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Tired of paying royalties? How would you like to get in on collecting them? That's one of the reasons--among many--behind an innovative fund created to allow multi-unit franchisees to own or invest in franchise brands.
"If you're in franchising as a multi-unit franchisee and have built your enterprise by paying royalties, it's a very natural hedge to have an investment in an entity that's in the business of collecting royalties," says Aziz Hashim, founder and general partner of the new fund, called NRD Partners.
Hashim, who has made a career operating restaurant franchises, says he has been preparing for this new role all his franchising life. "I've entered and exited 14 brands in my career. So in a way I've been practicing as a little mini-private equity or fund anyway. Because that's what funds do: they buy an investment, improve upon it, hold it for a period of time, exit it for a return, and move on to the next one. I've been doing it as a franchisee for the past 20 years, and now I'm about to do it as a franchisor."
This experience, says Hashim, has given him a level of comfort in managing deals, underwriting transactions, and the confidence to take this step. "I think that's one of the reasons many of the investors were comfortable investing with me. They have seen that kind of operation for many, many years." We asked Hashim about the fund--what it is, where it's going, and how it might change the face of franchising.
Tell us about the fund, and why you started it.
What I did as a multi-unit franchisee was to respond to the current trends in franchising. Some of that revolves around the fact that it's very difficult for potential franchisees to decipher what represents a good deal for them. There are too many brands proliferating--it's become too easy to create a franchise brand--and people have no idea on how to truly evaluate and how to invest in a brand that has the highest degree of success for them.
So part of the response to that is this fund I've created, with the sole purpose of identifying franchise companies to take an interest in or to buy outright that will offer compelling unit economics and a good partnership culture between franchisor and franchisees, such that we do franchising in what we consider to be the best way possible--an ethical approach to franchising, if you will. That's the essential premise of the fund.
The context of the fund is that most of investors are also multi-unit franchisees like me who, for a long time, have really not had an avenue to invest or to diversify their capital into the franchisor side of the business. Most of us have spent our entire career paying royalties and being a franchisee, but we have not really participated on the franchisor side because there really haven't been many avenues to do that. The only ones available were: 1) if your franchisor was one of the few that was public, you could go out and buy shares, and 2) a few franchisees have actually purchased a franchisor. But no one had really found a vehicle where multiple multi-unit franchisees could have an investment strategy. We've also identified that as a gap, and this fund is evidence that, because of its popularity and its support for multi-unit franchisees, there was pent-up demand there. So we solved that problem as well.
The third thing is that there are challenges in franchise development, and a lot of brands are struggling to identify qualified franchisees.
How is this fund different?
The idea for the fund is to provide superior return rates for the investors, as well as for potential franchisees of the brands we acquire. We're doing it for both. That's what makes us different. Most funds normally are looking out primarily for their investors. As I've said many times before, if you look at franchising objectively, there are diametrically opposed goals: the franchisor makes money off the top line and the franchisee makes money off the bottom line, and those are not always in sync. We're looking out for our investors and we're going to give them a superior return, but not at the expense of our franchisees. That's not going to happen, and that's not what our franchisee investors expect. Whether some of them happen to be limited partners in the fund, and others happen to be franchisees of a brand the fund buys, at the end of the day we're all franchisees.
Who are the investors?
There are almost 40 investors who operate a total of at least 1,500 units. Most are multi-unit franchisees, but some are individuals with high net worth who may not be franchisees but may have other holdings in franchising. Therefore our fund has the breadth of the contact network of all our limited partners, which extends to thousands of franchisees. So when we invest in a brand, our marketing is essentially internal. We can just go to our investor base, and if they want to develop (or if they don't, for whatever reason), they have access to many franchisees in their network who would be supportive of a brand that their friend was a part owner in. For a lot of multi-unit franchisees, the best source of advice on franchise development is from referrals from existing franchisees.
Why invest in the fund?
