Are you considering becoming a multi-unit franchisee of a new brand? Here’s what you need to know first.

Multi-unit operators (MUOs) in the US own more than 50% of franchised units. According to FRANdata, the number of MUO franchisees has grown by more than 50 units 112.3% since 2019. Some sectors score higher. MUO’s control 82% of all quick-service restaurant (QSR) units, 71.5% of beauty related and 72% of sit-down restaurants in the US

Some of this is natural consolidation of existing units due to retirements, and some is due to new multi-unit agreements. Many articles have been written about building wealth in franchising through multi-unit ownership. Should you consider it?

Related: 4 reasons to become a multi-unit franchise owner

Are you considering becoming a multi-unit operator?

Let’s break this down into two discussions: resale (which I’ll get into in my next article) and multipacks for new development. Selling new multipack licenses is becoming more and more common in franchising. The reasons are simple:

1. Multi-packs generate more money for the parent company.

2. They show “demand,” which franchisors hope will attract private equity.

3. Fewer franchisees are cheaper to support.

4. Only buyers with higher net worth are eligible

5. Buyers themselves are demanding multi-package buying capabilities because it’s easier to build operational scale and profitability.

Multi-packs can be as small as two to three units and as large as 50-100 units or more to sell out very large territories or states. Note that selling “multi-packs” is different from selling area development agreements or master licenses, which have different performance requirements.

The competition to attract franchisee talent is fierce and expensive. Outsourced sales channels with high commissions, marketing and expensive lead generation eat up franchise fees. Undercapitalized young brands are clearly at a disadvantage. Royalty self-sufficiency (when a brand can fund business operations through royalties) is being displaced as franchisee acquisition costs rise.

Traditionally, franchisors limited the number of licenses a new franchisee could sign until they had proven themselves an operator (or had existing MUO experience). Once in, limits were also placed on expansion licenses to ensure that only proven operators in good standing with the franchisor were allowed to add territories. But more emerging brands are now skipping the first step and going straight to selling multi-packs.

In addition to trying to sell their way onto the private equity radar, some fledgling brands are avoiding the problem of “high commission starvation” in an expensive sales environment. It seems nonsensical to me that anyone would agree to buy a pack of more than 10 licenses of a brand with only 10 open in total. But buyers do just that. Some brands even sell with messages about how they only accept “executive” buyers who don’t need financing. This is meant to flatter buyers in part, but could also indicate that there isn’t enough margin in the business to allow financing!

There shouldn’t be any pressure to buy that much upfront from an emerging brand. There is little chance that your home market will suddenly be “sold out”. But aggressive sellers sometimes convince buyers otherwise (“We have ten units, all in Florida. Where are you calling from? Indianapolis? Coincidentally, we have another candidate ready to sign for that market!”). In addition, candidates can be rushed through a 30-day buying process (“Don’t wait! Territories are selling fast!”).

Related: 5 Encouraging Facts To Know About Multiple Unit Franchise

Case study

Here’s a case study to consider. This is an emerging franchise currently being sold by an Outsourced Franchise Sales Organization (FSO). I’m not including names because I want you to take away the signals of a potential problem brewing…not getting hung up on a specific brand.

The company’s franchise disclosure document: Item 19 Earnings Disclosure for 2020 included the financials of only one business unit. Three franchise units had been sold but not yet open, so financials for those franchise units were not included. The company suffered a net loss of $92,000 in 2020 and only had $43,000 in cash. By the middle of 2021, the company was nearly $26,000 in credit card debt. The company paid $363,000 in franchise sales commission. There were also $753,000 in “uncategorized expenses,” a whopping 62% of total reported operating expenses. Based on the “power” of this FDD disclosure, the company hired an FSO to help it sell franchises. And sell it did! As the FSO proudly states on its own website, “from 3 to 320 awarded!”

The current 2022 FDD shows $9 million in revenue in 2021, of which $8.8 million is franchise fees. But 6.1 million immediately went out in sales commissions paid. Credit card debt was $32,000. The Item 20 showed 50 units open and another 49 in development. The training cost was $15,000. I pay more than that for my child’s school fees! What kind of training was provided for the 50 opened units costing only $15,000? And what happened to the “320 awarded?” Some multi-pack capabilities are worth it, but for me this emerging brand has red flags.

Here’s my advice on new multipack deals:

1. Start small – three or fewer units. Unless you have franchise experience and the system is proven, you’ll be burning money on fees on units you may never open. You can add expansion areas later. Have your attorney carefully review the territory, site approval, and language of the breach contract.

2. Validate! Talk to as many franchisees as possible. Are they meeting their profit targets? Did all their units open?

3. “Areas” sold based on population size require additional due diligence. It is often a devious way to sell you more and make you pay more rather than creating viable areas of the right size in the first place. If the territory isn’t exclusive, you’re in for double trouble. The population number also does not relate to demographics or density. Talk extensively with franchisees about what makes their territories and model financially viable. Determine the cash return for your investment. Is it worth it?

4. To delay. Do your homework. If you see red flags, don’t talk yourself into anything. Continue. The right franchise opportunity is out there.

Related: Are you considering franchise ownership? Get started now and take this quiz to find your personal list of franchises that fit your lifestyle, interests and budget.