In this ongoing series, we share advice, suggestions, and insights from real entrepreneurs who fight the battles of business every day. (Answers have been edited and condensed for clarity.)
Please give us a transient description of your organization’s activities.
My name is Alicia Miller. I’m the founder and CEO of Emerging Development Advisors and the creator Franchising Big Money: Scaling Your Business in the Age of Private EquityWe help franchise entrepreneurs maximize the value of their business, build with their goals in mind, and find the right capital partners. We also advise private equity firms, family offices, and independent sponsors investing in the franchise sector.
What inspired you to begin this company?
Franchising today is not a level playing field! Anyone who is investing their money in a franchise business or launching a latest franchise concept now needs to grasp this.
My “aha” moment was talking to the founding father of a franchise—a really smart guy with a good business. But he was completely confused and misinformed about the private equity landscape. He also didn’t understand why he was getting low offers when he tried to bring in PE to speed up his business. I spotted that PE was very misunderstood, and that put franchise entrepreneurs at a huge drawback. No one was talking about it. There were no tools to assist entrepreneurs understand the dynamics of PE that were so fundamentally changing franchising. I knew I could provide clarity and actionable insights.
What problem does your organization and your book solve?
The PE sector has wrapped itself in mystique and financial jargon, making it seem inaccessible and unknowable. Not true! PE has a clear plan of motion. Their investment actions are predictable, especially in the case of franchising.
Everyone has a unique superpower. Mine is transforming complexity into a clear game plan for success. I have spent my entire profession in go-to-market strategy. I spotted I could educate and empower founders, franchisees, and even investors in latest ways.
I made a decision to “reverse engineer” the most precious franchises to find how they got there—from the initial founding, growth, and missteps along the technique to the first private equity deal and subsequent deals. Then I documented what PE wants and is willing to pay the most for.
I analyzed tons of of PE deals, from the first entry of personal equity into franchising in the Nineteen Nineties to the present. I looked at the deals and histories of over 700 brands with a PE history and over 400 PE firms that have invested in the franchise thus far to search out common ground. I interviewed M&A experts and skilled investors. I spoke with founders and franchisees who had been through one or more equity sale events, in addition to lawyers, accountants, and bankers who advised on the deals.
All of this information is so vital now that PE dominates franchising. But no one has put all of it together to inform a coherent story. No one has created a toolkit to assist founders and franchisees achieve higher outcomes for themselves. As a PE advisor, a franchise investor myself, and a growth consultant, I used to be in a unique position to distill this complexity into a playbook and methodology to assist my clients.
What should entrepreneurs consider when considering expansion through franchising?
Franchising is much more competitive today! Especially the hunt for talented franchisees to build your system. You need to begin with superb capital. It takes an investment of $2.5-3 million to grow your system to the point where the royalties you collect from franchisees cover all the bills. Too many young brands start with undercapitalized capital. Then they sell a ton of licenses – often before they have really proven the concept – and find they can not keep the franchisees. Literally 1000’s – read that again 1000’s – concepts land here!
Franchising is a great model for expansion. But be smart about your entry plan. First, build at least a few corporate locations as proof of concept and to create money flow. Make sure every thing in your operating model is repeatable and teachable. Each unit should generate attractive profits. Then make sure you have enough capital to get your franchise operation off the ground. Be extra careful when taking on your first franchisees. Really think about what style of operator is prone to succeed in your model. Only take on franchisees who fit that profile. When all the initial signs look good, then and only then step on the gas and pursue more aggressive expansion.
Keep in mind that outsourced sales organizations and brokers currently generate about 40 percent of all latest license sales in the U.S. If you sell through these channels, the commission will eat into your franchise fees. If you don’t sell through these channels, your brands need to actually stand out to draw organic traffic.
What Mistakes Do Private Equity Investors Make in the Franchise Sector?
I expected that excessive debt can be a huge problem when PE invests in franchise businesses. It seems that it is not. In fact, at one end of the spectrum, acquisitions of emerging brands are often money transactions. Debt is not a factor until much larger scale is achieved. In the larger systems, many of them now use securitization of the entire business, debt secured by franchise royalties, and the levels are relatively modest. PE has learned to avoid excessive debt in franchise businesses for the most part. Studies show that there have been few bankruptcies at the franchisor level.
These are smart people. PE has a clear investment mandate and attractive financial incentives to do it right. And franchising is a easy business model. If franchisees are blissful and profitable, the system continues to grow and latest franchisees want to speculate. Simple! Most examples of PE failing in franchising are because the sponsor loses sight of this basic formula for success. They don’t nurture the relationship with the franchisees, they don’t focus on profitability at the unit level, they back the improper management team, they take too much for themselves and don’t reinvest enough in the business, etc. There has to be a balance in the franchisor-franchisee relationship.
Fortunately, we now have a variety of PE firms operating in this sector with extensive franchise experience. They understand the formula for success and execute it well.
I worry more about the latest PE sponsors that are coming into the market today. I hope they do enough research to learn from the mistakes of others. But every now and then I see sponsors and their management teams do things that destroy franchisee confidence and enthusiasm for growth. That’s when the brand stalls. Once it stalls, it normally takes a Herculean effort and additional investment to show things around and get franchisees to consider again.
What should potential franchisees think about?
Now that the landscape has modified, you have to put private equity on your radar. Is your brand currently owned by PE? Do your research and discover if they were a good sponsor. What happened to other franchises they owned? Talk to a lot of franchisees. Do they like the sponsor? Has the profitability of the unit improved? Is management invested in the business?
If it’s a good business, it’s going to attract buyout offers. That management team you fell in love with may leave for PE owners during the license period. What do you think about that? Make sure the concept itself is solid, because decision makers can change.
If it doesn’t attract PE offers, that’s also a data point to think about. Why doesn’t PE find the business attractive? You’ll have to ask franchisees and the industry network for answers. But it’s value it to avoid investing in a dud. Several corporations have grown quite large without PE. Most of them were launched long before PE became a factor. But it’s very rare today to attain significant scale without help. Of the top 500 brands by system revenue, most have a history of PE investment at the brand or entity level, or each.
PE is now also a buyer of units in large systems. Is PE a viable buyer when you are able to retire? If there is no PE activity in the system, which means the only buyer might be current or incoming franchisees, which can affect exit prices. Something to think about.
Independent franchisee associations are also paying attention to all this PE activity! They are organizing earlier and becoming much more proactive to make sure that franchisee voices and perspectives are considered in the context of systemic and ownership changes. This is a work in progress. I expect to see much more activity here and I get a lot more consultation requests coming in from franchisee associations.
Where can readers learn more?
Information is power! I help entrepreneurs select their path rigorously, at all times keeping in mind the changing competitive landscape, and build with the end goals in mind. This is the focus of my consulting practice at Emerging Development Advisorsand also my book, Franchising Big Money: Scaling Your Business in the Age of Private Equity. Please contact me – I’d be blissful to assist or recommend.