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Franchising creates wider avenue to expansion

Franchising can be a growth engine for the right company.

“The franchisor gains the rapid expansion of the franchisor’s brand at the expense of the franchisee,” says Dennis Kessler, Edward and Agnes Ackley Clinical Professor of Entrepreneurship at the University of Rochester’s Simon Business School. Kessler is also co-owner and co-founder of Kessler Family Restaurants LLC.

As attractive as franchising might be, it comes at a cost—and could hurt the franchisor in the long run.

Franchising, in general terms, is an arrangement: The franchisor gives the franchisee the right to use its brand, business systems and processes to produce and market its goods or services in specific ways.

“Anything that can be packaged, has a good hook to it, and is not easily replaceable is always something that’s good for franchising,” says Brett Dawson, president and founder of the Dawson Law Firm P.C. His firm has helped about 10 firms become franchisors, most of them in the Rochester area.

Franchisees initially pay a one-time fee to their parent firm for the franchise, followed by regular royalties. As welcome as that capital infusion might be for the franchisor, the arrangement offers many other benefits. To begin with, franchising can allow a firm to expand to other sites at low or no cost—the franchisee generally foots the bill.

“You’re not incurring all the costs and expenses of building out or renting out a new location, furnishing it,” Dawson explains.

The franchisor determines the number and placement of new restaurants, stores or shops and can expand site-by-site, area-by-area, or by what Dawson calls “master franchising.”

“You’re selling somebody an entire state … as a territory,” he says. “It’s a great way to push a system out.”

Franchisors also avoid the burdens of hiring and maintaining their franchisees’ workforces, while gaining a great deal of control over their operations.

“By franchising, everything’s exactly the same in each and every location,” says Salvatore Fantauzzo, owner, founder and CEO of Salvatore’s Old Fashioned Pizzeria Since 1978 Inc., which began franchising in 2012. “The franchise license controls the look of the location, the look of the employees, the quality of the food, the (processes) that are being used.”

In addition to using franchisees’ sweat equity, a franchisor might also be able to pick their brains. Gene O’Donovan, former president of then Montana Mills Bread Co., gained that benefit after his company began offering franchises in 2001.

“A lot of franchisees may have other experience in the same industry or a similar industry,” says O’Donovan, who shared the ownership of Montana Mills with his wife, Suzy. “You can just kind of learn from your franchisees, maybe improve your best practices.”

Other intangibles could arise from franchising, as well. Cyndi Weis, founder, president and CEO of breathe yoga & juice bar inc., saw franchising as a way to meet the needs of customers outside the Rochester area without having her two daughters, who work for the firm, move away to run them.

“What I really valued was being able to run the business alongside my daughters,” she says.

To meet those needs, breathe yoga began franchising in 2012.

O’Donovan and his wife hoped franchising would not just drive the growth of Montana Mills, but bring it to the attention of potential buyers.

“We … felt it might make us a more attractive takeover candidate,” he says.

Though the benefits of franchising appear to be skewed toward the franchisor, a franchisee can also gain from the relationship.

“When you purchase a franchise, you purchase a company that has brand recognition, or you believe that that brand recognition will grow nationally,” Kessler explains. “You have a much better chance of success.”

As attractive as franchising might be, it isn’t for all businesses.

“Franchising can never compensate for issues which either your business model or your brand may have,” O’Donovan explains. “You need to have absolute control of and confidence in both to ensure a successful franchise effort (for the) long term.”

At the same time, the process of becoming a franchisor takes time and money. The U.S. Federal Trade Commission requires prospective franchisors to fill out a Franchise Disclosure Document.

“The disclosure document is essentially making sure both sides are on the same page in terms of governance, regulations, risks and other specifics of the relationship,” says Kat Murphy, an attorney with Harris Beach PLLC. “Any agreements the franchisee needs to sign—for instance, a franchise agreement or a non-competition agreement—will be attached, along with three years of the franchisor’s audited financial statements.”

Most companies should probably turn to accountants and other professionals before tackling an FDD.

“Creating this disclosure document is a fairly complex, time-intensive process, so it’s a good idea to bring an attorney on board to make sure it’s done properly the first time,” Murphy says.

The process can be particularly complex for some firms. Salvatore’s had about 20 restaurants, all licensed to family members, when it began filling out its FDD.

“Because we were already established and open, it was a harder process and a more extensive process,” Fantauzzo explains. “Twenty people had to reveal their books, their records and all that to make sure they were cool in the way they were operating.”

Franchisee candidates must have the lengthy legal document at least 10 business days before they sign up, according to Murphy.

Some companies turn to specialists for help with the process of franchising. Weis turned to a franchising consultancy for assistance when she began expanding her business.

“They helped me develop my operations manual—it’s a 350-page manual of how to operate your business,” she says. “It’s part of what is necessary to pass down a business concept and best practices to a franchisee.”

All this professional assistance can prove pricy. O’Donovan says that the cost of franchising was “well in excess of $100,000” for Montana Mills. The completed FDD must then be registered with the New York State Department of Law, though that’s just the start for a franchisor.

“A franchise renewal is required every year, with an audited financial statement, information about the franchises sold and some basic contact information,” Murphy says. “If the franchise disclosure document needs to be amended—for instance, if the terms of the agreement change or the franchisee moves to another location—an amendment needs to be filed with the state right away.”

Franchisors then have to make sure that the franchise setup works. It’s in their interest to develop an in-house structure for monitoring their franchisees, train them to operate in a way that meets the terms of the franchising agreement, and give them the support they need to succeed.

“They provide those kinds of things that help the franchisee, to mitigate the risk of failure,” Kessler says.

Perhaps most important, the franchisor has to be careful to pick the right franchisees.

“They look for business acumen, drive, ability to grow, financial wherewithal,” Kessler explains.

Fantauzzo knows what he values in a franchisee.

“I’m looking for guys that want to have the independence of being self-employed under a franchise concept, that work their stores 50 to 60 hours a week to make sure everything’s perfect,” he says.

The wrong franchisee can drive down business at a site, causing long-term problems for the franchisor.

“If it doesn’t do well, you’re going to have to close it, and then there is what we consider in the industry the blemish of having a closed restaurant,” Kessler says. “That reflects on the brand.”

Despite such potential pitfalls, local franchisors seem to have benefited from taking on that role. Breathe yoga & juice bar now has four corporate locations and a franchise in Greece.

“We can look at growing in Upstate New York, and really through the East Coast,” Weis says.

Since Salvatore’s began franchising, it has added about 10 new restaurants to its chain.

“We have about three in the works right now,” Fantauzzo says.

By the time the O’Donovans sold Montana Mills to Krispy Kreme Doughnuts Inc. in 2003, the company offered its goods at 31 sites in and around the Rochester area, and was in the process of developing five franchises.

“I believe our franchising—and our resultant expansion plans—substantially increased our value to potential suitors.”

The couple went on to found the Yotality Frozen Yogurt chain and recently opened Pizzeria FAVO, an upscale pizza restaurant in Pittsford.

“While it is very early to talk about expansion, I think this new concept may lend itself to franchising,” O’Donovan says.

Mike Costanza is a Rochester-area freelance writer.

7/10/15 (c) 2015 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email rbj@rbj.net.

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