First is diversification. If you're in franchising as a multi-unit franchisee and have built your enterprise by paying royalties, it's a very natural hedge to have an investment in an entity that's in the business of collecting royalties. That's just kind of Business 101--hedging your investments. Second is that the fund's profile is to invest in emerging brands--not necessarily startup brands, but brands that are, ideally, between 50 and 150 units. Those brands typically represent the best opportunity for developers because chances are you can get an entire territory to develop. Being a part of the limited partner base of the fund gives you certain privileged access to the brands the fund acquires--before we go to the broader franchise community. And third is because our goal is to provide some outstanding returns for investors.
Is there a monetary goal for the fund?
The fund was initially marketed as a $50 million fund. However, due to demand, we have increased the size of the fund to $100 million.
What types of brands are you targeting?
We are open to any sensible investment in franchising. However, there are 5 verticals we have a particular interest in: food, because it represents the largest segment in franchising; wellness and beauty; education; healthcare; and senior care.
Do you think this will change the fundamental structure of franchising?
Fundamental is a strong word. Franchising is a $2.1 trillion industry, and I feel a $50 million or $100 million fund within that doesn't change it overnight. But I certainly feel I've started something that is going to lead to fundamental change down the road. There's a huge imbalance between the risk-adjusted economic returns of the franchisor and the economic returns of the franchisee as franchising in the U.S. matures. This fund is a response to that reality and others will, in due course, find ways of replicating it. So it's an evolution, like what Uber did to taxis.
If you take any public franchisor company and look at what has happened to their stock in the past 5 years, it is remarkable. While franchisees have done well in this period as well, in general it cannot be compared with returns garnered by the franchisors. The natural question is, Why were the franchisors able to outperform the franchisees in such a profound way? The reason is that franchisees work really hard: we build stores using our own capital, we pay the royalties, and there's very little incremental expense to the franchisor. That is the essence of the franchise business model: a license of intellectual property to others for a fee. And it works very well, so well in fact that it has led to a proliferation of franchising. But when the underlying business model for the franchisee is not based on a solid unit-economics footing, it can create an imbalance. In other words, a franchisor can continue to make outstanding returns while the franchisee does not. This fund's goal is to identify those brands that represent a great investment for a franchisee, and use the power of the fund's network to help the good ones grow.
The fact that franchisees can band together, that they can unite, that they can create a capital base, that they can go out and buy great franchisors, and that they can choose to develop those franchisors in which they have an investment--that's a fundamental change, no matter how you slice it.
What kind of feedback are you getting, now that more people know about the fund?
I've received only positive feedback from every quarter. I have not received any negative feedback from anyone--including my franchisors, the people who should be most worried. They know that I've scaled down, but they have been as encouraging as anyone. It's been really heartwarming.
Are you getting calls from emerging franchisors looking to be purchased?
I don't think a day goes by where I don't get a new phone call. This has been going on for several weeks. I can't even return the phone calls. We're getting franchisors in the 50- to 100-unit range who are saying, "Hey, this is what we need to break out of the doldrums here." Because at that range, franchisors can become stuck. There are hundreds and hundreds of franchisors in that range, all vying for the next franchisee. So we're getting a lot of calls. There also have been discussions with very large franchisors with upward of 1,000 units that have also reached out and said they've reached a certain size, but they want to accelerate their future growth and don't mind partnering with the fund if that means access to our franchisee base. I wasn't expecting that.
When you say "partnering," what might that look like?
If there's a franchisor with 1,000 or more units, the fund, today, may not be capable of buying it. It may not even be for sale. The idea would be for us to take a minority stake in that brand so that we would become owners of that brand but may not control the brand. In exchange for that ownership stake, that partnership would include access to the fund's franchisee base, as well as counsel, support, and guidance from us on how to improve their franchise offering to make it even more palatable to multi-unit franchisees.
Why have you reduced the number of units you operate?
