Franchising Explained: Costs, Earnings & Growth

I have a client called Shoebebebeauty. When I started with him, he had just a few locations and now he's got a hundred plus operating and no one's probably ever heard of him. And he does eyebrow threading. You know, that's his franchise. Who would have thought of that? They franchise that. They've got 50 of those or a hundred? That's amazing. Hi, welcome back to How Much Can I Make, the podcast all about jobs and careers. I'm your host, Meravo Zeri. Before we start today's show, I want to tell you that next week's episode is with Nuta Gautier, who started a Thai spa business with just $1,000 and grew it into eight locations and 13 franchise spas. So today's conversation ties in perfectly because I'm talking with Dr. Tom Dufour, a franchise consultant who has helped hundreds of businesses grow through franchising. So let's start my conversation with Tom and find out how the business of franchise really works. Tom, thanks for coming on the show. So let's start by telling us what exactly you do as a franchise consultant. What I do with franchising is I work primarily with what I describe as successful entrepreneurs and I help them franchise their businesses. So typically it's a founder led organization and they've created a successful business of some kind of say, I want to grow or I think I want to do this. And so franchising is one of those options to expand and we help them get set up and get a strategy and a package and an offering put together so that they can go to market with it. Okay, so when I talk to friends and people and tell them franchising, they think, oh, okay, I'll franchise and it's a passive income. What is the truth about that? Big picture, yes, it becomes more of a form of passive income. But I'm of the mindset that if you own a business of any kind, you still have to be involved. So the way passive income works in the franchise world is once you franchise a business and you sell some franchises, you're now earning royalties, you share in the revenue that's generated at each individual franchise location. So in that instance, yes, you're generating revenue from a local, locally owned and operated franchise that's getting sent back to corporate. However, for that, there are some duties or responsibilities that you have as a franchise or so you still have to train them and coach them and support them. And well, franchising to me is really that idea of taking a business that you've already created, if you're the founder, no one in the world knows more about this business than you do, and you're essentially creating a coaching business. So is it a form of passive revenue or passive income? Yes, but there are still some, again, those responsibilities to train franchisees, support them, help with marketing. It's not just a set it and forget it. What is the process? Let's say I have a whatever successful business, I come to you and say, listen, I want to franchise. What would be the process like? So if you want to franchise, what one of the first things I'd like to take a step back on is just take a look at and say, well, is your business ready for franchising? Or is it quote, franchise a bowl? What makes it ready? Exactly. So we look at three big check boxes to say, if you can check each of these, the business, there's a good chance of business is in a position for franchising. And so the three check boxes are number one, do you have a profitable prototype? It seems common sense, but I've been doing this over 20 years now. And there are lots of people that will come say, I've got this great idea, I want to franchise it. I said, well, let's get the first one open and, you know, make some money and get it profitable and then build a system around that. So so one, I have a profitable prototype, which makes sense. And sometimes owners will say, well, my tax return says, you know, that I don't make any money. So well, but what we're really looking at, are you paying for your lifestyle out of the business? Some owners write how they, depending on how they pay themselves. Oh, yes. Okay, well, that's what we're looking at for a profitable prototype. The second piece then is, can you teach someone how to run your business in a reasonable time period? An example to think about is if you were to train a general manager, how to run day to day operations. And could you train that person in maybe a few days or few weeks or even up to maybe two or three months on how to run that business? And if that answers, yes, okay, then we can move to the next checkbox, which is, do you have potential customers on a national basis? Is it likely you would have customers if you were to open up in different markets across the country? And ideally, internationally, why not? You never know where this could expand into. Oh, you deal with that too? With international? Of course. Oh, wow. Yes, very much so. That seems complicated to me. It is and it isn't. Franchising internationally actually helps make international expansion, in my opinion, a lot less cumbersome and a lot easier to understand. And the reason why is usually you're signing a master franchise agreement or a master license agreement for a country, then that master franchisee's responsibility or job is to now sell franchises in their area and train them and support them and help them out. And what I found why it's a lot easier than say opening up company-owned locations is if it's company-owned locations, you now have to hire local lawyers and figure out all the local ordinances and laws and restrictions and rules and the