IS IT A FRANCHISE IN NAME ONLY? SBAS NEW RULES, A FRANDATA STUDY - - PowerPoint PPT Presentation

IS IT A FRANCHISE IN NAME ONLY? SBA’S NEW RULES, A FRANDATA STUDY

ASSIST ANCE T O HAVE F E WE R L OSSE S IN YOUR PORT F OL IO

I nfo rma tio n a nd Ana lysis fro m the F ra nc hise Busine ss Mo de l E xpe rts

WHY ARE WE HERE?

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Share insights on how the SBA Franchise Directory process is working, and an easy way to understand navigating the new rules with practical tips.



Understand the role of the Franchise Directory and the Franchise Registry in your lending process. What you don’t want to do!



Insights from a study on over 1,700 franchisors to help you understand and assess emerging franchise brands – and avoid unnecessary losses!

What else do you want to make sure we cover before leaving today?

FRANCHISE EXPERTISE DELIVERS

FRANCHISOR VERTICAL

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Franchisor Best Practices

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Provide best practices on the 12 pillars

• f responsibility of a franchisor to

improve the business model that franchisees invest in.

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Franchise International Market Research

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Cost of failure internationally is enormous.

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Franchise Development Services

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Improve Franchisor Capital Access

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Private Equity Due Diligence

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Advise PE firms purchasing franchisees and franchisors whether to buy. 2018 PE firms either backed out of transactions, lowered the purchase price, and advised to how to realize white space

LENDER VERTICAL Improve And Grow Bank Franchise Portfolios Advance Bank Franchise Underwriting Capabilities

VALUES OF FRANCHISE EXPERTISE

FRANCHISOR VERTICAL LENDER VERTICAL

FRANdata brought forward quality analysis and perspective in the Franchising and Dry Cleaning arenas. They were able to gather and analyze financial and

• perational information as well as provide us with helpful

insights and metrics that enabled us to focus our strategy. – Jeff Wampler CEO, Tide Dry Cleaning We have relied upon FRANdata to deliver extensive and relevant country analysis. Given their unique expertise around the franchise model, they have provided us with information that helps us ensure successful expansion. – Kathy Daniel, Home Instead, Director of International Business Development I use FranData because they get me the exact information I need, allowing for laser focus in my marketing efforts.

• Oliver Campbell, –1- 800-Radiator

The financial consultation call with Darrell Johnson was extremely valuable. The insights into the lending community and my company were helpful and provided me with additional information that will aid me in future decisions. Well worth the

• time. – Rebath

“The Franchise Registry, combined with FRANdata’s support team, is a great service that includes a unique franchise system credit scoring model to augment our internal underwriting process. It provides analytics and credit risk information that is accessible and useful in developing and monitoring our underwriting framework, as well as industry details that are helpful in our discussions with regulators.” – John Coffin, Atlantic Capital Bank We evaluated the FUND score with its supporting attributes and discovered that by combining FRANdata’s brand-level risk information with Experian’s Financial Stability Rating, clients can get a more complete picture of severe delinquency or business failure risk for individual franchisees. This should be particularly useful to clients with portfolios that are rich with franchise customers. – Piew Datta, Experian, Director of Commercial Data Science FRANdata has been a tremendous resource for helping us build out our target marketing lists. Their research is comprehensive, and data is complete and accurate. Plus, everyone I deal with is pleasure to work with and extremely responsive with all of our last-minute requests.

• Intuit

WHAT IS A FRANCHISE?

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Business in a box

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Proven success

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Support

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Training

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Small business

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American dream

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A chance. An opportunity

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Hard work

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Quick buck

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Hot Investment

FEDERAL LAW – FTC RULE

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Under the FTC Franchise Rule, there are 3 elements of a franchise:

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• 1. Trademark.The franchisee is given the right to distribute goods and services that bear the franchisor's trademark, service mark, trade name,

logo, or other commercial symbol.

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• 2. Significant Control or Assistance. The franchisor has significant control of, or provides significance to the franchisee’s method of operation.

Examples of significant control or assistance include: approval of the site requirements for site design or appearance designated hours of operation specified production techniques required accounting practices required participation in promotional campaigns training programs providing an operations manual

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• 3. Required Payment.The franchisee is required to pay the franchisor (or an affiliate of the franchisor) at least US$500 either before (or within 6

months after) opening for business. Required payments include any payments the franchisee makes to the franchisor for the right to be a

• franchisee. These include franchise fees, royalties, training fees, payments for services, and payments from the sale of products (unless reasonable

amounts are sold at bona fide wholesale prices).

