Jay Sachetti joined Jeff O’Brien, partner at Husch Blackwell and Dyanne Ross-Hanson, president of Exit Planning Strategies talked about the market for mergers and acquisitions, exit planning opportunities for companies that don’t end up for sale and how companies can maximize their eventual sale price during an early October panel at the first Upsize on Tap event at Summit Brewing Co. in St. Paul.
When the state Legislature passed a law requiring employers to provide paid leave and safe time for employees, Justin Bieganek started hearing differing details from friends, colleagues and peers.
“You have to continually upgrade your brand, or time will pass you by, says Charles Modell, an attorney who works with many franchisors at Larkin Hoffman Daly & Lindgren in Bloomington. He talked with Upsize about how to build a successful system.
Q. I read again the article you wrote for Upsize, and I was struck by the ending: If franchisors only provide what’s in the letter of their agreement, they’ll give their attorney plenty of work but they won’t be successful. Can you expand on that? What do you mean?
A. I mean two different things. There’s pre-opening and after opening. As a lawyer, we ought to be able to say what’s going to happen the next few months and the next year as to what you’ll do for a franchisee when they open the business. But if I’m writing a 10-year, 20-year agreement, the world will change. So most lawyers do not lay out everything a franchisor will do for the franchisee during the whole agreement.
If all you do is the minimum that the lawyer put in your document, this is probably not going to be very successful. The franchisees are looking for you to continually upgrade your model. Think of McDonald’s. When I was a kid, it was simple. Today it’s much different. But certainly there was not anything in the agreement that committed the franchisor to make all those changes.
The other piece of it is, even though you’re complying with your obligations, the long-term success of your brand depends on your franchisees being successful. If they feel you’re not contributing to their success, ultimately they’re going to test the contract. And if they test the contract in court, you may win in court but when you get your legal bill, you may not consider that a win. You don’t want to be continually litigating.
Q. Do you see franchisors taking that only the letter of the law∫ approach often? Or do most go above and beyond the contract?
A. I see both. Yes there are systems that people start franchising that never should have been franchising. When we meet with people who are talking about franchising, we convince half of them not to do it. We often get people coming to us who are understaffed and undercapitalized, and they think, I`ll just get others to open units. If you don’t have the staff, and the capital to support the system, you’re going to fail.
People look at it as, well they’re going to pay me money up front so I’ll make money up front. Then they’ll use their money to open, and how hard can it be to babysit? Actually, it takes a lot more than that to be a successful franchisor. Ironically, it’s often people who were franchisees in the system, who want to become franchisors, and they say it’s so easy to be a franchisor but they haven’t seen what goes into it.
Q. I wanted to ask you about best practices by really top-notch franchisors that you work with. What is the No. 1 thing it takes to create a thriving system?
A. The best example is a local company called Anytime Fitness. They started about 8 years ago with a concept of 24/7 fitness, and their concept was very simple. They were three guys, one who owned a traditional health club, with babysitting and juice bars and all the rest. They polled their members and found that 90 percent of their members didn’t use most of that stuff. They found they could cut their prices in half, plus it’s a smaller club and you could get in and out quicker. That was the basic concept, and they had 40 to 50 franchises.
Today if you walked in, cosmetically it looks much nicer. They have formal training programs that you can take or not take. They’ve integrated it with something called Anytime Health, which is a web-based health program that you can use with your membership, so you can put your exercise routine on there. You can track calories on there. So here’s a company that started out as bare bones, very simple. Now today they’re very nice. Now you have reciprocity with other clubs. Today they are over 1,700 clubs, and that’s in less than 10 years.
The point is: You have to continually upgrade, continually stay ahead. They were the first ones to do 24/7 fitness, but now a lot of other concepts do it, so you have to keep changing.
Q. Isn’t it a challenge to get older franchisees to go along with the newer changes?
A. Yes, it is a challenge to make changes, and getting people to upgrade, because if you bought an Anytime Fitness club five years ago, it still looks nice but it’s not the latest model. Typically what’s done is on renewal that franchisee is required to bring the facility up to standards. Often these days franchisors are helping to finance those renovations too.
Back in college I was the manager of a Burger King, and they said we’re going to start doing drive-thru windows. And the franchisee I worked for said, I’m not going to do that. It will cost me six figures, and all I’m going to do is lose the drink orders from people who come into the restaurant. Well, fast-forward 40 years, and for most of these the drive-thru business is 40 percent of their business.
