Ready to grow? Should you choose franchising or venture capital?

Inside Franchise Business: expand your business through venture capital or franchisingWeighing up the pros and cons of releasing equity in your business to a venture capital partner or taking the franchise route to business expansion.

This is a question I’ve been asked with increasing frequency in the last couple of years and as first world problems go – it’s certainly right up there!

Here’s the scenario:

You’ve been around a while with a proven profitable concept, your supply chain is sound, you may even be manufacturing some of your own products, you have reliable systems and some trusted key people who been with you for a good part of your journey. This steady solid growth is underpinned by dependable cash flow and little or no debt.

You may have duplicated your business with a second or even third unit and now you’re looking to expand. You can see a market opportunity because you are differentiated from your competitors and you’re wondering how to take the next step that lets you seize that opportunity.

You’ve thought about franchising and if you haven’t been on Shark Tank, a few people have said you should! In fact a number of your loyal customers keep asking when they can buy a franchise.

Here’s when this curious phenomenon kicks in……..

You get a call from a mate or a supplier introducing you to some folks with some seemingly serious money who could be looking to invest in your business. In equal measure you’re intrigued, sceptical, flattered and very interested! Your first thought – is this the answer to your expansion plans and dreams, and the second, you’d be nuts not to at least have a chat and see what’s on offer.

Of course you obtained an effective confidentiality agreement from them, and then you let them have a good look at your financial data, your supply, your operations and you’ve shared your hopes with them.

Then the dance begins: what percentage will you each own; are these venture capitalists hands on or more passive investors who’ll let you be; do they have a manufacturing, distribution or other agenda; are they part of a larger group or a small family held or private venture capital?

You’ve done all that, they’re still very interested and now you really have to weigh it all up.

Weighing up the franchise and venture capital options

So you come back to franchising and ask – how does it stack up against the offer on the table?

There’s no simple answer but here’s a few questions:

  1. Why do you want to expand – you’ve got a business you know well that without too much brain damage offers a comfortable if not stellar lifestyle?

  2. What do you REALLY want – yes after financial security, kid’s education, beach house, or even yacht, Greek islands or private plane? What excites you, what drove you to push through all the challenges that got you where you are now? Why do you get up in the morning?

  3. Are you really up for some more seriously hard graft – because by either route, that’s what it will take?

Expansion takes capital and it takes good people.

So let’s weigh up how venture capital (VC) compares with franchising.

Your VC partners have capital and enticingly it’s so right here and right now, you can almost smell the suntan oil. You may even have mapped your store roll out in a time frame, and again, the money’s in the bank. And you’ve negotiated more than 50 per cent equity, so you’re in control.

Sure, you’ll need to get some more good people and you’ll have to shape up a few things operationally and in your head office in order to duplicate the business. But the money is there, you’ll have access to the best, so you can work that out as you go along.

And franchising? Well you’ll need to shape things up operationally and at your head office right away.

You’ll need to invest in developing a comprehensive franchise business model with experts because if you’re going to have a compelling enough offer to have someone (not rich) stump up the half million it will take to open a store, then you and they know it has to work as soon as they open the door.

You want to find say 100 people each prepared to invest $500,000 in your business (that’s $50 million!), so what would you reasonably expect to spend on getting that right so you can genuinely attract that calibre of entrepreneur?

But remember that franchisees will bring you the capital. Even more importantly as you get a few more stores, each one of these owner operators will give you their sweat because it’s their money and they’re so committed, they’ve probably borrowed against the family home to invest in your business.

So the capital is raised one store at a time by a series of investors you can profile, screen and ensure will be the quality brand ambassadors that care for your customers just as much as you do.

Let’s look at the human capital

Where does that come from in the VC model?

Well it’s you and the few trusted people you have now, and then you’ll need to find them over and over again each time you open a new store. You’ll need to train them and monitor their and each store’s performance with the same diligence you currently do in your existing business.

