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Bagging the elephant

Selling to area development franchisees


Published:

 
Mark Siebert is the chief executive officer of the
iFranchise Group (www.ifranchisegroup.com), a franchise
consulting firm with consultants who have worked with 98 of the
nation’s top 200 franchisors.

Mark can be reached at
708-957-2300 or at
info@ifranchise.net.

Over the last decade, few trends have been as pronounced as the increasing importance of area development franchisees. In fact, FRANdata reports that while only 18 percent of all franchisees are multi-unit operators, this group controls nearly 50 percent of all franchised units in the U.S. Even more telling is the fact that the 3 percent of franchisees who own more than five franchises control a staggering 24 percent of all franchised units. Clearly, the importance of multi-unit franchising in today’s franchise sales marketplace is hard to overlook.

The advantages of area development franchising are compelling. Selling blocks of franchises accelerates the franchise sales process and makes for a better story for bankers, investors, and the franchise press. At the same time, these better capitalized buyers often come with their own infrastructure and bring an increased level of sophistication to the franchisor’s unit level development—reducing the franchisor’s support requirements and improving their economic efficiency. A network of area developer franchisees may also reduce the franchisor’s support costs, as the franchisor is required to manage a much smaller network of franchise owners than it would in a system comprised of only single-unit franchisees.

These advantages are not lost on franchisors, which increasingly are including area development provisions in their contracts and making a concerted effort to target these prospects. But franchisors intent on hunting the elephant are well advised to use different tactics than those targeting smaller game, as these more sophisticated prospects require a much different process than traditional single-unit franchising.

Before starting the hunt, the franchisor should ask whether he or she has what it takes to carry this massive prey home. Does the business model lend itself to passive ownership? Are the unit economics strong enough to attract area development prospects? And is the franchisor’s senior management and support staff ready for the challenge of area development franchising?

In fact, this process should start well before breaking camp—with the development of the offer itself. Multi-unit operators are planning a much bigger investment, and typically are more sophisticated than the average single-unit operator. Return on investment will be a primary consideration—especially if you do not have an established brand—so a well-documented earnings claim is almost mandatory. Moreover, this more sophisticated operator will be intent on understanding the franchisor’s value proposition. A critical aspect of their buying decision will be the franchisor’s support structure in the areas of advertising, training, real estate, design, construction, and operations assistance. And they will scrutinize the franchisor’s financial strength and management team in the process. If it is just you in the hunting party, you would be well advised to consider smaller game.

And, of course, there are more obscure structural questions to be answered as well. Does your contract mandate that your franchisee cannot operate a competing business—and if so, what constitutes a competing business? If you are going to target franchisees with established operations, will you require them to use your POS system and your specified charts of accounts, despite the fact that they may have different systems and accounts in place? Will you require your franchisees to develop new buying relationships, despite the likelihood that they have already developed some significant economies of scale with their existing vendors? And if you are going to hunt for the franchisees of specific franchisors, have you read through their UFOCs to ensure that you will not ask them to violate their existing in-term restrictive covenants—effectively poaching in the game reserve?

Once you have made the decision to pursue area development, your next decision will be where to begin the hunt. And the success of your expedition will largely be a function of how well you understand your quarry. Will you target franchisees with industry experience? Existing multi-unit operators? Or will you attempt to “grow your own” while targeting operators without an existing base of units.

When it comes to established multi-unit operators, identifying these prospects can be much easier than selling them. The first thing that the franchisor targeting these operators should know is that the market is extremely competitive.

Much of this is simply a question of supply and demand. According to FRANdata, between 11 percent and 15 percent of all multi-unit franchisees operate more than one unaffiliated franchise brand. Thus, if a franchisor wants to hunt for big game among existing multi-unit operators, they should realize that they are probably not looking at the entire universe of 37,000, but more realistically at about 6,000 multi-brand, multi-unit operators. This number looks smaller still when we recognize that these same operators are in the sights of a significant percentage of the 3,000 or so active franchisors in the U.S.