I’ve used that example many times today, because people didn’t know then that it would work. It is hard sometimes to convince people. Most of it is not as dramatic as knocking down walls and putting in a drive-thru. A lot of the changes, even at Anytime Fitness, most of those things are small things, and training. Those kinds of things franchisees embrace, because you want the franchisors to be updating. But again, you can’t make them do it just because the agreement said so. You have to show why it’s going to be good for them. And if it’s not going to be good for them, you shouldn’t be doing it. Your systems have to work.
Q. What about the flip side: Mistakes to avoid, when building a franchise system?
One of them is when you sell franchises, the joke is there are people who just have the mirror test: if they can fog a mirror and write a check, I’ll take them. That often leads to problems. There are a lot of people who should not be franchisees. It’s sometimes people who are too smart and too clever and too entrepreneurial, because they want to change it.
A second one is not providing solid training and backup to your initial franchisees, because if your first ones aren’t profitable you aren’t going to sell any more. And this is hard, because when you start outtoday McDonald’s has Hamburger University, Burger King has Whopper Collegebut when you start out you don’t have those things. I’ve seen people who develop the operations manual on the fly and that’s usually a mistake.
A third one is not respecting your franhcisees. Your franchisees are not sheep you can herd. I wouldn’t call them partners, but you have to work hand in hand with them. You can’t cede authority of decisions to franchisees, but you have to get input. It’s like the difference between a democracy and a dictatorship, and the democracy is going to last longer.
If you own a successful business, someone may have asked you recently whether franchises are available. However, not all successful businesses will become successful franchises. Is your business or idea franchiseable? Here’s how to tell, from Larkin Hoffman’s Chuck Modell.
Ideas are the backbone of every franchise system. However, many ideas that were franchised too quickly are now mere footnotes in the history of franchising. Implement your idea before licensing it to others.
Even then, proving your idea at one location may give you a successful business, but having a successful business does not necessarily equate to a successful concept. To be certain your success is not due solely to a location, or to your own personal efforts in the business, test the concept at multiple locations before embarking on a franchise rollout.
Apart from the concept itself, the most important element of many franchises is the name under which the business operates. It must attract customers, but it also must be one you can prevent others from using. To do so, the name must be unique.
While you may know that nobody else in your market is using a similar name, is it being used in other markets? If so, even if no one else has obtained a federal trademark registration for that name, you will not be able to expand the business under that name, or a similar name, in those markets. Conduct a nationwide search to determine whether others are using the same or a similar name.
Once you know the name is available, register the name on a national level to protect it from future users. To do that, the name cannot be merely descriptive of the business. Apple can be protected as a trademark for a computer, but it could never be protected as a trademark for an apple-growing business. While Pizza Hut may give the consumer the image of a restaurant at which pizza is consumed, the restaurant is not actually a hut, and therefore the name is not descriptive, and was able to be registered as a trademark. However, Pizza Restaurant, while conjuring up the same image, is not a name that can be protected.
Keep it simple, at first. When McDonald’s began operating, it offered more types of milk shakes (chocolate, vanilla and strawberry) than sandwiches (hamburger and cheeseburger). When Taco Bell began, it offered primarily beef tacos, not the variety of enchiladas, burritos, gorditos and chalupas you find on the menu today. Many mature franchisors started as very simple businesses, but added products or services over time, giving franchisees the opportunity to learn a very simple operation but later add additional profit centers.
While the business should be simple, the system should not. You may attract prospective franchisees by your unique concept or name, but to be successful, franchisees need systems that allow them to operate the business and stay ahead of the competition.
The assistance you provide must not only be initial assistance, but ongoing assistance as well; once franchisees are established, if they do not feel you are constantly adding value, they will quickly forget the initial assistance you gave them.
If you are already established as a household name throughout the world, the ongoing value you bring to franchisees is obvious. Apart from everything else they get, without the McDonald’s or Subway name franchisees of those systems lose hundreds of millions of dollars a year in advertising that brings people to their restaurants. What is it that you will offer your franchisees to keep them in the system for five, 10 or 20 years?
If all you have is your franchise agreement, that bodes well for the lawyer who will enforce it, but it is not the way to build a franchise system.
Don’t get too invested in just one franchise deal, advises Scott Korzenowski, who represents franchisees exclusively at Dady & Gardner law firm in Minneapolis. His top tips follow.
The No. 1 thing I see prospective franchisees do is put off the legal analysis of the agreement until the very end. It’s like if you have your heart set on a certain car, you’re going to buy the car even if the dealer isn’t going to give you a good deal. So what I do, I find another dealer with a car I like, and get that competition going.
