Real Estate Investing Basics

13 Tips on Buying and Owning a Franchise

Expertise: Business Management, Mortgages & Creative Financing, Landlording & Rental Properties, Real Estate Investing Basics, Personal Finance, Real Estate Deal Analysis & Advice, Commercial Real Estate, Personal Development, Real Estate News & Commentary
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Owning a Franchise

I rarely see this topic covered on Bigger Pockets, so I decided to interview my partner, Bob Paulus. In addition to PPR, he’s been quite successful in running franchises. He started out buying a couple Rita’s Water Ice franchises, before getting involved with Hollywood Tans. These were all successful. It wasn’t until Bob got more involved with PPR that he and his wife sold several of the franchises, except for a Rita’s Water Ice. He has seen all three sides—buying, running, and selling—of a franchise.

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Starting Out: How He Did It

  1. Can you tell us a little bit about how you got started in Franchises or Franchise Investing and why it was right for you?
    I wanted to work for myself. I started researching what companies were available in the area. And my three main considerations were: what can I afford; what interests me; and what is a good fit? But, as much as I wanted to work for myself, I didn’t have the time, knowledge, or money to start a business from scratch. And, when you get involved with a franchise, because they have processes in place, it makes it much easier.
  2. What advice would you give someone that’s new about investing in a franchise?
    Make sure you do your research—it is all about the due diligence. Also, make sure you’re not stretching yourself too thin financially. If you have a partner, even if it’s a spouse, it is critical that everyone’s roles are clearly defined from a time and financial perspective. I’ve seen a lot of partnerships dissolve for lack of communicating the responsibilities.

Buying a Franchise

  1. What’s the easiest and safest way to buy a franchise?
    The easiest way, of course, would be if you have cash in the bank and you don't need to get a loan. If you have a line of credit on your house, that's easy to tap into as well. It may be more difficult, and more paperwork, if you need to get an SBA loan. But, this could be easier if you have 20% liquid and finance the rest; as they will not want to give an SBA loan to finance the business 100%.The safest way, however, would not be to have the business tied to your primary residence. Statistically 90% of businesses fail in the first 5 years. So, I wouldn't suggest risking your primary residence knowing that there's a 90% chance of failure.
  2. How do you analyze a franchise (due diligence)?
    You will want to research the franchise to find out if they’re stable and have a good reputation. Franchisors may vary in the level of input or guidance they give you. Some may be very flexible, giving you guidelines but allowing you to be creative, while others may be stricter, providing more structure. Make sure that it’s a good fit for you. It’s crucial to speak to as many franchisees as possible and retrieve information about the positive or negative aspects of their dealings with the franchisor. Make sure the franchisor’s information is the same as what the franchisees are saying. Do this to make sure the franchisor is being honest with you. Also, research how much the franchise would charge for royalties.
  3. What kind of capital is required to buy a franchise?
    Franchises probably run from as small as $30,000 for a cleaning company to an excess of $1 mil. if you want to buy a hotel franchise. The biggest variable would be if you’re buying property. If you’re taking property out of the equation, probably the bulk of franchises cost between $50,000 and $200,000. When you’re starting out this could include a franchise fee, initial start up cost of goods, purchasing equipment, any improvements/alterations to the building so that it fits your business model (negotiable in the lease), and some cash set aside for the first few pay rolls, marketing and advertising, and as a safety net.
  4. Are there certain franchises that you stay away from?
    Yes. I stay away from absentee owner franchises, which means the franchisor will tell you that you don’t really have to be there that much. I don’t think that a franchise can fully maximize its profits if the owner isn’t there enough. I also stay away from a franchise with the reputation of not supporting the franchisees or any franchises with a well above average royalty percentage. I would stay away from a franchise that is new to the market as well, because there may be more risk of it being unsuccessful in that geographical area.

