Follow the money to sort out brands’ prospects
In the early stages of their franchise journeys, young brands can find their growth stalled, sometimes before it’s even really gotten started. Perhaps the concept itself is simply unfit for franchising or the franchisor hasn’t built the necessary infrastructure to support the growth plan.
But one of the most common reasons for stagnation is lack of capital. While these emerging franchisors budget enough to get systems in place, create an operations manual and develop training programs, when it’s time to spend money to attract franchisee candidates, that’s where the capital well runs dry.
It doesn’t have to be that way. This month we look at how our three Living Large brands are financing their franchise programs with an eye on longevity.
“What has set us apart historically from other restaurant companies is we’ve been pretty savvy in how we use our capital.” — David Morton, DMK Burger Bar
Fuel from investors
“I would never in a million years recommend investing in a restaurant, but I’m a big proponent of investing in a portfolio of restaurants,” explains David Morton.
That’s what Morton says he tells potential investors interested in his DMK Restaurants group, which began franchising its DMK Burger Bar concept in October 2017. There’s less volatility with a restaurant group versus a single restaurant investment, Morton says, because you’re not reliant on the success of just one concept but instead can benefit from multiple locations and, in the case of DMK Restaurants, eight other concepts.
“Essentially we’ve been all investor capitalized,” says Morton. “We launched these businesses with zero debt.” And, continues Morton, most of that investment capital has been driven by the success of DMK Burger Bar.
“That’s our most well-known brand,” he says of the five-unit craft burger concept he launched with James Beard Award-nominated chef Michael Kornick in Chicago’s Lakeview neighborhood in 2009. Investors, who can choose from three funds, are mostly individuals “who’ve heard about the success other investors have enjoyed,” says Morton, and want to be part of DMK’s nationwide expansion.
The setup is such that no investor can own more than 4 percent of any fund, a structure used for two reasons: “No. 1 is, god forbid something goes wrong and we have to part ways,” says Morton, “and then No. 2 is, in Illinois, if anyone owns more than 5 percent interest, they’re subject to additional scrutiny for the purposes of liquor licensing.”
Growth for DMK in the premium burger segment will be quick but conservative, notes Morton, adding, “What has set us apart, historically, from other restaurant companies is we’ve been pretty savvy in how we use our capital.” That’s attractive not just to investors but to potential franchisees, who see the restaurant group’s track record with its other concepts, ranging from barbecue to seafood. DMK Burger Bar is also working to finalize its listing on the U.S. Small Business Administration’s registry as an approved franchise. That registration provides a faster track for franchisees seeking loans.
“Because of our strong net worth investors we could definitely get favorable bank financing when we’re ready for that.” — Andy Howard, Huey Magoo’s
When Andy Howard purchased Huey Magoo’s Chicken Tenders from its founders in spring 2016, he brought more than his decades of franchise and restaurant industry experience to the table. The former Wingstop executive VP also brought fellow departed Wingstop cohorts and execs Mike Sutter, Wes Jablonski, Bill Knight and Tom Roberts in on the deal, the quintet all investors in the seven-unit Orlando-based chicken franchise with Howard serving as president and CEO.
It’s with that investor caliber that Huey Magoo’s is expanding, first in Florida and then to new markets, as funding for its growth comes from within.
“A lot of the investors have pretty good net worth,” says Howard. “So far we’ve been all privately funded pro rata to everyone’s percentage of ownership.”
That ownership equity is also split with Huey Magoo’s founders Matt Armstrong and Thad Hudgens, who stayed on and are franchisees of two locations. While Howard’s had conversations with venture capital groups and says the company is “very bankable,” he’s cautious in these early stages of growth about bringing on more partners.
“Equity is very, very valuable so we want to be careful about giving up any equity at this point in our development,” says Howard. “Because of our strong net worth investors we could definitely get favorable bank financing when we’re ready for that.”