Franchisees go to Discovery Day, they maybe have leased space and formed a corporation, and they come to us and say, Hey, look at the agreement. And we look at it and say, you should really go back and negotiate. Sometimes the franchisor will change a lot, if they’re desperate to sign franchisees, and sometimes they won’t change at all. But it’s important first of all to understand exactly what’ s in the agreement, and then to know that you’ve gotten the absolutely best deal you can.
You really have to test to see how badly they want you as a franchisee, so the process of negotiation is a wonderful process. You should always engage in it, because at the end you will know, this is the best I’ll get from this franchisor. They might not change, but you’ll know.
New franchisees don’t understand territory. They don’t understand if I’m a Quiznos franchisee, it’s bad enough that I’m going to have to compete against Potbelly and Subway and all these other sandwich chains, but I’m also going to have to compete with Quizno’s. Most franchise agreements don’t provide adequate territorial protection for franchisees, and that’s a huge problem for franchisees. They say, the franchisor won’t do anything to hurt me, and that’s not true. The franchisor gets paid a percentage of the total sales; the franchisee makes money from their revenue minus all their expenses.
Let’s say I’ve got a store that’s doing a million dollars a year, and Quiznos puts in another store, and my revenue goes to $700,000. And that second store gets $700,000 in sales, too, so the franchisor now has $1.4 million to draw royalties from. Franchisors are motivated to get in as many stores as they can to get as much revenue as they can. Franchisees can get hurt.
That’s another thing that the franchisees have to understand is that the franchisor is not their business partner but rather it’s a person with whom you have a contractual obligation.
A second item that’s very important is renewal rights. Franchisees do not understand that when you’re a franchisee, you’re spending the money to build out that store, you’re doing all the work, but you don’t have the rights forever. I’ve seen rights last five years, or 10 years, or 20 years, and if you don’t have the right to renew then you’re out. Or, typically, an agreement will say that when you’re up for renewal you have to sign the then-current agreement, and terms could be changed substantially.
You want to try to get the protections that you can in your agreement, and if you don’t get the protections in your agreement, the franchisee should be in a position to walk away. But what I see is so many times the franchisees are so excited and so set on buying that franchise, that they say, Oh, that franchisor would never do that to me.
A lot of franchisees that call our firm think the franchisor is out to get them. I don’t think the franchisor is out to get the franchisee. The franchisor is out to do the best for the franchisor, for their investors. The franchisor is not evil or nice or mean or anything else. The franchisor is motivated by things that will drive their top line, their sales.
For example, in one case the franchisor wanted very fancy cups that they would sell their ice cream in, and these cups were twice as expensive as other cups. The franchisor liked the fact that the cups looked very nice, that it gave their brand a more superior feel. But for an extra 50 cents of ice cream, the cups were killing the bottom line for the franchisee but driving the top line.
Why don’t newer franchisees understand this? Many, many people that go into franchising are typically middle managers, dentists, they’re very smart guys but they’re ignorant. Most prospective franchisees are ignorant about business. They don’t understand that when you sign a contract, both sides are trying to get the best deal for them. There’s a feeling if you’ve been working in an office, you think people are nice, people are going to help you, people are a team.
Secondly, franchisors trying to sell franchises take advantage of that, intentionally. Franchisors train their salespeople to give the perception that we’re in this together. And I think there’s a little disingenuous about how they sell franchises. We all think of the used car salesman, and we don’t trust them. Well, we shouldn’t trust anybody who gets paid to sell us something.
It’s nothing personal, and it’s not that these franchisors are bad, it’s just understanding that they have different motivation than franchisees.
Another big issue is, what does the franchise cost? They have to put in the FDD, the franchise disclosure document, a range of what it will cost to open up. I focus on what happens after that. An average royalty is 5 percent, so for every dollar that comes in your store, the first five percent is going to the franchisor. That’s a lot of money. What are you getting for that money? One of the biggest things you’re getting is name recognition. Obviously if I buy a McDonald’s, I have 50 years of goodwill in that brand. If you’re buying a startup franchise, you’re not getting that.
Second, you’re buying expertise, so is this the sort of business where that expertise is going to be important? If it’s SK Smoothies, or whatever, how hard is it to make smoothies?
A third thing you’re buying is efficiency in numbers. When you have a large group of franchisees and you can pool your money together and buy advertisements, or pool your money together and buy supplies, that’s helpful.
