Thursday, June 08, 2017

Financing Post the Great Recession

Will U.S. small businesses be the main beneficiaries of increased competition in the lending space?

The crisis is long over but we are not out of the woods yet. Most indices are up although consumer confidence and spending have yet to reach pre-crisis levels. In fact, as of 2014, based on 100 financial crises going back to the 1890s, it took an average of eight years for real income per person to return to pre-crisis level. By comparison, just seven of the 12 countries where systemic crises began in 2007-08 managed to get back to at least their starting point.
Banks worldwide are not in the best of shapes either and that has implications for lending. As of May 2017, the S&P 500 banks index is down 30% from its peak in May 2007. By comparison, the STOXX Europe 600 index of bank share prices is down two-thirds from its peak in May 2007.
Still, small business lending in the United States is up on all levels, including SBA lending, conventional lending and alternative lending. 
Overall, in the United States, 5,400 community banks provide 43% of small business loans. These are relatively small operations as over 5,000 have less than $1 billion in assets and more than 1,500 less than $100 million.
On the face of it, community banks appear in good shape. Between March 2016 and March 2017, their loan books grew by 7.7%, more than twice the rate at other, mainly much bigger, lenders. However, net income rose by 10.4%, against 12.7% for the whole industry. Returns on equity, at 9.2%, were a little below the average.
And there are other market forces at work and there are certain trends that may to a shift to an increasingly changing landscape for U.S. small business lending. Since many community banks are very small, they are increasingly consolidating. Mergers and the aftermath of the financial crisis resulted in a drop of over 30% in the number of U.S. community banks between 2006 and 2016. Just between 2008 and 2012, more than 400 U.S. community banks failed and only four have opened since.
Going forward, they are facing additional challenges. For starters, finding talent will be increasingly difficult for banks as some graduation trends show. Between 2006 and 2016, finance as a graduate subject dropped from 31% to 15% at MIT's Sloan School and from 55% to 37% at Columbia. By comparison, technology increased from 12% to 33% at Stanford while doubling at other schools. Further, retaining talent will also be harder. A small community bank in the middle of nowhere is not as attractive as a big player in New York.
In addition, fulfilling their regulatory obligations is increasingly costly. Between 2011 - the year after the Dodd-Frank act regulations - and 2015, the number of people working directly on "controls" at the U.S. largest bank JPMorgan increased from 24,000 to 43,000. While a biggie like JPMorgan is able to absorb such costs, many small community banks will struggle more. The Trump administration has promised to cut through the red tape and reduce regulatory requirements. However, that may take years.
More importantly, regulations and mergers aside, community banks have to find ways to handle competition from a completely different set of players. Enter digitalisation and so-called fintech start-ups. As of 2017, about 20% of U.S. small businesses look to online lenders when seeking a loan. Regular lenders are trying to counter this with increased digitalisation and streamlining to reduce the costs of the lending process. Still, they will have to watch their backs as more and more fintechs enter the market. For instance, in 2016, peer-to-peer lending in the United States reached $19 billion on the country's biggest platform. In addition, between 2012 and 2016, U.S. Fintech investment grew from an estimated $2.5 billion to $6 billion, with a peak of just under $8 billion in 2014.
While the U.S. lending market may experience a few disruptions, there is little reason to believe that lending overall will be negatively impacted in the long run. Rather, increased competition and alternative sources of lending capital could actually be advantageous for borrowers.

Sources: AltFi Data, Autonomous Research, Business Schools, The Economist, FRANdata, Harvard University, Thomson Reuters, U.S. Federal Deposit Insurance

Monday, May 22, 2017

Food Trucks — Fasted Growing Food Segment in the United States

Within the U.S. food industry, food trucks are the fastest growing segment. Between 2008 and 2016, the industry reached $1.2 billion. (The Economist)
As of 2017, in the United States, counties that have experienced higher growth in mobile-food services have also had a quicker growth in their restaurant and catering business. (U.S. Bureau of Labor Statistics)
Between 2005 and 2016, In Portland, OR, the share of food trucks per person in a metropolitan area grew from less than one to close to five. By comparison, over the same period, that share remained under one in Chicago, IL which has some of the strictest food truck regulations. (U.S. Census Bureau)
As of 2017, despite being home to more than 7,000 restaurants and 144 craft breweries, Chicago, IL, has just 70 food trucks.  (U.S. Bureau of Labor Statistics)
As of 2017, in New York, a food truck operator must obtain a two-year permit that comes with a 15-year waiting period — or rent one on the black market for as much as $25,000. (The Economist)

Wednesday, April 05, 2017

Franchising in Singapore

Franchise Update publishes LeOS Franchise Consulting's feature on Franchising in Singapore!! 

