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How Emerging Franchises Can Thrive in a Crowded Market

by Ana Lopez
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According to FRANdata, an average of 250 new franchise brands have been launched in the US each year since 2001. That is no less than 5,250 brands that have been launched in the past 21 years. But in 2022, FRANdata totaled only 4,000 active franchises – up from 3,000 in 2010, which also remained flat at 3,000 in 1990. So, where have all those emerging brands gone?

Just because several thousand brands have stopped active franchising doesn’t mean those businesses have failed or closed. Some reverted to a business model, were acquired and reflagged by competitors, or stopped adding new franchise units. Their franchise efforts went from “active” to “idle”, while the business entity itself continued. And yes, some emerging franchise brands also failed. Franchisees who thought they were joining something destined to get bigger were disappointed.

A cottage industry of enablers helps businesses launch new franchises. Unfortunately, the fees charged for these services create a conflict of interest when it comes to quality control. A consultant whose entire business model is focused on launching new franchises may be reluctant to tell anyone that they need to delay the launch or that they are undercapitalized. The top firms specializing in new concept launches publicly publish their track record and have extensive screening and training for newly launched brands. They continue to work with those brands until they reach a maturity level. Unfortunately, others like to take a hefty fee to amend a boilerplate Franchise Disclosure Document (FDD). Founders who try to launch their franchise businesses on the cheap without studying franchise best practices are also to blame.

Related: How to Launch, Grow and Thrive in Franchising

If they haven’t taken the time to study franchising, founders have a steep learning curve. Many also fail to understand how competitive the market has become to recruit franchisees. So they launch, hoping their concept is exciting enough to catch fire and be disappointed. Those who keep sputtering in hopes that private equity buyers will bail them out before they run out of money should think again. Private equity investors want growth stories, not unproven brands without infrastructure. Even PE companies that specialize in working with emerging brands usually want to see an EBITDA of at least $500,000 and $1 million+ is preferred. They want good bones, a backable team and real potential.

Franchise advocates worry that potential franchisees don’t understand how risky emerging brands are and will join a concept that turns out to be a bad bet. The Federal Trade Commission (FTC) franchise rule requires extensive disclosures. Potential franchisees have an avalanche of information at their disposal from the franchise itself and the wider industry to help them research the viability of the concept. In addition to the required disclosures, there are plenty of buying guides (including businessroundups.org’s Franchise Buying Guide), learning resources, consultants, and attorneys to help candidates. All these resources seem to have a positive influence on the choices of potential franchisees. The market seems to be turning away from, or is simply too noisy for, the smallest concepts to successfully attract new franchisees.

The market is consolidating

Stronger concepts have momentum, thanks in part to help and investment from private equity. Going back to 1990, the top 3% of brands (100 of the then active 3,000 brands) accounted for 34% of the total number of stores. Now the top 20% (top 800 of 4,000 brands) represent an impressive 80% of new units sold each year (both to existing franchisees and new franchisees). The businessroundups.org Top 500 (12.5% ​​of 4,000 brands) are opening more than stores. This means significant consolidation and strengthening of top brands. More than 600 franchises are now receiving or have received help from private equity at some point in their growth cycle. Not surprisingly, there is considerable overlap in the top performing groups.

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.

Everything is more expensive for emerging brands

Over the past two decades, private equity has made it much more expensive to launch and grow a new franchise brand. Their influence and spending habits are pulling oxygen away from emerging brands in favor of their own portfolio companies and their multi-brand platforms.

Private equity firms investing in franchising are betting on growth. They spend on proven expansion tactics, including working with brokers and outsourced sales groups. The sales commission can amount to 80-100% of the franchise fee actually collected. Since PE’s profit plan depends on growing recurring revenue and not one-time upfront payments, they are willing to pay high commissions as part of their comprehensive growth plan. Then they invest to get sold units open and productive. PE-backed franchises are also highly visible at franchise conferences and expos. These are expensive events for small brands. Platforms supported by PE have additional cross-selling benefits. And of course, Google is the start of most searches and a place where PE-backed brands can afford to maintain high visibility.

Unaffiliated emerging brands get locked into a very expensive competition to win new franchisees. The cost of maintaining an active franchise program often exceeds the commitment and ability of an emerging brand to sell and support franchise units. So they just switch back to a corporate model while they are still small. They switch from ‘active’ to ‘inactive’.

Related: 7 things you need to know before becoming a franchisee

The brightest new concepts now launch their franchise efforts when they are well capitalized with proven strong performance at the business unit level. FRANdata’s most recent New draft report identified 86 new franchise brands. Of these, 16 were affiliated with existing franchises through their parent company. Forty-seven percent reported annual average unit sales of $1,299,297. Brands reporting annual sales of more than $1 million doubled from 11 to 22 from the prior year. Two brands were associated with platform companies. Two others already had private equity connections. So something has changed. These new concepts are launched at a more advanced level to try and compete.

The consolidation of the market around quality benefits future franchisees who seem to be largely migrating to more proven concepts. It seems many of today’s buyers recognize that “ground floor boarding” is a risky proposition and are awaiting proof of viability.

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