cultural differences, you know, and so when you have a master franchise or a master license that buys rights, usually it's someone who lives in that country, grew up in that country, went to school in that country, you know, they've got connections and family and friends, maybe other businesses there. So that's a big leg up as you start expanding internationally. You're now helping your job as the franchisor is to support the master franchise who then sells trains and supports in that local region. And usually there's a smaller revenue share that comes back to you at corporate, but it's a much faster pathway in many cases to expand internationally then. Why is it good to do both for the franchisee and the franchisor? Why is it good to do a franchise? Great question. So from a franchisee standpoint, the reason franchising makes sense in the value add is it gives you a system and a methodology and processes on how to run a business model that's been validated, that's been proven. So very often you find that a lot of franchisees tend to be middle-aged. They're in their 40s or 50s. They've worked a career for 20, 30 years. Their kids are maybe a little bit older and they're saying, I want to go into business for myself, but I don't want to take the risk on of figuring a business out. What business would I go into? I don't know how to do all that. So the benefit is they get a system, a process, they get training, they get support when the franchising is done well and depending on how large the franchise system is, I work with everything from brand new startup franchise systems that have zero, one or two franchises in their system all the way up to brands that have hundreds or even thousands of franchises in their system. And so each system has its pros and cons based on the size for why a franchisee might want to get into it. But the bottom line is they all have a common thread is helping that franchisee get launched faster than they otherwise would have on their own and avoid a lot of common missteps. What usually are the percentage? Let's say I buy a franchise of whatever, a juice bar. Yes. What percentage do I have to give the franchisor every month or every quarter? Yeah. So typically for the juice bar situation, it's probably going to be a five or six percent royalty on gross sales that would go to the franchisor. And who checks the books? Well, in today's world, it's much, much, much easier than it ever has been because of just technology. So the point of sale system, quick books, electronic bank statements, it's hard to hide stuff. And plus most customers today, very few customers pay with cash anymore. Everything's recorded electronically so you can validate and verify that. But for most, for example, in the situation with the juice bar, it's likely that it's some kind of common point of sale system that's being used. Well, the franchisor and the franchisee are going to be able to see the transactions, what revenue came through. What is the perfect business or industry is good to go franchise? Boy, that is a big question. And I think if I knew the answer to that one, I might not be on this podcast here. But what I have found in the years I've been doing this, when I first started in franchising, I thought I had it figured out, I was like, oh, you need all these ingredients. It makes a perfect franchise. And then it's funny, the funny thing, time and weathering, little wisdom comes as you get older, you realize, oh, wait, franchising is just a method of distribution. That's all it really is. It's a method of distribution. And so I really consider myself a distribution expert. Franchising is really ideal for anyone that owns a business or, and it's saying, how can I get more of my products or services in front of more customers? Franchising applies to dozens. I mean, it seems almost countless industries, because if you want to grow, franchising can tend to apply. It doesn't mean that you ought to franchise, though, just because you check those three boxes and franchising could fit. Most people that I've spoken with over the years in franchising decide not to franchise. What's the obligation of the franchisor? The primary obligation of the franchisor that they're committing to is to protect the brand and system at all costs and from all threats, internal and external. How does he make sure that the franchisee keeps his brand, his image, his service, all of that? Exactly. Part of that protection is making sure that the franchisees are following the system and the standards. So this is where having a manual comes in place, right? Having manual and brand standards set up. That's part of what we help our clients establish is building out these kinds of manuals and documents. Part of that is having regular coaching calls or appointments with your franchisees. Well, some franchise systems do that very well, where they have great support and great... That's how you're helping ensure those standards. And others are more laxadaisical, where they don't provide that kind of support. And therefore, oftentimes you find the brand standards start to drift from one franchise to another. What's the biggest expense to go franchise? So the biggest expense for a franchisee is generally the startup cost of just launching the business. But do they have to give certain amount to the franchisor before they even open a place? They do, right. That's called the franchise fee. That's the upfront fee that they have to pay. And in today's world, from a data source that I pull from, there are about 2,500 franchises in this database. And