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HomeFranchise InvestmentsCriteria For Investing In Franchises: An Often Overlooked Asset

Criteria For Investing In Franchises: An Often Overlooked Asset

Angel investors are continually looking for new opportunities to invest in sound, well-managed startups. Many are focused on sectors such as technology, biotech and real estate. However, there is another, often overlooked opportunity that some are beginning to recognize: franchises.

In addition to providing portfolio diversification, the attributes of many franchise organizations align well with the investment criteria of angel investors. If you are looking into investing in a franchise, here are some criteria you should consider when investing.

The Likelihood Of A Solid Return 

Angel investing typically involves more risk than other classes of investments, so if you want to get involved, you should have expectations of stronger returns to offset this risk. With franchises, there can be a stronger forecast of returns due to the item 19 earnings claim within the franchise disclosure document (FDD). This document, and particularly the item 19 section, provides would-be franchisees and investors with a reasonable investment return expectation.

A Compelling Reason To Invest 

Most angel investors are or have been successful entrepreneurs themselves. They often enjoy helping others build and create a thriving enterprise. While each investor has their reasons for investing, many enjoy participating in something they consider to be meaningful.

In franchising, the support of an entrepreneur (franchisee) that is able to provide for customer needs in their local community can be attractive to investors that carry not only a desire for returns but also have an altruistic perspective in how their investment is used. Examples of franchise business types that lend themselves to this include in-home senior care providers, fitness and wellness gyms, childhood enrichment and the many environmentally friendly businesses that aid in sustainability through recycling or enhancements via home services.

An Experienced And Solid Management Team

A complete management team with leadership ability is a must if you are looking to invest in a business. Essentially, an angel investor is investing in people, so they need to have confidence that the business is in the hands of those who are knowledgeable, competent and trustworthy.

When investing in franchisees, not only are investors supporting an entrepreneur, but they also get the experience and support of the franchisor and his/her home office management team. This can benefit an investor who wants to see a chain of experienced leaders who can help guarantee the success of the enterprise. As with any business investment, you will want to meet with these leaders and see if their vision aligns with yours.

A Thorough Business Plan

When investing in a business, you should require a business plan that is both convincing and complete. Items to look for include financial projections, detailed marketing plans and specifics about the vision. Luckily, due to the nature of franchising, these types of businesses often receive high marks in regards to these items.

There are few other businesses that provide such detailed research and examples to gauge the future success of a new franchise location. The ability to not only forecast financials based on the franchisor’s FDD, but the visibility into past successes of marketing plans and operational initiatives that comes from a franchise system’s community is invaluable. 

An Investable Business Structure

While some angel investors invest on the debt side, many investors I have seen are looking for minority equity ownership positions. This means that the business has to be structured to allow for investment. Franchising accommodates this need in a relatively simple way. Depending on whether the investor is semi-passive or relatively active as an owner-operator, most structural arrangements can be accommodated through a limited liability company (LLC) accompanied by an operating agreement that outlines the respective distributions among other items.

In operating agreements, it is important to include clauses for when things don’t go as planned. As I like to say, “Partnerships are great until they are not.” You need to see how multiple levels of decisions will be made: day-to-day operating decisions, loan obligations and exit decisions. The more clarity provided on the front end, the less time and potential attorney fees will be spent on the back end.

The Opportunity To Be Involved

For many angel investors, it is not only about the money; they want to be relatively active and participate in building the business. While franchising involves following a systematic playbook provided by the franchisor, there are still many areas for strategy development. These can include marketing, staffing and expansion.

While some may see a franchise system’s playbook as restrictive, others see it as the reason they chose to purchase a franchise. One item I am often asked about is how resales of a franchise location are handled and what consent is required of the franchisor. It has been my experience that while franchisors technically have to sign off on the new buyer, it is rare that they don’t consult with all the players.

An Exit Strategy

You should expect to see an exit strategy before you are willing to put your money to work in a business. While angel investors are typically patient and willing to make long-term investments, they need to understand how they are going to achieve a strong return.

Resales of franchise units to other franchisees or outside buyers is very common. Also, with the significant interest that large private equity firms have taken in franchise systems in recent years (for example KKR’s purchase of the Neighborly brands or Eagle Merchant Partners’ purchase of Code Ninjas), the potential of a PE-backed franchisor’s interest in purchasing franchise locations is a possibility.

An Often Overlooked Asset

In summary, franchising not only supports an angel investor’s portfolio diversification, but its inherent attributes also align well with their overall investment criteria. Franchising, though it has been in play for decades, is surprisingly an often overlooked arena for thoughtful investors. However, given the interest that large PE firms are now exhibiting toward overall franchise systems and the amount of capital currently on the sidelines, expect to see the grassroots franchisee investment landscape begin to catch on with more angel investors.

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