Calculated Risks: Investing in emerging brands requires due diligence

Investing in up-and-coming franchise brands can offer a prime opportunity for franchisees seeking to harness innovation and drive growth within the multi-unit industry. Often, the franchisee’s core brand has limited ability to expand, the economic model has evolved, and the franchisee can diversify. Opportunities are significant for established franchisees, and growth-minded companies generally have both human and financial resources to access when considering additional brands and growth outside of their core operations. As a result, we see more and more established franchisees taking on a second, third, or even fourth brand to drive growth and diversify their revenue streams. Is this strategy right for your company, and what factors should one consider when investing in a new concept?

Newer brands, which are less known compared to established names, present considerable growth potential due to their limited locations, significant development green space, and being first into a new market. Their appeal often lies in unique dining concepts, innovative service approaches, or distinctive consumer experiences that set them apart from established chains. Essential traits of these brands include a focus on innovation, significant growth potential, adaptability, and an entrepreneurial mindset. Although still developing, these brands typically offer comprehensive training, support, and resources to franchisees to facilitate their success. Often, emerging brands have a better unit economic model than established brands and usually offer newer, more enticing and flexible footprints that can result in lower development costs.

Market research

Thorough market research is critical when considering an investment in emerging franchise brands. Understanding the competitive landscape is vital to assess how the brand differentiates itself and whether it holds a sustainable competitive advantage. Customer reviews and feedback provide invaluable insights into the brand’s market acceptance and highlight potential areas for improvement.

Additionally, financial health and growth forecasts are key elements in the decision-making process. Investors need to meticulously review financial statements to evaluate the brand’s financial stability, focusing on revenue growth, profit margins, cash flow, and other indicators. It’s critical to the review process to understand the brand’s ownership, long-term strategy, and financial resources.

As one evaluates the growth and profit potential of the new brand, focus on due diligence with existing franchisees in the brand. Are they happy? Are they satisfied with the brand’s leadership, direction, etc.? Most importantly, are existing franchisees building and growing new sites, and would existing franchisees invest if they could do it over again?

Aligning an emerging franchise brand with your personal and company goals and capabilities is essential. What is the time period for your investment? Does second-generation ownership supervise the new brand? Have a growth, human resource, and financial plan completed before the investment. Be careful in diverting too many assets, both financial and human, from the core brand. 

Diversification within your franchise portfolio can significantly mitigate risks and enhance growth potential. By investing in a variety of franchise concepts, you can spread risk across different market segments and consumer bases. For instance, combining a chicken concept with a burger brand or a casual dining concept can provide balance and stability. Each type of franchise offers unique advantages and faces distinct challenges, so a diversified portfolio allows you to capitalize on different trends and market conditions.

Diversifying also provides a buffer against sector-specific downturns. If one segment experiences a slowdown, others in your portfolio might perform well, stabilizing overall returns. Additionally, exposure to various operational models and consumer demographics can provide valuable insights and cross-promotion opportunities, enhancing the overall resilience and growth potential of your investments.

Investing in emerging franchise brands inherently involves risks. To make informed decisions, it’s crucial to recognize potential challenges and risks. Developing contingency plans to address possible issues, understanding brand-specific hurdles, and having an exit strategy if the investment does not pan out are essential steps. Being comfortable with the size of the investment and understanding the associated risks can help mitigate potential downsides.

Advantages

Despite the risks, there are significant advantages to investing in emerging franchise brands. The potential for growth and expansion is considerable, offering early investors the chance to benefit from the brand’s growth trajectory. Flexibility in responding to market feedback and evolving trends supports continuous improvement and innovation. Moreover, franchisees often gain more influence and control over the brand’s direction, promoting a collaborative and entrepreneurial environment. Additional brand investment also provides new and different opportunities for employees and often second-generation management. Several of our clients have invested in second brands with younger family members managing the new brand successfully. 

Investing in emerging franchise brands can be highly rewarding for those prepared to take calculated risks and conduct thorough due diligence. By understanding market dynamics, evaluating financial health, assessing brand potential and scalability, and aligning the investment with personal goals and capabilities, investors can make strategic choices that align with their financial aims. Emerging franchise brands represent the future of culinary innovation and growth, making them an attractive option for astute investors.

Jack Grespin is a vice president with C Squared Advisors, a boutique investment bank that has completed hundreds of transactions in the multi-unit franchise and restaurant space.