the average franchise fee in today's world is just over $43,000. That gets paid to the franchisor. When you think of it, it's a big chunk of money for most founders or entrepreneurs. You realize, well, $43,000, that is a lot of money. But I spent a lot more than that making a whole lot of mistakes. And so that's where the advantage for the franchisee comes in to say, I'm just kind of prepaying for all of the learnings that have been figured out along the way. And they're going to get trained and supported. That's part of what that usually comes along with. For the franchisor, the big cost for them getting the documents in the franchise system set up correctly. And so that's where a service like ours comes into play. They can hire us as a third party consultant instead of hiring full time staff. Or for the do it yourselfers out there that try to franchise on their own, the big expense then becomes, what did they miss along the way? It's like the old adage, you pay now or you pay later. And usually paying later is a little more, it costs a lot more. So that's the idea with that. But how do you protect? Let's say I come to your cell, say, listen, I really want to buy a franchise, blah, blah, blah. I meet with the owner, get a little bit of training. And then I say, okay, I can do it by myself. I don't need to buy the franchise. How do you protect yourself? Yes, a great question. And I've been involved with many franchise sales over the years. And that question comes up in almost every franchise sale, where the franchisee says, well, you know, why don't I just do this myself? Right. And the short answer for the franchise or is to say, well, if that's kind of your real mindset that you're thinking, then I would encourage you to do that. That's how we advise our clients is encourage the franchise buyers, not buy your franchise and go start their own. Because if you're too entrepreneurial and you want to tinker with things and change things and move things and do it your way all the time, franchising is not going to be a great fit. You're going to feel constrained. You're better off just not buying the franchise and going and doing it on your own. And from the franchise or standpoint, usually in the sales process, you're not giving away all of your trade secrets and all of the little nuances that have been figured out over the years of running the business. You're not giving all of those away. That's what I was thinking. If I franchise a restaurant, I have to give out all the recipes and everything and, Buf, it's gone. I cannot protect that the owner of the franchise will not give it to their friends and family or whatever. Sure. Well, there's always that potential risk. Now, part of the contract and in almost all states, the non-competes are enforceable so that a franchisee can't just open up, you know, let's just say a Domino's pizza or something, and then they can't pull the sign down and call it John's Pizza. They would not be able to do that for at least two years in most instances. But that brings me back to the international. How can you see what's happening in your international market? Somebody monitors those all the time? Sure. There's monitoring happening. And that's where in I actually like the master franchise or master license model because the master is now responsible. They have a vested interest because they get a share of the royalty now, the master will. Is there opportunity for things to go missed, to be people to be deceived, of course? But I found that to be very rare. Let's say I'm a franchisee. Let's take a restaurant for an example. And I added more stuff to the menu that the original owner didn't have. What happens in that case? Do I divide the profits from my new idea or everything has to go? Five percent's got to go. Five percent of everything. Okay. And first, hopefully, the proper course of action, the way the contracts are all structured and the way the manuals are written, is that there's a process if you want to add something new to the menu. So franchisees are required to get approval first before new menu items come into play. Now, there are some instances, for example, I think of an ice cream shop that might franchise and they might let franchisees pick one or two flavors that they every month, that they get to come up with their own flavor and they can do whatever they want. And that's just kind of a freebie that they don't really need approval on, that they can just do. That's great. But in most instances, anything you're doing, a menu change, a service offering, needs to be approved by corporate, by the franchise or first, before it's allowed to be implemented. What's the most common mistakes both sides make? I would say the biggest mistake that new franchisors make is assuming that selling franchises is easy. And it and so many people out there think, oh, it's easy to sell a franchise. Oh, yeah, no problem. We can sell like a hundred of these things. Well, if it was that easy, why doesn't everyone have a hundred locations? It's not that way. And so it just takes time. It takes patience. We hear the stories of brands that sell 200 franchises in five years or 500. Those are the exception. And then the second part for the franchisee, what do they assume? The assumption that I see franchisees make is, well, if I buy this franchise, this is going to be an ATM machine for me. All I do is I turn on the lights and the cash just comes spitting out of this thing. It's like, now I'm a millionaire overnight. You're working a proven system. You have a process. There's a brand. There's a