WEBVTT 1 00:00:00.000 --> 00:00:03.680 I had two different businesses that approached me, both had franchises open. 2 00:00:03.680 --> 00:00:06.640 I had almost an identical conversation with both, and I'll tell you one of them, 3 00:00:06.640 --> 00:00:08.480 which is a whitening, a teeth whitening business. 4 00:00:08.480 --> 00:00:11.280 What I break down is how I help them walk through this decision of, 5 00:00:11.280 --> 00:00:14.240 should we go more franchises, or should we go more privately owned? 6 00:00:14.240 --> 00:00:16.240 And it really comes down to four main variables. 7 00:00:16.240 --> 00:00:21.360 Number one is the cost versus the return of every dollar you invest in opening more locations. 8 00:00:21.360 --> 00:00:24.720 The second is the actual effort that it takes to open a location, 9 00:00:24.720 --> 00:00:29.360 which comes down to, is it centralized or decentralized in terms of where the work is being done. 10 00:00:29.360 --> 00:00:34.000 Centralized, and it means that there's more operational drag at the franchise or level. 11 00:00:34.000 --> 00:00:36.800 If it's decentralized, there's more work to the franchise Z. 12 00:00:36.800 --> 00:00:38.960 The third thing was actually looking at this at scale. 13 00:00:38.960 --> 00:00:41.840 If you have a number you saw for, which almost every entrepreneur that I know, 14 00:00:41.840 --> 00:00:44.960 who is in a local chain, wants to solve for some big exit. 15 00:00:44.960 --> 00:00:48.160 Usually it's 50 or 100 million, and if you want to own a forever, totally fine, 16 00:00:48.160 --> 00:00:51.120 you still think about building it as an asset, even if you're never going to sell it, 17 00:00:51.120 --> 00:00:53.440 which is transparently like, we don't want to sell anything anymore. 18 00:00:53.440 --> 00:00:56.000 We want to hold and grow, buy and build, baby, that's what we do. 19 00:00:56.080 --> 00:00:58.720 But we also understand that so much more is do want to sell and 20 00:00:58.720 --> 00:01:03.680 reversing your net worth goal into what you actually have to open at a location level 21 00:01:03.680 --> 00:01:07.440 between franchise and local privately owned ones that you own all of them 22 00:01:07.440 --> 00:01:10.720 is a good math number to know because it makes the decision much, much easier. 23 00:01:10.720 --> 00:01:13.040 And then finally is a little bit of a personal thing, 24 00:01:13.040 --> 00:01:14.880 which is which type of entrepreneur are you? 25 00:01:14.880 --> 00:01:16.480 Are you more of a promotional entrepreneur? 26 00:01:16.480 --> 00:01:19.760 So you love the sales of the marketing and selling the franchises, selling the franchises, 27 00:01:19.760 --> 00:01:23.920 or are you more of a product-driven, operational leadership-driven entrepreneur 28 00:01:24.000 --> 00:01:27.120 who's like cool with a longer time rise and just loves investing in people and building kind 29 00:01:27.120 --> 00:01:28.960 of a big thing. So we'll break down all four of these. 30 00:01:28.960 --> 00:01:30.400 Here are the business metrics that are important. 31 00:01:30.400 --> 00:01:33.040 Top line per location is about 500,000-year. 32 00:01:33.040 --> 00:01:35.680 Bottom line per location is 250,000-year. 33 00:01:35.680 --> 00:01:37.360 The cost to open was 50. 34 00:01:37.360 --> 00:01:41.520 So I spend 50, I make 500 top line, I keep 250 a year later. 35 00:01:41.520 --> 00:01:42.480 Really good numbers. 36 00:01:42.480 --> 00:01:46.640 If you have a business that gets like less than 100% return on capital, meaning it usually 37 00:01:46.640 --> 00:01:51.600 makes more sense to franchise right off the bat because the return on capital is too slow 38 00:01:51.680 --> 00:01:56.400 and not big enough. If you look at a McDonald's, for example, it costs 1.1-1.2 million 39 00:01:56.400 --> 00:02:00.160 dollars to open a McDonald's, they make 150,000-year on average afterwards. 