But look carefully at the purchasing. Franchisors will often cut deals with suppliers, in which they’ll guarantee that, say, 5,000 of our franchisees will buy this dough, but in exchange for that you’ll give us a kickback. That’s legal, so long as it’s disclosed in the FDD, You have to add up all the fees. When you think about it, for franchisors the only customer is the franchisee. Franchisors that are looking to generate more revenue, look to their franchisees and look for ways to get more money out of them.
1. How long have the franchisors been franchising?
This question is important because you need ample historical data to comfortably make a decision. Be wary of going with a young franchise. If you want the best territories, don’t go with a franchise that has many units already open in your area.
2. How many units have been closed?
If they’ve closed several units within the last three years, make sure you understand why and determine that their explanation is palatable to you.
3. How do they provide training and support (and what are the details)?
It is important that you understand how much support they provide during startup and ongoing operations. Whether you need your hand held, or you need to have the right to take a few liberties here and there, make sure there is a cultural alignment with your business style.
4. Do they have any litigation in their FDD, or franchise disclosure document?
Chances are rare that you will find an established franchise that doesn’t have some litigation. If you find one, it might be a keeper. Excessive litigation shows they are unwilling to sit down at the table and work things out amicably.
5. What do existing owners say?
It’s called validation and it is exactly what the word implies. Validate what the franchise home office is telling you against the real life experiences of those who have come before you. They have no vested interest in you coming on board, so you will usually get straight answers
Charlie Simpson: I’m president of Great Clips, a leader in the limited service value category. We have 3,200 units, and will add 150 to 200 this year. I was VP of development, then COO, and became president one and a half years ago. Prior to that I was a franchisee of Great Clips in Texas, and was with 7-Eleven before that.
JOE KEELEY: I’m president of College Nannies & Tutors, building stronger families with our services, and we’re in 27 states. I grew up in a North Dakota farm town, and I’m a former many, a nanny who’s a man. Twelve years ago I started the brand, and in 2005 we started franchising. We have 50 owners now.
Q: What does benchmarking mean to you, and how do you employ it in your system?
Keeley: When we look at benchmarking inside of a growing, younger system, it’s both the hard and soft. Hard is finding those few simple numbers that our franchisees can use. We call it M2V, margin, mix and volume. I like to have a few simple rules, repeat them often and be consistent.
Soft is, one of our jobs is to identify how our franchisees are doing, changing a career and owning a business. How are they aligned with the brand? How are they doing? We’ve started some measures to get at those things.
Simpson: Benchmarking has changed in the last few years, with the ability to collect data. We collect 75 million customer transactions a year and put it into a database to analyze. We’ve been doing that for 12 years. We use it for two areas: to drive the top line, and we focus on customer growth rather than sales growth. And we collect the top 25 percent to share that data with franchisees.
Q: A lot of franchisors don’t use benchmarking on the development side, when seeking to find new franchisees. Do the two of you?
Keeley: It’s all under the umbrella of having a few simple rules. We create a very simple funnel for a sales process, and break that down into activity points. Now as we’ve grown we’ve gone back and said, getting a franchisee is not that difficult. Getting one that is successful may be.
The main thing to look at is, actions speak louder than words. There’s always a lot of hope in any sales process, but really understanding what it takes to bring in a successful candidate is key.
Simpson: We do an earnings claim in our franchise disclosure document, called Item 19. The most importance metric for getting new franchisees is the earnings claim number. As that number declines, interest declines. We just had a record year last year, and once your earnings claim rises, the interest grows exponentially.
We like to look at first year performance and ask, did they open a unit? Our internal sales metrics, we look at close ratios, and we look at lead sources: brokers, referrals and others. Finally, we use our financial benchmarks, such as the cost per new franchisee.
Keeley: This is about a partnership, and if the news is that bad we shouldn’t be franchising anyway. If there’s a transition time, you can talk about it and communicate it. Facts and honesty right up front is the positioning we like to take.
Q: How do you use benchmarks in getting new franchisees up to speed?
Simpson: The first thing we do is bring them back for new franchisee orientation and we’re brutally honest, to take the wide-eyed edge off. We show them the metrics that if they perform against those metrics they will succeed, and vice versa. We put everything on one document with what the brand is on one side, and what the metrics are on the other side.
These numbers are communicated on a weekly and monthly basis. It focuses the conversation so you’re talking about the things that really matter.
Q: Once franchisees are past their first year, how do you use the metrics?