website. All of that's in place. It still requires elbow grease. But that brings me to the question of, let's say I bought a franchise and then a year down the line, it's not working that well. I have a better idea. I want to get out. What are the buyout options? The key thing in when you're a franchisee is it's your business. If you're a year or two into the business, you can sell it. There's actually in franchising, similar to that they call the seven year itch in marriage, well, it's a seven year itch in franchising too. Seven years is when a franchisee start to kind of phase out of the franchise system. They're kind of ready for the next thing. And the franchisor, they have some rights in approving the buyer, but in general, if the buyer is qualified, the franchisor will generally will approve. Right. It's in their interest, of course. Exactly. So that's option one. Option two is you could go back to the franchisor and say, do you want to buy me out? I'm ready to exit. And if you just say, I'm done. I can't do this anymore. I just want to shut it down. Your best bet as a franchisee is to work with your franchisor, call them, work with them, talk with them, make an effort to show that you tried to sell the business. You tried to bring in an alternative partner to do something so that you can get released from your contract. Because typically that first term of a contract is 10 years. And if you terminate the contract early, if the franchisee does, you could owe up to two years of royalty as essentially a buyout as part of that or an exit penalty. But you said something interesting. 10 years is the deal. What happens by the year 11? So then the franchisee has an option to renew the contract. So a typical contract is it's actually a 20 year life cycle with an initial 10 year term and then two five year renewal periods that are part of it. At the end of that 10th year, the franchisee could say, you know, I think I'm done. So you did hundreds of businesses, I think 600, right? To something like that. Oh yeah. That's a huge number. Are you a lawyer also, by the way, or you just a consultant? I am not a lawyer. I'm a consultant. Okay. Well, how did you pick this lane? Like most people in franchising, it was kind of by accident. I actually got into this, was my first job right out of college. And I was a business management major. And I just remember I wanted to be a management consultant. I had no idea what that meant. I just thought that sounded fun and interesting. And so my first job as a management consultant ended up being in the franchise world helping entrepreneurs franchise or business. I was a junior consultant when I started. And if married these things I love, I love entrepreneurship. I love the American dream. And so it's like, wait, I get to help entrepreneurs grow their business by helping other people become entrepreneurs. What's wrong with this picture? This is awesome. And so I fell in love and have been here ever since. What separate businesses that successfully scale from the ones that struggle? The fundamental difference that I found between brands that do well long term versus those that don't is when they the franchise or is constantly asking, how can I help my franchisee make more money? It's franchisee focused first. Because what when they're thinking that then they're also thinking of product innovation, customer service support, all of these things that go to ultimately impact the end customer for the business where franchisee or is get into a lot of trouble. In my opinion is when they stop asking, how can the franchisee make more money? And they start asking, how can I make more money? When that's the first question, well, that's when we hear these problems of franchise systems that overcharge for napkins and plastic spoons. You know, it's like you're nickel and dining your franchisees and slowly bleeding them to death. So you said something that turned on a light bulb. You said the franchisor is coming up with a new product. Is he committed to give whatever new product to the franchisee? Yes. So like a new menu item at a restaurant or if you own a, I was a franchisee, I owned a restoration franchise for many years. And in the beginning, when I first bought it, the only services we offered were if somebody's house floods or business floods, you go in and clean it up. And that was it. And then over time, they started adding in other things that you could do to help that same customer. So you could offer that. In most instances, the franchisee over time will eventually be obligated to offer services or products as they're added into the menu or into the services. Now, to your earlier question about can a franchisee kind of come up with their own ideas and, you know, the franchise folklore stories of in McDonald's is a great example of franchisees that it was franchisees that came up with the Big Mac and adding breakfast and the filet of fish. You know, these are, I didn't know. Yes. These were things that came up from franchisees. Do you have a story of a success franchise that you helped put together or and one that failed maybe? Sure. Sure. I'll share a failure story, I guess. And the common fail story that I see with clients that we work with that, that launch into franchise systems, there are two common fail points I see. The first is they hire us and they bring in good lawyers and, you know, they go through the time and expense of doing this. And then they, they market for six months or a year or 18 months and they say, well, I guess I haven't sold one. I guess it's not for me. And they