As the fund manager, my duty is to manage the investments that others have entrusted me with. Therefore it's incumbent on me not to divide my time between personal endeavors and the fund's endeavors. So over the past year or two I have significantly scaled down my personal holdings. The idea is to scale it down to a very minimal level, but I will always be a franchisee. I believe it's very important for me in some capacity, even though I may not be a day-to-day manager of a franchise business, to stay connected at that level. But by far the substantial portion of my time will be spent managing the fund.
What else should multi-unit franchisees know about the fund?
I think they should take pride that fellow franchisees are now able to embark on such ventures that until a very short time ago may have been out of the realm of possibility, or even out of the realm of talk. How is this possible that we could actually control brands ourselves? Because individually, very few franchisees have enough financial horsepower to take on a brand. Some larger franchisees have bought small brands, but they bought only one. We're a fund, we're going to buy many. Franchisees should take heart that they have now reached a level where we are in the same investment category as those who own brands, not only figuratively, but literally, because we're going to become franchisors.
Also, they should look at their own portfolio and think strongly about diversification. Franchisees are sometimes concentrated in the brand they operate, and there could be risk there. That risk can be mitigated in a number of ways. One is to do multi-branding as I've done previously in my career, to have different types of brands so that if one is not doing so well, another might be doing better. But another way could be investments such as the one we have here, where they have some money allocated toward the franchisor side of the business. So on the one hand their "day job" involves paying royalties, but they also have an investment in a structure that collects royalties, so you have a little bit of what I call a financial hedge. They should look at that and see if it's something that works for them.
Franchisees also should take note of the power of collaboration. This endeavor is essentially an exercise in demonstrating the power of collaboration. When franchisees get together and pool our resources, it allows us to do far more than any one of us could have done individually--because we have a resource which, in franchising, is more powerful than funding: we are operators.
There are just so many tracks this endeavor tries to address: the sophistication of franchisees, the recognition of their financial power, how franchisees can rise to the next level, the inequities in franchising between risk-adjusted franchisor and franchisee returns, the growing inequities in franchising in terms of the relationship, the franchise agreement, it goes on and on. It sounds like we're trying to take a stab at all of these issues through just one structure. We'll see how far we get, but I'm very optimistic, and most of the people I talk with feel this is a really important first step and will lead to, hopefully, many other steps by many other people that will continue this work.
How do you think this will affect the future of franchising?
People who are familiar with what I'm doing say this represents a significant innovation in franchising and a turning point in the growth of franchisees. When people come up to me and say, "This is going to change the face of franchising," I don't take that stuff lightly. This is going to change the future of franchising because it's going to be the equalizer, rebalancing the scales between franchisors and franchisees. It's going to make franchisees stakeholders in the franchisor in real terms, not in lip service. This represents major innovation in that it allows sophisticated franchisees access to "the other side of the trade," that is, being able to participate in franchisor ownership, in the royalty collection part of the business.
Number two, we have a fund now that, potentially, will provide that Good Housekeeping Seal of Approval. It will not guarantee anything, but will say that, for at least the brands we buy, they have been vetted by other franchisees. We didn't buy a brand because it was a way to make money at the expense of the franchisees. This fund is owned by franchisees, and we're buying brands we believe in. And as I mentioned, a lot of our limited partners will be developers of many of the brands we buy. So that's a huge innovation as well. This is really a big game-changer--and should have been done a long time ago.
Rob Branca is a Dunkin' Donuts franchisee based in Central Massachusetts who operates more than 70 units.
Ali Lakhany is the CEO of CSM Group, which operates more than 70 Popeyes Louisiana Kitchen and T-Mobile USA units in Texas, Tennessee, and Alabama.
Why we invested. The reasons our group, which has been in franchising for decades, feels it's good to put a substantial amount of money into this fund are:
Spencer Smith, President and CEO of the Smith Group in Cortez, Colo., operates 44 Aaron's and 2 Big O Tires.