Yes, you can hire the best, but how do you manage them to optimum profitability and ultimately incentivise them to stay?

Independent research shows that you can take your best corporate store with your best manager and within 30 days of converting that to the ownership of the right franchisee sales has grown by 15-30 per cent, increased profitability by up to 100 per cent, reduced costs and improved customer loyalty.

And they’ll be there hiring, training and managing their employees (yes, their employees) to deliver the customer care you know from experience only happens when the owner’s in the store running it.

Not only that, you know the staff retention in retail and food businesses – about two years if you’re lucky – franchisees on average stay for seven years.

So what role do you want in heading up a network?

Either way it’s a hands-on role getting the first few stores up and operating smoothly, but what’s the longer term picture as the network grows? Are you the VC’s minion running a growing number of corporate stores – basically what you’re doing now, but on steroids?

Or are you a franchisor with a network of owner-operators each responsible for all the day to day concerns of running their businesses independently under the guidance of your head office team?

As a franchisor, you’ll be free to improve systems, find new suppliers, new markets, develop new products, the big picture you dream of now – working on, not in your business.

Another important point…even if you franchise, it doesn’t mean that every store should or will be a franchise. Good networks often have a mix of both franchise and corporate stores. So over time, you should look to own as many corporate stores as you can readily fund and comfortably manage.

What if things go pear shaped with the relationship – venture capital versus franchise?

If things sour with your VC partners and you end up in a legal stoush fighting out the terms of the contract – then sorry to be so blunt, but it will be the one with the deepest pockets for lawyers who’ll probably win that battle.

If you have franchisees who don’t follow the rules, you’ll turn to the franchise agreement and, as it’s a highly regulated sector with well-documented processes, follow process outlined.

At first, that means providing support and more training for breaching franchisees.

If that doesn’t work, you issue a breach notice with time to rectify; if none of this works, you turn to mediation and as a last resort, termination of the contract.

The franchisee’s post termination obligations will apply; ideally you’ll be holding the head lease on the premises or at least a step-in deed, so after observing due process, you will have the right to take over the business.

So is there a role for venture capital in the franchise journey?

Most definitely yes! It’s just a case of when.

Right now your business is worth the least it will ever be worth if you expand successfully, and that’s why it’s so attractive to investors – they’re after a deal. They know that as you grow the value, their investment will grow on the back of your hard work. Yours will too, but at what price?

What is the real cost of this venture capital in terms of control, the reduction in equity, potentially repayments and interest on loans or even the freedom to follow your vision?

For 35 years we’ve built and consolidated a huge number of franchise networks in varied industries from government enterprise, retail and fast food to professional and trade services nationally and internationally, and brokered exit or partial liquidity events for many of them.

This is what it’s taught us: the strategic decisions you make now about how you set up and grow your business will directly impact its value upon exit. The reasons that make franchising your chosen growth strategy – provided the franchise business is carefully developed and well executed – will be what make it a more attractive and valuable proposition to the very investors interested in your business now.

What’s not to love about franchising?

  • A tied network of independently owned outlets run by customer facing brand ambassadors with superior customer service, profitability and brand loyalty;
  • Well-documented operating systems, procedures and training that ensure consistent unit replication and compliance;
  • Well-established, reliable manufacturing, supply chain and distribution processes and agreements;
  • Multiple revenue streams from supply chain rebates, wholesaling, online and franchisee royalties and levies;
  • Clear, enforceable KPIs underpinned by tested legal agreements in a well-regulated sector;
  • A recognised brand with a defined USP, significant market share and brand authority;
  • An effective corporate structure with a lean head office team and owners who could replace themselves.

It’s a lot about mitigating risk for investors, and a well-developed, profitable and sustainable franchise network ticks all the boxes for the widest range of VC or other investors or buyers.

So keep the contact details of those venture capitalists because they may be the key to your exit strategy when you’ve built a truly valuable acquisition and you’re ready to realise the rewards for all your hard work.