The city state offers plenty of opportunities for franchise brands. Strategically positioned at the heart of Southeast Asia with a multi-cultural society, the rule of law and one of the highest GDPs per capita, it is one of the most business friendly countries.
However, there are some challenges franchisors need to be aware of. Enjoy the feature.

Thursday, March 16, 2017

Krispy Kreme Expands further into Africa

Last year, Germany’s Reimann bought U.S.-based Krispy Kreme Doughnuts, an 80-year-old franchise. Now they company announced its move into Nigeria, the continent’s most populous country. This follows Krispy’s first African venture into South Africa in 2015.  Worldwide, the brand operates over 1,100 locations.
It seems, the Germans made a wise decision. In its domestic market, Krispy Kreme grew at a CAGR of 5% between 2009 and 2015. The company locations grew at a faster CAGR of 6% over the same period. The franchised store continuity rate was an average 96% each year pointing towards sustainable and stable growth. 
In addition, average store revenues increased at a CAGR of 6% to over $2 million between 2010 and 2015.

Now that the ultimate owner is German, there is hope for consumers in the country. So far, Krispy Kreme only operates locations on U.S. military bases. 

Thursday, March 02, 2017

Should You Forgo the Initial Franchise Fee and Go with a Higher Royalty Instead?

In a recent discussion with a representative from a global food franchise, I was asked what I thought about the idea of not charging an initial franchise fee (IFF) and instead go for a higher royalty rate. My initial response was that they would buy themselves a higher revenue stream at the expense of the franchisees' profitability. On the other hand, the franchisor would have upfront costs that they would only recoup over time instead of receiving cash right away.
The thought stuck with me so I built a model to see what the numbers would look like.
  • Initial Investment:      $1 million
  • Initial Franchise Fee:  $50,000
  • Term:                          10 years
  • First year AUV:           $1.25 million dropping to $1.175 million in year 2, rising by 2% thereafter
  • EBITDA:                      25% constant
  • Royalty:                       5%

Under this scenario 1, the franchisor’s IFF and royalty revenues from that unit add up to $685,584 over the ten-year term of the agreement. Over the same period, the franchisee’s total EBITDA minus royalty will reach $2,542,338. This pattern follows a honeymoon period typical for a food concept.
Under scenario 2, after excluding the IFF the initial investment drops to $950,000. For simplicity’s sake, I applied the royalty rate that would drop the franchisee’s total EBITDA minus royalty amount by the same amount over ten years. In short, the franchisee roughly pays the $50,000 IFF in form of a higher royalty rate of 5.4% over the term of the franchise agreement.
The franchisees pays a lower initial investment but also makes less money over ten years due to the higher royalty payments which at the 5.4% rate somewhat compensate the franchisor for not having collected the IFF at the beginning of the term. He loses out on the profit margin from the start, the most crucial phase in a new business.

Is this Viable?
In my view, there are downsides for both parties because too many assumptions need to hold. First, the unit needs to be around for the entire term. Second, the unit’s margin cannot drop under 25% and third AUV needs to rise by 2% each year for ten years.
The franchisee pays a lower IFF, so that’s $50,000 less for the loan he needs to take out. But the running expenses go up, eating into his margin. On the other hand, at the increased 5.4% royalty rate, the franchisor gets basically compensated for foregoing the $50,000 at the beginning of the term. Yet, why would the franchisor wait for the cash for ten years when the early phase requires him to invest the most first into finding, training and initially supporting the new unit?
An additional increase of the royalty from 5% to 6% would provide a good cushion for the franchisor, increasing his revenues from the unit by over $77,000 more with no IFF revenue at the beginning. However, the franchisee loses over $127,000 over the ten year term. Even adding back the $50,000 IFF means he will be close to $80,000 short.
The only way this could make sense is if the franchisor exclusively partners with large corporate franchisees. Presumably these guys won’t need as much training after ten units so you can perhaps just have them open locations on auto pilot. Also, the franchisor won't incur expenses for finding new franchisees and making sure they are qualified. 
But even then, there are costs involved for the franchisor as for instance legal, site approval etc. And the same rule applies, the assumptions need to hold for ten years.