Unlike single unit franchising, the marketing vehicles that succeed in attracting established multi-unit operators have a more narrow range. Some of the franchise marketing vehicles that are most successful in attracting start-up franchises have seen very limited success in attracting big game. The Internet, for example, is the happy hunting ground for start-ups, but established area developers are less likely to rely on it to identify new opportunities. Likewise, brokers, who have recently become a significant factor in the sale of individual franchises, are less important in the sale of area development agreements—at least those targeting established developers.

Over the last several years, magazines and conferences targeting area developers have surfaced, but the best strategies often involve significant amounts of brand recognition through public relations. Trade publications, trade shows, and direct contact strategies can all be effective means of reaching this audience, but nothing will be more important than the third party credibility of a well-placed story.Multi-unit operators who are interested in new opportunities are likely to be very much in tune with their industries and will be on the look-out for these opportunities in their particular trade press.

When it comes to franchisors that are targeting new franchisees for multiple unit development, franchisee qualification becomes a significant consideration. Many franchisors have found that franchisees well qualified for a single unit franchise may be quickly overwhelmed with multi-unit ownership. The best franchisors will exercise extra care and diligence before signing area development agreements. And some who choose this strategy will opt for pure multi-unit franchising (in which units are granted one at a time, without being subject to an area development agreement) as an alternative to being locked into a territorial development contract with an operator who may not be up to the task.

Likewise, the message used to attract area developers will be significantly different than the message used in targeting start-up operators. While start-ups will continue to be attracted to the “be-in-business-for-yourself-but-not-by-yourself” message, area development franchisees are more likely to focus on the franchise sale as an investment. These operators are less inclined toward and may even resent a pure emotional “pitch,” so the message needs to be crafted in a way that will communicate the value proposition clearly and without puffery. Additionally, area developer candidates have a greater expectation than single-unit prospects to receive earnings data. Providing an earnings claim in the UFOC is thus more relevant for most area developer-based systems.

The sales process itself is also more complex when dealing with the area developer prospect, as the sale involves increased levels of investment, risk, and complexity. Moreover, the area development franchisee will typically have more bargaining power than will a start-up operator. Area developers, understanding their relative bargaining power, may want to negotiate everything in the agreement. And inexperienced franchisors, at once seeing the trophy prize and fearing that it may bolt, may give up too much. Or, equally worrisome, inexperienced negotiators may lose deals because they lack the flexibility to work true win-win scenarios and simply resort to a take-it-or-leave-it posture.

These negotiations often center around three critical deal points: payment of fees (the developer will want a pay-out schedule that is more generous than the one proposed by the franchisor), development schedules (and what happens if they are not met), and negotiated discounts or other favorable deal terms.

Another occasional point of negotiation will be which contract will be signed. The area development agreement acts much like an option agreement, giving the area developers rights to execute contracts according to a predetermined schedule. But which contract? The area developer will want to sign the existing contract while the franchisor will want the flexibility of signing the “then current agreement.” All of these questions are issues the franchisor should be prepared to address, one way or the other, in the sales process.

Of course, area development is not without its issues. A significant number of all area developers fail to open the number of locations called for in their development agreements, and if problems develop with an area development franchisee, their territory can remain undeveloped as issues are resolved. Combine that with the fact that larger area developers can wield a tremendous amount of power within a franchise system, and the advantages of pursuing big game may be more illusive than the game itself. For the new franchisor, it is wise to limit the size of area development territories during the early stages of growth. Doing so will mitigate the potential damage to your system if any single area developer relationship sours. As experience with area development franchising is gained, the number of locations awarded within each area development contract can always be increased.

While area development franchising is not right for everyone, it can deliver rapid growth, sophisticated franchisees, and reduced support costs—a combination that is of interest to many franchisors. And for those who are well-suited to the pursuit, the trophy can be well worth the hunt.

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