40 00:02:00.160 --> 00:02:03.120 So you're looking at like a 15% rate of return, right? 41 00:02:03.120 --> 00:02:07.120 Versus spend 50, make 250, you're talking about 5x, right? 42 00:02:07.120 --> 00:02:08.880 Very different. And this happens all the time. 43 00:02:08.880 --> 00:02:11.520 I've seen this with moving businesses that have crazy returns on capital. 44 00:02:11.520 --> 00:02:13.840 Seeing with the gym business doesn't really matter with the businesses, 45 00:02:13.840 --> 00:02:18.000 but you have to switch from your business hat to your investor hat and start looking at your 46 00:02:18.000 --> 00:02:21.520 business investment because once you start generating real money, you have to think, 47 00:02:21.520 --> 00:02:23.360 where is the best place I can put my money? 48 00:02:23.360 --> 00:02:26.000 And if opening another location, 5x is your money every year. 49 00:02:26.000 --> 00:02:30.000 You go from 1 million to 5 million, 5 to 25, 25 to 125. 50 00:02:30.000 --> 00:02:32.960 That becomes a very attractive machine if you expand the time horizon. 51 00:02:32.960 --> 00:02:34.000 We have this business. 52 00:02:34.000 --> 00:02:36.480 These individuals had decided to do the franchise. 53 00:02:36.480 --> 00:02:38.960 So this is what their franchise economics looked like. 54 00:02:38.960 --> 00:02:40.960 They would get 7.5% of top line. 55 00:02:40.960 --> 00:02:44.480 It's a royalty top line and it's usually some sort of marketing fund that everyone 56 00:02:44.480 --> 00:02:46.480 chips into so they can give national branding. 57 00:02:46.480 --> 00:02:49.840 Some franchises do flappies, some do royalties, it doesn't really matter. 58 00:02:49.840 --> 00:02:51.760 There's a certain percentage of revenue that you're going to collect. 59 00:02:51.760 --> 00:02:54.000 Now, these guys are charging 7.5. 60 00:02:54.000 --> 00:02:59.760 And so on 250, it was like $35,000 per year that they're making from the franchise, okay? 61 00:02:59.760 --> 00:03:00.560 Stay with me. 62 00:03:00.560 --> 00:03:05.280 Now, if the franchise runs at the same margins that the individual locations is, at 50%, 63 00:03:05.280 --> 00:03:10.960 so $20,000 of what they're going to make in net earnings at the franchise or level, 64 00:03:10.960 --> 00:03:13.360 per location that they open, here's the kicker. 65 00:03:13.360 --> 00:03:16.640 And this moves us on to our second kind of variable here. 66 00:03:16.640 --> 00:03:19.040 You move past the first checkpoint and you're like, okay, 67 00:03:19.040 --> 00:03:20.480 our economics are pretty good. 68 00:03:20.480 --> 00:03:22.720 Like, we're over 100% we're in that line. 69 00:03:22.720 --> 00:03:24.320 But now it's like, well, how hard is it? 70 00:03:24.320 --> 00:03:27.760 If you have $20,000 in net earnings per franchise you open, 71 00:03:27.760 --> 00:03:31.520 and you've got 250,000 per location that you open on your own, 72 00:03:31.520 --> 00:03:34.640 the franchises get usually two times the multiple 73 00:03:34.640 --> 00:03:36.720 that a brick and mortar local chain will get. 74 00:03:36.800 --> 00:03:40.640 So they might get like 15 times earnings in terms of the enterprise value, 75 00:03:40.640 --> 00:03:42.320 what an investor might buy for it. 76 00:03:42.320 --> 00:03:45.120 Because franchises usually have a certain amount of open, 77 00:03:45.120 --> 00:03:46.960 and usually more have yet to be open. 78 00:03:46.960 --> 00:03:50.400 And so an investor is willing to pay 15 times today, 79 00:03:50.400 --> 00:03:52.240 because they already really know their peg. 80 00:03:52.240 --> 00:03:54.800 If nothing else changes, a 5x multiple, 81 00:03:54.800 --> 00:03:56.480 because they know the other 200 are going to open. 82 00:03:56.480 --> 00:03:57.600 Guaranteed is legal. 