FRANCHISE INVESTING: EVERYTHING YOU NEED TO KNOW ABOUT INVESTING IN THE $800B FRANCHISE INDUSTRy
Table of Contents
- An Introduction to Franchise Investing
- The Rise of Franchise Investment
- Why Franchise Investment Works
- Returns and Diversification in Franchising
- Investment opportunities with healthy potential returns
- Challenges and Risks of Franchise Investment
An Introduction to Franchise Investing
Investors have long thought of franchise ownership as a preferred method of achieving stable investment portfolio diversification. It offers high-yield returns, a predictable investment timetable, and resistance to both inflation and recession. The franchise model also offers a safe, low-volatility investment vehicle that’s regulated by the Federal Trade Commission (FTC).
Despite these benefits, the traditional franchise model presents barriers that deter many investors from participating. For instance, franchise ownership requires hundreds of thousands, if not millions in upfront investment – making it a tool primarily for wealthy investors.
Also, owning a franchise requires some level of experience with franchise management, which prevents many otherwise qualified investors from moving into franchising.
A third barrier for the average investor is that franchising requires a significant investment in time. The hours required to operate
a franchise location (for activities such as hiring, scheduling, and ordering) are often an issue for investors who simply do not have the time to spare.
These challenges have prevented many from investing in franchises.
First, let’s talk about franchising.
The Rise of Franchise Investment
Franchising certainly isn’t a new concept; it’s been around for more than a hundred years. Early brands such as Singer and Ford perfected their products and processes, then licensed them to resellers and dealerships. From these early successes, the modern franchise model was born.
A new wave of franchise ownership took off in the 1960s and 1970s. Brands like McDonald’s began licensing independently owned locations on the strength of brand recognition and evolving consumer preferences.
Today, more than 4,000 franchised brands across over 100 industries are operating 780,000+ franchised locations throughout the United States. In spite of the severe economic downturn caused by the COVID-19 pandemic, the International Franchise Association predicts that global franchise employment will grow by 3.5 percent by the end of 2021. During that same timeframe, franchise locations boosted by an expected post-pandemic economic recovery are set to add approximately 800,000 jobs to U.S. employment numbers.
With these statistics in mind, the potential for growth in franchise investment is exciting. Pre-pandemic, growth in terms of GDP averaged 4-5% YOY, while many franchise owners enjoyed returns ranging from 24.9% to 166.7% annually according to audited financial statements from franchisors.
This growth is expected to continue with the return of economic stability
looking to 2022. Industry analyst FRANdata notes that post-recession, franchise businesses often lead the way in both business and job generation, according to data from four previous recession cycles.
Why Franchise Investment Works
The numerous benefits of franchise ownership make it an attractive option to those with the time and capital to invest. A combination of low volatility and high potential return has made the franchise model a perennial favorite of investors looking to better diversify their portfolio and income streams.
Recession and Inflation Resistance
Unlike other asset classes such as stocks and bonds, holding real assets presents lower volatility and hedges against market downturns.
Franchise businesses offer a variety of goods and services, so they tend to be inflation resistant. In simple terms, inflation is an economic response to low supply and high demand for materials or services. As costs for materials increase, so can the price of products and services; thus, your franchise may realize increased profits during periods
of inflation. Additionally, investments with real assets benefit from appreciation. A profitable franchise can appreciate over time and provide a buffer against future recession and inflation activity while providing an inflation-adjusted income stream.
Regulation and Transparency
Franchise ownership falls under the governance of the FTC, and
fractional franchise ownership through FranShares is additionally regulated by the SEC. The SEC requires annual financial reporting in order to maintain transparency for investors.
This level of governmental oversight provides a measure of security for those considering investing in this asset class. While it cannot remove all risk from investing in a franchise, regulatory reporting allows potential investors to fully evaluate franchising as part of their investment portfolio.
The FTC requires every franchise to have a Franchise Disclosure Document (FDD). The FDD outlines everything about a franchise for a potential investor to make a decision. This includes everything from the leadership team, affiliates, company history, litigation, the financial performance of franchisees, and an outline of all costs in the investment.
Brand recognition is one of the most powerful aspects of the franchise model. Franchise licensing offers new business owners the benefit of a turnkey experience, with a proven road map, centralized support, and standardized marketing materials and process. Under a franchise model, investors can mitigate the common risks associated with establishing or investing in a small business.