Thursday, February 16, 2017

Young Franchisors Can Save Themselves a Lot of Trouble

You have the right idea, you even got the money — now make sure you do it right.

A recent announced by the International Franchise Association (IFA) and performed by LeOS’ partner FRANdata uncovered some of the biggest challenges for emerging franchisors.  One conclusion I draw from the results is that many young and bright businesses can avoid the biggest pitfalls by one simple trick: get the facts!
This is crucial since over 90% of emerging franchisors dig into their personal savings and/or ask friends and family to chip in. In the United States, emerging franchisors spend almost $580,000 to launch the original business. Of that, an average of almost $560,000 comes from personal finances or out of mom’s savings account.
In addition to the initial investment, the budding franchisor needs to spend money on the future franchise infrastructure and meeting regularity requirements. You’d think that cash flow will soon become a huge issue for such a young franchisor. And while it is a concern stated by over 40% of emerging franchisors, the real challenge they face is executing the franchise business model.
According to the survey, all but one of the top six challenges for new franchisors relate to franchise related issues. They include finding qualified franchisees, how to market the franchise, handling growth and increasing support needs or finding qualified employees with franchise experience. Many feel the acute lack of franchise experience. No wonder, since only 25% of new franchisors have any form of prior knowledge about the franchise business model.
So what do you do when you have the right idea and managed to get your original business to a stage where you consider franchising as a growth model? Get the expertise you need to avoid expensive mistakes. Here are just a couple of things emerging franchisors need to consider:
  • Does my initial franchisee fee reflect the expenses required to find, guide and train qualified franchisees?
  • Where do I find them?
  • What kind of initial training will set new franchisees on the right track?
  • Does my royalty reflect the brand’s value but also the ongoing services provide to franchisees?
  • What ongoing services help franchisees to succeed?
  • What is a good ratio of field staff to franchisees/businesses?
  • Can the franchisor run its operations without having to sell more franchises?

These are important questions and the best thing is that answers to all of them are available. Even better, they are not based on gut feeling but analysis of actual performance data of franchise systems. So, congratulations on your great idea. Excellent you got the money. Now, to make sure you apply the franchise business model successfully, find support from franchise experts like FRANdata or LeOS. Also, your mom will be grateful, too.

Wednesday, February 01, 2017

Setzen deutsche Franchisesysteme mit U.S. Expansionsplänen auf das falsche Pferd?

Es sind nicht die legalen und regulatorischen Hürden, die deutsche Franchises von dem Sprung über den großen Teich anhalten sollten.

Die USA sind mit rund 4.000 Marken, die Franchises anbieten der weltgrößte Franchisemarkt. Kein Wunder also, dass auch deutsche Franchises über eine Expansion in die USA nachdenken.
Und warum auch nicht? Mit einer Bevölkerung von über 300 Millionen und der größten Wirtschaft der Welt ist das Land ein attraktiver Markt. Da lohnt es sich, die rechtlichen Hürden zu nehmen und sich den dortigen regulatorischen Standards anzupassen.
Zu denen gehört als erstes die Erstellung eines Franchise Disclosure Documents (FDD). Aufgrund des föderalen Regierungssystem haben einige Bundesstaaten ihre eigenen  Regeln, die man zusätzliche erfüllen muss, bevor man dort Franchises anbietet. Kalifornien und Illinois zeichnen sich durch ein sehr striktes Reglement aus. Allerdings sind beide Staaten gleichzeitig große Märkte. Los Angeles, San Francisco und auch San Diego in Kalifornien und Chicago in Illinois gehören zu größten Metropolen des Landes.
Um mehr oder weniger alle 50 Bundesstaaten mit dem geeigneten FDD abdecken zu können, entstehen juristische Kosten von zwischen $30.000 und $100.000 — bevor man überhaupt damit begonnen hat, nach qualifizierten Franchisenehmern zu suchen.
Vor diesem Hintergrund lohnt sich ein Blick auf deutsche Franchisemarken, die den Schritt in die USA gewagt haben – und wie es ihnen dabei ergangen ist. Ein schneller Blick auf die U.S. Franchisewelt führt zu fünf deutschen Marken: 
  1. Engel & Völkers 
  2. Hofbräuhaus 
  3. Teegschwender 
  4. Vapiano 
  5. VomFass 
Also eine Marke im Immobilienbereich und der Rest in der Gastronomie.
Alle fünf haben in der letzten Dekade mit dem Franchising in den USA begonnen und operieren insgesamt 140 Franchisenehmer und –geber betriebene Geschäfte. Wie weit haben sie es in den ersten fünf Jahren nach dem amerikanischen Franchisestart gebracht?  Zusammengefasst ist das in der Grafik:

Die Immobilienmarke Engel & Völkers sticht heraus. Die ersten fünf Franchisejahre dieser Marke fielen in den Zeitraum von 2006 bis 2010. Die Hamburger nutzten den Immobilienboom für sich und konnten ähnlich wie die gesamte Branche schnelles Wachstum vorweisen. Was Engel & Völkers über den anschließenden Zusammenbruch half, war, dass sie ihre Dienste auf den kommerziellen Immobilienmarkt ausweiteten. Bis zum Ende des Jahres 2015 wuchs die Marke auf knapp 100 Franchisegeschäfte.
Wie die Grafik zeigt, taten sich die Gastronomiemarken während ihrer ersten fünf Jahre schwerer. Mit 15 Franchisenehmer betriebenen Geschäften wuchs Vom Fass in den ersten fünf Jahren am schnellsten. Bis Ende 2015 hatte es die Kette auf 30 Franchisenehmergeschäfte gebracht. Dazu kommen noch sieben weitere, die der Franchisegeber betreibt.
Vapiano sah sich nach einem guten Start aus verschiedenen Gründen gezwungen, nach 2014 keine weiteren Franchises mehr anzubieten. Ähnliches gilt für Hofbräuhaus. Nach fünf Jahren in den USA konnte die Marke bis Ende 2013 drei Franchisenehmer betriebene Restaurants aufweisen. Das vorläufig letzte Mal wurden 2014 Franchises angeboten. Teegschwender hat es ebenfalls nicht geschafft, sein Franchisesystem aufzubauen. Nach 2009 bot die Marke auch keine weiteren Franchises mehr an. Lediglich zwei Franchisegeberbetriebene Geschäfte haben ihre Türen noch in Chicago, IL geöffnet.
Welche Rückschlüsse können deutsche Franchisegeber daraus ziehen? Zum einen, dass die rechtlichen Hürden nicht das Hauptproblem sind. Die fünf untersuchten Marken sind in den regulatorisch schwierigsten Staaten vertreten. Engel & Völkers hat dort 11 und Vom Fass vier Franchisenehmer betriebene Geschäfte. Die Kosten, die durch das regulatorische System in den USA jedem Franchisegeber entstehen, waren nötige Investitionen. 
Vermutlich gab es für Hofbräuhaus, Teegschwender und Vapiano operative Herausforderungen. Bevor also der Schritt in die USA gemacht wird, müssen deutsche Franchisesysteme einen nüchternen Blick auf ihr Produkt werden. Nur weil es in Deutschland ankommt, heißt es noch lange nicht, dass es auch in den USA funktionieren wird. Amerikaner lieben deutsche Bier? Ja. Aber scheinbar nicht so sehr, dass es Hofbräuhaus zu schnellem Wachstum verholfen hätte. Tee geht immer in Hippster-Metropolen? Vielleicht, aber Teegschwender ist bis jetzt nicht durch Franchising gewachsen. Italienisch muss in dem Land ankommen, das die Vermarktung der Pizza praktisch erfunden hat? Scheinbar nicht.
Passt das Produkt? Wunderbar, aber reicht das? Deutsche Franchisegeber müssen sich auch fragen, ob sie eine wettbewerbsfähige Franchisestruktur haben, die es mit tausenden von anderen U.S. Franchises aufnehmen kann. Auch wenn man den Amerikanern gerne nachsagt, sie seien geborene Entrepreneurs, so ist der Kampf um qualifizierte Franchisenehmer in den USA ebenso ausgeprägt wie in Europa. Vor einer Expansion in die USA muss eine Marktanalyse auch diese Dinge berücksichtigen. 
Ein FDD ist somit nur eine Hürde. Nicht unwichtig, aber für das gesunde Wachstum eines Franchisemarke nicht so entscheidend wie das Produkt und die Franchisestruktur.