Related: BP Podcast 028: Note Investing and Raising Private Money with Dave Van Horn

Owning and Running a Franchise

  1. What are some of the pitfalls of franchise investing?
    I guess a pitfall would be when the franchise decides to change the business model, you don’t really have much of a say. That could be, for example, deciding to add or subtract a product line. They might decide to add a product line that could cause additional expense in equipment or they may decide to remove a product line that was very profitable in your particular location.
  2. What are the advantages of owning a franchise?
    Brand recognition is probably the biggest advantage, as you will have customers who are loyal to your brand right off the bat, although this does depend on your geographical area. Another advantage, as I may have mentioned, is you’re able to be your own boss while still having the franchiser help you—you’re not totally on your own.
  3. What kind of time commitment do your franchises require?
    On average, a franchise should probably require a minimum of 30 hours a week.
  4. Are there exit strategies for franchises? Are there upsides to selling?
    There are no more so exit strategies or upsides to selling than a self run business. I wouldn’t start any business venture without an exit strategy in place prior to starting it.
  5. How does real estate factor in?
    Well, first off, owning the property provides stability because you’re no longer at the mercy of the landlord as far as terms and dollar amount.  Also, the tax benefits of owning your properties are better than if you’re renting.
  6. What’s the most important thing you learned as a franchise owner?
    I guess I would say that I learned how to run a business, with the safety of having the franchisor’s guidance for major processes. But, in a sense, I learned how to run a business by doing it myself.
  7. Are there any other words of wisdom you’d like to offer or resources you suggest?
    A successful franchise that’s been in business for a long time, more than likely, has good processes in place to make the franchisee profitable. If you have enough belief in the franchise to invest, use their processes.

Another Strategy to Acquire Commercial Real Estate

While doing this interview with Bob, the real estate question did strike a chord with me. While Bob leased/leases the properties for his franchise, a unique strategy for acquiring commercial real estate would be to do the McDonalds, CVS, or Wawa model. These franchises use the proceeds from their business to fund the property. Even if for some reason they went out of business, they have the safety net of owning prime commercial corners in highly populated areas.

Here are a few more resources Bob recommended on buying and selling a franchise or franchise investing: The Educated Franchisee by Rick Bisio or Street Smart Franchising by Joe Matthews

Photo Credit: El Gran Dee

Since 2007, Dave Van Horn has served as president and CEO of PPR The Note Co., a holding company that manages several funds that buy, sell, and hold residential mortgages nationwide. Dave’s expertise is derived from over 30 years of residential and commercial real estate experience as a licensed Realtor, a real estate investor, and a fundraiser. As the latter, Dave has raised over $100 million in both notes and commercial real estate. In addition to his investments and role as CEO, Dave’s biggest passion is to teach others how to share, build, and preserve wealth. He authored Real Estate Note Investing, an introduction to the note investing business, helping investors enter the “other side” of the real estate business.

