice president. It ends up that you're always just kind of working yourself up in an operational role.

If that sounds like something that's exciting to you. If working the same process in a location over and over again and really just getting it down to perfect using someone else's system, then a franchise is for you, but if that sounds like nails on a chalkboard because, as I said it, my shoulders were getting tight. Oh, sorry. Man, if you're like me, you had a physical reaction to even thinking about that. There's no way I could ever run a business where I just did everything that someone else told me to do. Literally, I think it would drive me nuts, but I also don't judge the operator who likes to get the same process over and over again day after day and make it better because, believe me, I've had a lot of businesses where I need that operator, and they are worth their weight in gold, especially when they're good at it.

If that's who you are, and you're looking to invest in a franchise, look for the things that I talked about. Make sure that you have a high number of performing locations. If that's the type of personality you have, if you're that type of operator, you'll absolutely love franchising or buying a franchise and then, probably, buying multiple locations and moving up in the organization, but if following someone else's process every day until you get it perfect sounds confining to you, then I would recommend you don't buy a franchise. If, instead, you want to start your own business and follow your plan, help the population you've been thinking of, go after your own avatar and make something happen, you should understand what's been holding you back and why you haven't been doing it already.

My book, The Entrepreneurial Personality Type, is an explanation of why people like us hold ourselves back and don't take the opportunity that's right in front of us. It will also show you how to create momentum in your life, stop limiting behaviors, and understand yourself better than you ever have before. You can go to freemomentumbook.com and download your copy of The Entrepreneurial Personality Type optimized for mobile so you can be reading it right now. Takes about 45 minutes to an hour to read. It's concise, but most entrepreneurs say it tells them more about themselves than anything ever has. Do you have 45 minutes right now? Freemomentumbook.com.

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