Keeley: A lot of what we do is around the theme of managing the emotional intelligence of our franchisees. At the beginning, they look up to you, and they follow everything you say. Then they’re adolescents, and we’ll leave that there. And then they move into adulthood and it becomes a matter of how you interact with them.
The hardest franchisee is the one who’s doing well but not as well as they could be. We take a consultative approach and try to find out where they want to be and how to get there.
Q: If a franchisor wanted to get started with benchmarking, what are the two key things you would advise them to collect?
Keeley: I would identify the five to seven numbers or benchmarks, and you need to give it 90 to 180 days to identify some trends, and for each line somebody needs to be accountable for it and say what success is.
Simpson: I view data collection as an investment rather than an expense. If you’re going to have multiple units, develop a relationship with a POS or point-of-sales vendor and roll that out before you have many franchisees. If you wait and try to convert existing franchiseesgood luck with that!
If returning customers are important to your business you really need that transactional database to understand what’s going on with your business.
Q. Describe your system.
A. We are franchise-based, with 28 stores, selling pizza as the centerpiece and made-from-scratch cooking. We own eight stores and 20 are franchised. Plus we have one new concept, called the Crooked Pint.
Q. Why did you develop Crooked Pint?
A. I learned about branding with Green Mill, and I knew the pitfalls of our model. Green Mill has a good history in Minnesota and the Twin Cities. We decided to look at other models that could serve the same demographic we already knew. We have franchisees that wanted a different concept to add. We opened our first one in September. We developed our training systems. The next step will be opening a corporate-owned one.
Q. You’ve said training is a big part of your growth strategy. How do you train front-line employees?
A. Training and education are big, but I feel like it’s been harder for me to get the kids today to have fun with the guests. The key to restaurant success, you have to drive top-line sales, check averages and customer counts. The training program we have today for the young kids is how to smile and have fun with the customers. That’s where a lot of concepts aren’t doing well. That’s what Green Mill has been focusing on.
I remember my Dad saying when you meet someone: smile, say your name, shake their hand. Now they come in without that.
Q. What do you think is behind the difference?
A. I think technology has got kids talking less and interacting less face to face, and so they’re interacting maybe more but it’s through Facebook, instant messaging, e-mail. And the face-to-face personal contact isn’t what it used to be. It’s more of a stretch for kids. They do a great job in a lot of areas but it’s a stretch to do that. They’re maybe not as aware of how they’re perceived. In an environment like a restaurant where people are paying to go out, you have to pay attention to what their needs are right away.
Around June 2010 we started a big initiative around being genuine, being yourself. Our theory is we’re still a made-from-scratch kitchen, so we serve genuine food at genuine prices. So we’re working on presenting ourselves at the table, how we listen intently, trying to read the guest as best as possible.
Q. What are the results of the training program?
A. We’ve had it strongly in place since June of 2011. First of all, complaints are down 8 or 9 percent. Also, we have a secret shopper program, and each store gets two a month, and secret shopper scores are up. Our sales are up and our net income is up. I’m not attributing it directly to service, but it’s not hurting us!
People are always looking for ways to finance growth, but franchising is not effective with all concepts, according to Dennis Monroe, an attorney with Monroe Moxness Berg in Bloomington. For example, he says, franchising doesn’t work well when a concept is not fully developed, has not been proven with diverse demographic and geographic locations, has not shown consistent performance or has too many complications.
Businesses need to take a different look. There’s a whole toolbox of different ways to grow a company,∫ said Monroe. We have become too myopic, and lawyers are particularly bad about that.∫ The first step is to determine the attributes of the business: Is it capital intensive? How fast can you grow it? How fast can you exit? What are the unit economics? Once you’ve got your hands around that then the financing can dictate itself,∫ he said.
There are other ways to grow a concept, and the most common is through private equity and a reasonable amount of debt, says Monroe. Private equity sources start with friends, family, 401(k) rollovers, second mortgages and the like, and progress to more sophisticated funding sources after the concept gets to critical mass.
A joint venture is a second option, often used when a good concept has developed a few stores, and almost a must when doing business internationally. The partner might be a strong operator, or simply an investor who doesn’t want to keep a hand in operations. In either case, the concept owner needs to use separate entities and a licensing agreement for the name and concept.
Straight licensing is another source of funds, or entering into a license for certain intellectual property owned by the concept owner. The concept owner has to be careful not to violate franchise rules. This can be an effective way to leverage the concept name but not be involved in the actual business of the licensee.
Dennis Monroe, Monroe Moxness Berg, Bloomington: 952.885.5962; dm*****@********rm.com; www.mmblawfirm.com
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