83 00:03:57.600 --> 00:03:58.400 Passed to happen. 84 00:03:58.400 --> 00:04:02.160 Versus getting 8x on the individual locations. 85 00:04:02.240 --> 00:04:06.800 8x on 250 would be $2 million versus 15x on 20, 86 00:04:06.800 --> 00:04:08.240 which would be 300,000, 87 00:04:08.240 --> 00:04:11.040 which means that for every location you open at the franchise level, 88 00:04:11.040 --> 00:04:14.560 you add $300,000 to the franchise valuation. 89 00:04:14.560 --> 00:04:16.960 For every location you open on the privately held side, 90 00:04:16.960 --> 00:04:18.720 you would add $2 million. 91 00:04:18.720 --> 00:04:22.160 So that then informs how hard is it to open these locations? 92 00:04:22.160 --> 00:04:23.280 What is the constraint? 93 00:04:23.280 --> 00:04:25.280 If we have a super decentralized model, 94 00:04:25.280 --> 00:04:27.440 meaning the franchises do most of the work, 95 00:04:27.440 --> 00:04:30.720 then it might mean that we could open 10 times more franchises 96 00:04:30.800 --> 00:04:32.160 for the same effort as opening one. 97 00:04:32.160 --> 00:04:34.000 At that point, it might make more sense 98 00:04:34.000 --> 00:04:36.160 to open more franchised locations. 99 00:04:36.160 --> 00:04:38.400 If it's super centralized and you're doing most of the work, 100 00:04:38.400 --> 00:04:39.840 then sometimes it makes a lot more sense 101 00:04:39.840 --> 00:04:42.640 to actually just keep opening locations on your own, provided. 102 00:04:42.640 --> 00:04:43.920 The return home capital is there. 103 00:04:43.920 --> 00:04:45.440 You don't need to open, spend a million dollars 104 00:04:45.440 --> 00:04:47.600 to open a facility to make 200 grand, right? 105 00:04:47.600 --> 00:04:49.840 And the numbers pencil out, 106 00:04:49.840 --> 00:04:51.600 where you just look dollars and cents 107 00:04:51.600 --> 00:04:53.760 if I want to have a $100 million exit, 108 00:04:53.760 --> 00:04:55.280 which you can't have an exit or not, 109 00:04:55.280 --> 00:04:57.760 but you can still always build as though we're a sellable entity. 110 00:04:57.760 --> 00:04:59.840 We will always build an asset so that it is sellable, 111 00:05:00.000 --> 00:05:01.200 not so that we sell it. 112 00:05:01.200 --> 00:05:04.400 So 100 million means 50 locations open privately, 113 00:05:04.400 --> 00:05:07.920 or 333 locations open with the franchise. 114 00:05:07.920 --> 00:05:09.280 And so you have to look at that and think, 115 00:05:09.280 --> 00:05:12.320 okay, if I can open, let's say, one or two locations a month, 116 00:05:12.320 --> 00:05:13.920 which most franchised locations do, 117 00:05:13.920 --> 00:05:16.160 then it would only take me like two, maybe three years 118 00:05:16.160 --> 00:05:17.040 to get to this number. 119 00:05:17.040 --> 00:05:19.280 Now, what's my rate of opening at the franchise level? 120 00:05:19.280 --> 00:05:22.080 Oftentimes, especially when I talk to franchised doors, 121 00:05:22.080 --> 00:05:25.280 they're usually limiting factors internal, not external. 122 00:05:25.280 --> 00:05:27.120 The problem is internal, 123 00:05:27.120 --> 00:05:28.560 then it means maybe they can open like, 124 00:05:28.560 --> 00:05:31.280 rear four locations for the franchise, 125 00:05:31.280 --> 00:05:33.360 which means they would actually take them longer 126 00:05:33.360 --> 00:05:34.560 to get their ultimate outcome. 127 00:05:34.560 --> 00:05:36.280 And that's assuming they can sell franchises 128 00:05:36.280 --> 00:05:38.120 like hotcakes, which is not always that easy. 129 00:05:38.120 --> 00:05:40.400 That leads to the fourth point on this checklist 130 00:05:40.400 --> 00:05:41.440 that I walk through mentally. 