Like their franchisor, current franchisees are well-capitalized, Howard notes, and have been able to mostly self-fund the development of their locations, which cost around $500,000 to open.
Real estate, accounting, franchise sales and PR all come from outside consultants, as Howard is mindful of overhead while Huey Magoo’s builds out its footprint. “We actually don’t even have an office, right now we’re all working out of our homes,” says Howard. “The people we have really wear multiple hats and we’re all really
“As president and CEO, I feel the responsibility of watching every penny,” he continues. “The investors are looking to me to be really careful.”
“Overall, Digital Doc is a very stable business. Cash flow is very steady.” — Levi Dinkla, Digital Doc
Parent company power
It was funding issues in the early going that brought about the sale of Digital Doc by its founders to Highland Ventures, and since that acquisition in 2015 the device repair franchise has doubled its footprint to 38 locations spread across 19 states.
Digital Doc is in growth mode, says President Levi Dinkla, with more than 50 stores sold, and while the business and its continued expansion have necessitated “some financial help from the parent company,” Digital Doc hasn’t had to take any outside funding and will maintain its practice of reinvesting cash flow back into the business.
“Overall, Digital Doc is a very stable business. Cash flow is very steady,” says Dinkla.
Digital Doc benefits from having an established parent company, says Dinkla, one that isn’t content to let the concept simply float along aimlessly but is intent on its development.
Glenview, Illinois-based Highland Ventures is the largest franchisee of Marco’s Pizza, with its Hoogland Foods subsidiary running 140-plus locations, and it owns 750-unit Family Video, along with 13-location fitness center brand Stay Fit 24 and Highland Pure Water & Ice, which sells purified water out of kiosks next to some Family Video branches.
The company, with roots going back to 1946 when owner Keith Hoogland’s grandfather started a distribution business, pulled in an estimated $400 million in revenue in 2016 from Family Video alone. Highland Ventures also has extensive holdings through its Legacy Commercial Property business, owning nearly all the real estate for its stores.
The backing of Highland Ventures helps give franchisees confidence in the staying power of Digital Doc, and while the company doesn’t directly offer financing to ‘zees, “we’re SBA approved and we do have preferred lenders,” says Dinkla.
“We want our franchisees to first have a very good understanding of the capital needs and then we can direct them to lenders who understand our business and what we do,” says Dinkla. The total investment to open a Digital Doc franchise is between $128,200 and $195,500, including the $44,900 franchise fee.
Laura Michaels, managing editor, reports the progress of three emerging franchisors through an entire year of unit sales and growing pains. Join the discussion and contribute your brand’s best practices in her LinkedIn group, Franchise Times Insights. Upcoming topics are: accelerating franchise sales, navigating legal matters and selecting sites. Reach her at email@example.com.
DMK Burger Bar’s offerings include chef-inspired fries.
What the experts say
- Be realistic. When it comes time for young franchise brands to look for funding, Brian Schnell says a mistake he often sees is “the inability to present a credible story on a realistic three- to five-year strategic plan regarding both the franchisor and franchisee performance” along with providing a corresponding analysis of strengths, weaknesses, opportunities and threats. Schnell, chairman of the franchise practice at law firm Faegre Baker Daniels, stresses that performance at both the franchisor and franchisee levels matters when it comes to attracting capital.
- Get validated. Before attempting to secure private equity partners or other investors, Dean Zuccarello, CEO of investment banking firm The Cypress Group, says emerging franchisors must get validation on the concept’s unit economics and have “a well-defined plan for growth and how the company can achieve that growth.”
- Consider other expansion tactics. Early on in development of the system, franchisors should consider a variety of tactics to assist growth, says Zuccarello, including new unit incentives such as “reduced royalties for a few years to stimulate growth,” and building company-operated units to then sell to franchisees. Schnell adds that early on it’s crucial to find franchisees who will be key stakeholders in the brand’s development and expansion. “Make sure they are all in, have reasonable expectations and are trending towards profitability.”