From a consumer perspective, franchise businesses represent a known quantity; customers know exactly what to expect of the goods and services provided as well as the level of customer service they will receive. This brand recognition gives new franchise locations a boost in the early days of operation, allowing them to “hit the ground running” as they move toward profitability.
While brand recognition is an important aspect for many franchise brands, there are many franchises that don’t benefit from brand recognition but more from the systems in place. For example, most home repairs after accidents paid by insurance companies are fixed by franchise companies. If you looked up these companies you wouldn’t know any of them but they provide a superior service and track record that allows them to be top of listings and partnered with your insurance
provider. Ever needed to find a senior care provider for a loved one? This is a highly competitive sector in franchising but you wouldn’t recognize any of their names until you started doing your research.
Alternative asset classes attract sophisticated investors for one main reason: They offer a historically better return on investment than other options available to retail investors.
Any investor can participate in alternative investing thanks in part to the JOBS Act (Jumpstart Our Businesses Startups Act), which allowed for the democratization of alternative investments with SEC regulations.
Regulation A+ of the JOBS Act is in essence a “mini-IPO.” The disclosures and accountability protect investors just like publicly traded companies do, which is why you can buy/sell stocks as a retail investor.
While alternative assets often require a higher investment and involve higher risk, they can often yield returns greater than the S&P 500, depending on the investment type, horizon, and economic factors at play. Franchise investment offers the high returns associated with alternatives, while mitigating the risk of other asset types.
When comparing the typical retail investment vehicles, franchise investment is an obvious choice in terms of return potential. Here are some reasons why franchises are a superior asset class:
The stock market rate of return has been approximately 9.6% percent over the last 100 years, though returns can vary widely in a given year
The historical bond return rate averages 5% percent.
Current CD interest rates range from 0.5% to 1% percent APY with typical investment windows of one to five years. The liquidity of funds varies by CD.
Venture capital funds offer higher returns averaging 25% percent; however, this asset class is primarily available to accredited investors and volatility in venture investment tends to be high.
Returns and Diversification in Franchising
Alternative assets offer more than just diversification; investment vehicles such as franchise ownership feature far higher returns than are typical of the stock or bond markets. Some alternative assets, such as venture capital investments, feature higher risk. Franchising offers similar return potential with more stability using an income-generating asset that is typically found only in real estate or dividend-paying stocks.
While those new to the franchise concept typically associate it with food service, the diversification potential within this asset is high. In the U.S., there are more than 4,000 options for franchise ownership, spanning industries from fitness and personal care to home services, pet care, and waste management. Each of these presents different investment opportunities, all with healthy potential returns.
Investment opportunities with healthy potential returns
As part of FTC regulation, every franchisee must submit a Franchise Disclosure Document (FDD) that includes information from start-up costs to Financial Performance Representations. Here we’ve highlighted franchises from our favorite industries.
Challenges and Risks of Franchise Investment
From inflation resistance to brand recognition to high yields and more, the advantages of investing in franchises are immense. Like any other investment opportunity, however, franchise investment is not without its risks and challenges. Investing in a franchise location requires knowledge on the part of the investor, as well as a functional understanding of how the franchise business model works.
Retail and casual investors looking for a passive income stream often run into three primary obstacles to taking advantage of a franchise opportunity.
- Up Front Costs — Investment capital is one of the primary barriers to establishing a franchise Costs for licensing, real estate, materials, and fees start at $100,000 for just the cash outlay portion of your investment. Often, franchise owners need more than $1M in additional liquid assets. Depending on your industry and location, it can take many years to achieve profitability.
- Time — Traditional franchise investment is not a purely passive income Although running a franchise location is easier than starting from scratch with a single-location business, it is still a time-consuming process. As the franchisee, you are responsible for implementing the management and marketing plans laid out by your franchisor. Standard operations like hiring, personnel management, ordering, and scheduling all require a time investment.
- Operational Expertise — As with running any business, operating a franchise business requires a certain level of business management knowledge. Franchise operators must be able to perform due diligence on the investment and must understand the market forces at play in establishing and running a franchise While the licensing agreement entitles the franchisee to benefit from branding and marketing, the success of the location hinges heavily upon the ability of operators to successfully run and promote the business.
With these challenges in mind, many investors decide that franchise ownership doesn’t make sense for their financial situation or their lifestyle. While these investors could benefit from the financial rewards and stability of franchising, they may lack the capital, time, or knowledge required to run a successful franchise.
It is up to you to decide if franchise investment is for you or not judging and keeping these factors in mind.