Franchising – Obtaining Financing and Rapid Market Penetration

 Companies that plan growth with multiple locations and wide spread distribution of products or services may want to consider franchising/licensing as an expansion strategy. Franchising is a legal definition that is specifically regulated by the FTC and is further regulated by a number of states.  Licensing refers to a broad range of rights licensed to other people that may be a franchise or may be a dealer/distributorship or other arrangement to sell the rights of one company to another.

Merger/Acquisition Strategy

A new trend in franchise growth is a more complex strategy to purchase independent businesses in one vertical market that lack sophistication and systems that would have enhanced their revenues and profits.  The franchise company or its franchisees under the direction of the franchise system purchase this independent operators in a new geographic market, convert them to the new system and greatly increase gross revenues.

  1. This strategy gives the franchisee and the franchise company very rapid penetration into a new market and makes debt financing much easier to obtain. Banks and other sources like the idea of established cash flow, new management, new systems and a regional or national presence.
  2. The strategy is also attractive to certain types of private equity groups since it somewhat mirrors a roll-up strategy – but with much more control and proven results.

Franchising is also a liquidity strategy for small to midsized companies that have multiple locations and now want to increase their liquidity.  By converting company-owned units to franchises the company is able to recoup their investment, get a return on the investment and keep the franchisee as a royalty paying franchisee for years.

 What to expect:

  1. Franchising allows the company that owns intellectual property, trademarks, etc., to sell those rights to a third party under a restrictive agreement for a cash payment, on-going royalties and the third party undertakes all of the costs of establishing the business.
  2. The third party business owner (Franchisee) provides the management and in some cases may have the rights to greatly expand the franchise system in a designated area or region. The key advantage in the management is a business owner, controlled in many ways by the franchise agreement, who has a significant investment in the success of the franchise.  If done properly this profit incentive greatly enhances rapid market penetration.
  3. As franchise systems mature the franchisees may become the target for the franchise company to purchase them as company-owned operations and in effect it becomes a roll-up strategy for the franchise company and a liquidity strategy for the franchisee.