131 00:05:41.440 --> 00:05:43.160 The final thing is just personality wise. 132 00:05:43.160 --> 00:05:45.400 So if I look at an entrepreneur and they're super pro-ocean driven, 133 00:05:45.400 --> 00:05:47.200 they love selling, they love the sizzle, 134 00:05:47.200 --> 00:05:50.160 they love the hunt, right, of selling franchises, 135 00:05:50.160 --> 00:05:52.040 then franchising, when I'm at 50, 50, 136 00:05:52.040 --> 00:05:53.240 might still be the right place. 137 00:05:53.240 --> 00:05:55.360 On the flip side, if there's somebody who's a little more product-driven, 138 00:05:55.360 --> 00:05:57.480 a little more leadership-driven, like love the ops, 139 00:05:57.480 --> 00:05:58.880 all that kind of stuff, then it might be more 140 00:05:58.880 --> 00:06:02.040 of a self-sustained lower number, higher value play. 141 00:06:02.040 --> 00:06:03.320 And here's the key difference. 142 00:06:03.320 --> 00:06:05.320 If you have a really stark difference 143 00:06:05.320 --> 00:06:07.320 between franchises versus private, 144 00:06:07.320 --> 00:06:09.160 let's say a super-promotion-driven entrepreneur, 145 00:06:09.160 --> 00:06:11.320 but all the maths is that you should own it privately. 146 00:06:11.320 --> 00:06:13.440 Then if you phrase the thing that you don't like 147 00:06:13.440 --> 00:06:14.840 as a deficiency in the business, 148 00:06:14.840 --> 00:06:16.120 then it becomes very solvable. 149 00:06:16.120 --> 00:06:19.240 So for example, staffing into these locations becomes hard. 150 00:06:19.240 --> 00:06:21.480 You've got all these kind of blow-skill, low-wage employees, 151 00:06:21.480 --> 00:06:23.560 which can be difficult to manage, lots of churn, et cetera. 152 00:06:23.560 --> 00:06:24.440 So what do you do? 153 00:06:24.440 --> 00:06:26.240 You hire somebody who's ran a staffing 154 00:06:26.240 --> 00:06:29.720 for a franchise that's gone from 50 to 250 multiple times. 155 00:06:29.720 --> 00:06:31.440 That's what I would do when we invest. 156 00:06:31.440 --> 00:06:32.720 It's exactly what the move would be. 157 00:06:32.720 --> 00:06:34.760 We can take somebody who's super-promotion-driven 158 00:06:34.760 --> 00:06:37.480 and then bring in one or two people to support them 159 00:06:37.480 --> 00:06:39.320 in the things that they don't like that are way better 160 00:06:39.320 --> 00:06:41.120 than them at it, and then you get the outcome 161 00:06:41.120 --> 00:06:43.880 where the math and the personalities work together 162 00:06:43.880 --> 00:06:45.640 to build the ultimate enterprise value. 163 00:06:45.640 --> 00:06:47.720 And on the flip side, if you're super-like ops product, 164 00:06:47.720 --> 00:06:49.160 et cetera, type entrepreneur, 165 00:06:49.160 --> 00:06:51.800 but all the metrics say that you should franchise this thing, 166 00:06:51.800 --> 00:06:55.320 then we bring a really hype sales-driven person 167 00:06:55.320 --> 00:06:56.960 into the business to go hunt for you 168 00:06:56.960 --> 00:06:59.680 to bring more franchises in so that you can scale faster 169 00:06:59.680 --> 00:07:01.720 because that's the way that your model is going to set off. 170 00:07:01.720 --> 00:07:04.400 Either way, these are variables that you can play with. 171 00:07:04.400 --> 00:07:06.440 And those are the four points that I look at as checklist 172 00:07:06.440 --> 00:07:08.720 of how I'm going to scale local business that comes to us. 173 00:07:08.720 --> 00:07:11.160 We made a checklist that you can actually look through 174 00:07:11.160 --> 00:07:13.080 these four things for yourself. 175 00:07:13.080 --> 00:07:14.480 Actually go through it and fill it out 176 00:07:14.480 --> 00:07:15.400 and look at both those things 177 00:07:15.400 --> 00:07:16.920 because you'll actually look at as an investor 178 00:07:16.920 --> 00:07:19.120 and it'll make you a better business owner.