Considering Becoming a Multi-Unit Franchise Operator of a New Brand? Here's What You Should Know First.
Here's what you need to know before making the decision to become a multi-unit operator for an emerging brand.
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Multi-unit operators (MUOs) in the U.S. own more than 50% of franchise units. According to FRANdata, the number of MUO franchisees with more than 50 units has grown 112.3% since 2019. Some sectors skew higher. MUOs control 82% of all quick-service restaurant (QSR) units, 71.5% of beauty-related and 72% of sit-down restaurants in the U.S.
Some of this is natural consolidation of existing units due to retirements, and some is due to new multi-unit agreements. Many articles have been written about building wealth in franchising via multi-unit ownership. Should you consider it?
Related: 4 Reasons to Become a Multi-Unit Franchise Owner
Should you consider becoming a multi-unit operator?
Let's break this into two discussions: resales (which I will address in my next article) and new development multi-packs. Selling new multi-pack licenses is becoming increasingly common in franchising. The reasons are simple:
Multi-packs generate more cash for the parent company.
They demonstrate "demand," which franchisors hope will attract private equity.
Fewer franchisees are less costly to support.
Only higher net worth buyers qualify
Buyers themselves demand multi-pack buying opportunities because it's easier to build operating scale and profitability.
Multi-packs can be as small as two to three units and as large as 50-100 units or more to sell out entire large territories or states. Note that the sale of "multi-packs" is distinct from the sale of area development agreements or master licenses, which have different performance requirements.
The competition to attract franchisee talent is fierce and expensive. High-commission outsourced sales channels, marketing and expensive lead generation eat up franchise fees. Under-capitalized young brands are at a distinct disadvantage. Royalty self-sufficiency (when a brand can fund corporate activities through royalties) is pushed out as franchisee recruiting costs rise.
Traditionally, franchisors limited the number of licenses a new franchisee could sign until they proved themselves as an operator (or had existing MUO experience). Once inside, limits were also put on expansion licenses to ensure only proven operators in good standing with the franchisor were allowed to add territories. But more emerging brands now skip the initial step and jump right to selling multi-packs.
Besides trying to sell their way onto private equity's radar, this is how some young brands get around the "starvation by high commission" problem in a high-cost sales environment. It seems nonsensical to me that anyone would agree to buy a 10+ pack of licenses from a brand with only 10 total units open. But buyers are doing exactly that. Some brands even sell with messages about how they only accept "executive" buyers who don't need financing. This is meant to partly flatter buyers but can also signal that there isn't enough margin in the business to allow any financing!
There shouldn't be pressure to buy so much upfront from an emerging brand. There's little chance your home market will suddenly "sell out." But aggressive salespeople sometimes convince buyers otherwise ("We have ten units, all in Florida. Where are you calling from? Indianapolis? It just so happens we have another candidate ready to sign for that market!"). Furthermore, candidates may be rushed through a 30-day buying process ("Don't wait! Territories are selling fast!").
Related: 5 Encouraging Facts to Know About Multi-Unit Franchising
Here is a case study to consider. This is an emerging franchise currently sold by an outsourced franchise sales organization (FSO). I'm not including names because I want you to take away the signals of a potential problem brewing … not get hung up about a specific brand.
The company's Franchise Disclosure Document: Item 19 earnings disclosure for 2020 included the financials of only one corporate unit. Three franchise units had been sold but were not yet open, so no financials for those franchise units were included. The company showed a net loss of $92,000 in 2020 and had only $43,000 in cash. Mid-year in 2021 the company had nearly $26,000 of credit card debt. The company paid $363,000 in franchise sales commission. There were also $753,000 of "uncategorized expenses," a whopping 62% of total corporate expenses reported. Based on the "strength" of this FDD disclosure, the company hired an FSO to help it start selling franchises. And sell it did! As the FSO proudly asserts on its own website, "from 3 to 320 awarded!"
The current 2022 FDD shows $9M 2021 income, of which $8.8M was franchise fees. But 6.1M immediately went out the door in sales commissions paid. Credit card debt was $32,000. The Item 20 showed 50 units open and another 49 in development. Training expenses were $15,000. I pay more than that for my kid's school tuition! What sort of training was provided for the 50 units open that only cost $15k? And what happened to the "320 awarded?" Some multi-pack opportunities are worthwhile, but to me, this emerging brand has red flags.
Here's my advice on new multi-pack agreements:
Start small — three or fewer units. Unless you have franchise experience and the system is proven, you're burning cash on fees for units you may never open. You can add expansion territories later. Have your attorney carefully review territory, site approval and encroachment contract language.
Validate! Talk to as many franchisees as possible. Are they meeting their profit objectives? Did all their units open?
"Territories" sold by population size require extra due diligence. It's often a crafty way to upsell you and get you to pay more in fees instead of crafting viable territories of the appropriate size in the first place. If the territory is not exclusive, you have double trouble. Population number also doesn't address demographics or density. Talk to franchisees at length about what makes their territories and the model financially viable. Determine cash on cash return for your investment. Is it worth it?
Slow down. Do your homework. If you see red flags, don't talk yourself into anything. Move on. The right franchise opportunity is out there.
Related: Considering franchise ownership? Get started now and take this quiz to find your personalized list of franchises that match your lifestyle, interests and budget.