just shut it, shut it down. It takes time. You're selling this dream to someone about owning their own business. And many of these people that are coming in, they've never owned a business. Those are the most common instances. And then the second one is when the franchise or sells the franchise system to a new buyer. In franchising today, private equity venture capital like a lot of other industries is pouring into franchising. And depending on who the buyer is, is this an investor or private equity group that is committed to franchising? Or are they just looking to buy it because they think it's a good business for them to own and occupy? And so we find in that transition from founder led to now investor led that that creates a lot of friction many times the founder led is asking the question, how can I help my franchisees make more money? And now when it's investor led, they're saying, how can I make more money? You know, so it's a paradigm shift. And then on success side, my favorite successes are the brands these clients that I work with, they have one, two or three successful operating units of something and they franchise it. And now they sell 50 franchises, 100 franchises. So I have a client called Shoe Beauty. And when I started with him, he had just a few locations and now he's got 100 plus operating and no one's probably ever heard of him, you know, it's amazing with what he's doing. And he does eyebrow threading, you know, that's his franchise. Oh my god, I could have done it. That's easy. Wow. That's amazing. It is amazing. Do you demand that the franchisor will have more than one location for proof of concept? One profitable prototype or existing unit from my vantage point will work. And I've seen it work more often than not. If I want to buy a franchise of whatever kind, where do I go to look for it? There are three big buckets of advertising buckets that produce franchise sales. So the number one category probably no surprise, it's internet, internet marketing of some kind, right? Probably no surprise there. And that accounts for almost exactly 50%, 50% of all franchise sales come through some form of an original internet lead. But as you would expect, it also has the lowest closing percentage. That's the big, big category. Then the second category is what I call referrals. These are referrals, friends, family, customer, suppliers, people that are familiar with either the founder or the brand, their ambassadors, their endorsers, they love what you're doing. And they account for, depending on the data source, anywhere ranges from 15 to 20% of all franchise sales in a given year. And it has the highest close rate at eight to 9%. That's a pretty good probability there. And then the third category is franchise brokers. And so these are people that I described, they're very similar to a real estate agent. They represent franchise buyers. That's not what I do. I work with the franchise or, but there are buyer side representatives, just like a real estate agent, they function in the same capacity. So those are called franchise brokers. And the broker kind of plays like matchmaker, they're connecting the franchise or to the franchise buyer, and they get paid a commission. So if, if that person ends up buying the franchise and they get a commission, no, they don't buy a franchise, no commission, you work with a flat fee or a commission because some projects can take you a long time, right? They can. We work on a flat fee with our clients. So they, it's fixed fee, so they know exactly how much it's going to cost. Is it according to how much their business is worth that you could determine the flat fee or you got your flat fee? Most clients are going to spend somewhere around $50,000 plus attorneys fees and other things to get into the franchise world. Okay. But when, once they do the first one, the second one is a lot easier, right? Oh, yeah. Yeah. Once it's set up, it's built, it's ready to go. There are some maintenance things you have to do every year for franchising, but the big cost is just getting it set up and going. And then you sell one franchise or a thousand franchises, your cost, it doesn't go, it's just a flat fee. It's, it's right there for you. Can you franchise your business? Yes, I can. I have thought of that. And there have been other consulting organizations, I mean, clients I've worked with that are consultants or marketing agencies that we help franchise. So absolutely. I have not done that yet, but that is definitely something that I have considered and explored for sure. All right. Hopefully, I can't believe I didn't think about the eyebrow plucking. I could have started such a business. Yeah, that's exactly right. That's a thing that's amazing with franchise. You think, who would have thought of that? They franchise that they've got 50 of those or 100? That's amazing. That's amazing. And it's in America? Yes. He's making good money, I bet you. I'm sure he is. Absolutely. Yeah. Yeah. All right, maybe it will come my way. Tom, thank you so much. That was totally educational. Well, thank you for having me. I really appreciate it. Of course. Of course. This is it for today. If you enjoyed the conversation and want to hear more shows about entrepreneurs, business owners, and people building careers in all kinds of industries, head to How much can I make that info and check out our business and entrepreneurship category? We've got lots of interviews and real world insights about what it takes to build a business and how much people can actually make doing it. And I will see you next week.