    Replied about 6 years ago
    November marks 3 years in the franchise business, we own a Dairy Queen. The best way to buy a franchise is find one someone else doesn’t understand how to run correctly. In our case the owner had a habit of paying the rent when he felt like it, and trying to reinvent the DQ model. His landlord was patient to the point of no return, as was corporate. Looking for a small business for my wife to operate (we are empty nesters now) I stumbled across an add on Craigslist ready to expire in 3 days. Contacting the owner resulted in meeting the very motivated owner. Needless to say he was weeks from having the landlord padlock the door, or having corporate pull his francise. I signed a purchase agreement on the spot contingent on negotiations with the landlord, and DQ. The business owner originally had a fellow who had locked the sale up for $60k (low) but could not perform and pulled out a month before D day. Needless to say the landlord and I hit it off, and I bought the place, a 32 seat fully equipped restaurant for 10 cents on a dollar. A month after taking over the place she was offered $60k to sell the place but declined. Today the place to put it mildly rocks! The business is solely in the name of my wife I have no ownership interest. As a benefit of having a wife with a DQ I am accompanying her to the corporate conference in Hawaii this January. My wife has always done the book on my contracting business, and REI (not as a slave as with most small contractors, but for a salary) but never had a business of her own. Nice thing about the whole experience is if something catastrophic would happen to me health wise of financially I know she knows how to run a business and make money. The franchise model takes away all for the sweat equity that one usually needs to do on the way up, and removes 90% of the risk to capital. Not much different then analyzing a REI deal for the downside risk its just all done for you. I have a good friend with a small shopping center, two of his tenants a pizza business, and a beer distributor contacted him with the bad news; they could not pay the rent. Instead of giving them the boot, he had both sign their failing businesses over to him, where he installed his unemployed over educated son to run the beer distributer, and his over educated unemployed daughter to run the pizza business. Both business pay the same rent to him each month. Now with his children in place both business have flourished. His son told me recently he wished he had never wasted $150k (of his father’s) and 5 years of his work life in college mostly getting drunk and laid.
    Dave Van Horn
    Replied about 6 years ago
    Dennis, Thanks for sharing your story. I appreciate your comments and perspective. Best, Dave
    Replied about 6 years ago
    90% of businesses fail in the first 5 years? That stat is so overused it gives me a headache. It goes back to a study run in the 90’s that 70% of businesses have new owners in the first 5 years. Meaning most businesses get sold within the first few years. There is no exact stat but most experts think the failure rate is closer to 25%
    Replied about 6 years ago
    90% of businesses fail in the first 5 years? That stat is so overused it gives me a headache. It goes back to a study run in the 90’s that 70% of businesses have new owners in the first 5 years. Meaning most businesses get sold within the first few years. There is no exact stat but most experts think the failure rate is closer to 25%
    James H
    Replied about 6 years ago
    Wonderful article, owning a business is definitely a tricky issue but if handled right can turn into a success. Thanks for sharing!
    Dave Van Horn
    Replied about 6 years ago
    Hi James, I agree. Thanks for your feedback! Best, Dave
    Kerry Baird
    Replied about 6 years ago
    My hubby is active duty, and we both would love to NOT work for anyone else once he punches out. We’ve got discipline from the military training, and a good handle on systems, logistics, and the like…but not running a small business. What surprises me is that the VA encourages veterans to buy franchises, too, with loan guarantees: The Veterans Financial Franchise Initiative, or VetFran, allows service members to pay only 10 % or less of the total initial investment cost of purchasing a franchise. The franchisee must be able to qualify for a SBA 85% loan guarantee package. At the present time VetFran is limited to franchises with initial investments which are $ 150,000 or less. As we start looking into options after military service, we will take another look at franchises. The answers and your succinct questions were very timely. Thanks~
    Dave Van Horn
    Replied about 6 years ago
    Hi Kerry, Thank you for your family’s service and thank you for sharing your story. That sounds like an interesting program–I didn’t know that was available. Best of luck, Dave
    Orlando Rivera
    Replied almost 6 years ago
    It can be a complicated process to sift through all the franchise opportunities out there and narrow your list down to one or two franchises that seem like they will work for you. It is helpful to be able to learn from the experience of someone who has been involved in all aspects of being a franchisee and has also had experience with different franchises.
    Dave Van Horn
    Replied almost 6 years ago
    Hi Orlando, I agree, and it can be complicated. It might also be helpful to interview a franchisee, who has successfully ran the type of franchise you’ve narrowed it down to. Also, since location is so critical, making sure the franchise has a track record for quality demographic research may be an important step. Best, Dave
    Michael J. rental_property_investor from Louisville, KY
    Replied over 4 years ago
    I don’t know if anyone is still following this blog but I enjoyed it. Thanks for posting. Franshising has interested me for a while but one thing I wondered is, if you have the money to get in with little or no debt would it be feasible to eventually get it to run more like an investment where your personal time is limited and you have managers running things? I have read about people owning dozens of franchises and there has to be a way for them to delegate down the management. Of course anything weather its RE managed by PM’s or a business managed by managers it will require time from the owner, I just don’t want to buy a job in other words.
    Annika Larson
    Replied almost 3 years ago
    Lately, I’ve been thinking about buying a franchise as a new investment. This interview was very insightful on the struggles and rewards of buying and managing a franchise. The part on analyzing a franchise was especially insightful. I will be sure to keep these tips in mind as I move forward with this decision in my life! Thank you for sharing.