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If all 3 elements are present, then the relationship will be a "franchise" for purposes of the FTC Franchise Rule and for purposes of the SBA rule.

FACTS

» Dealer Agreement » No FDD

» Agreement is entered into with Your Borrower and Red Wing Brands Of America (in Red Wing Minnesota!) » Dealer wants to open and operate a new Red Wing Shoe Store » Non Exclusive Right to sell Red Wing Shoes products in the Market

» Red Wing will supply deal with dealer requirements of products, packaging, forms and other store supplies at prices and on order, delivery and payment terms that Red Wing determines. (b) Make available to Dealer for a reasonable fee, and at Dealer’s option, signs, advertising and promotional materials, catalogues and other sales aids that Company periodically develops for use in operating a Red Wing Shoe Store; (c) Make available for a reasonable fee, and at Dealer’s option, a training program for

• perating a Red Wing Shoe Store and the sale of Company Products;

(d) Make available for a reasonable fee, and at Dealer’s option, Company’s Point of Sale (POS) system, an integrated point of sale and accounting system; (e) Make available for a reasonable fee, and at Dealer’s option, marketing services to assist Dealer in operating the Store; (f) At least annually, discuss and establish with Dealer inventory levels, annual sales goals, and

• ther operational and business objectives;

RED WING SHOES CASE STUDY

» Dealer has to construct, remodel, equip, establish and open Store as a Red Wing Shoe branded store » Must maintain Store premise in strict compliance with Company’s trademark guidelines, standards, operating procedures, etc outlines in SOP Manual » Must Refresh Store from Time to Time » Store Manager and sales personnel must successfully complete training programs » Must achieve and maintain minimum annual sales requirements » Company may allow for other products to be sold not manufactured by Red Wing » Must purchase minimum inventory agreed to in advance, and continuously maintain an inventory turn for the store of not more than 2.5, based on trailing 12 month same store sales » Term 5 Years and an additional 5 year term

RED WING SHOES CASE STUDY

IS RED WINGS SHOES A FRANCHISE?

What doesn’t meet the test? What meets the test?

Red Wing Shoes does not create an FDD for its dealers because it does not meet the Federal Trade Commission’s definition of a franchise. It does not meet the third part of the FTC test which is a required payment. Dealer and Company agree that the phrase “at Dealer’s option” means that Dealer is under no obligation to order, use, or accept the service or item offered by Company. Dealer represents That Dealer is willing and able to establish and operate the Store without the use of any optional services or items offered by Company. » Dealer is required to purchase inventory. The FTC does not consider inventory purchases a required fee. The Commission recognizes that it is, as a practical matter, virtually impossible to draw a clear line between start-up inventory that is purchased at the franchisee's option, and that which is purchased as a matter of practical or contractual necessity. In order to minimize the ambiguity in this respect, but consistent with the Commission's

• bjective that "required payment" capture all sources of hidden franchise fees, the Commission will not construe as

"required payments" any payments made by a person at a bona fide wholesale price for reasonable amounts of merchandise to be used for resale. The Commission will construe "reasonable amounts" to mean amounts not in excess of those which a reasonable businessman normally would purchase by way of a starting inventory or supply

• r to maintain a going inventory or supply.

» BOTTOM LINE: There aren’t any fees paid to Red Wing to start the business – SBA questioned fees such as their mood media and measure fit device, but those were paid to vendors who are not affiliated with the franchisor

RED WING SHOES CASE STUDY

SBA DETERMINATION

Red Wing Shoes Case Study – 11/2017 SBA Determination Not all brands on the directory are franchises. May get push back. Some were grandfathered in. TrueValu Hardware SBA determined they were a franchise. *As of 7/24/2018 – SBA Determination

SBA FRANCHISE IDENTIFIER CODE BRAND FTC FRANCHISE IS AN ADDENDUM NEEDED? SBA ADDENDUM - Form 2462 SBA NEGOTIATED ADDENDUM SBA FRANCHISE IDENTIFIER CODE Start Date NOTES Red Wing Shoes N 10/1/2017

SBA FRANCHISE IDENTIFIER CODE BRAND FTC FRANCHISE IS AN ADDENDUM NEEDED? SBA ADDENDUM - Form 2462 SBA NEGOTIATED ADDENDUM NOTES S1753 The Goddard School Y N

What do you do if you see this on the Directory?

GODDARD SCHOOLS CASE STUDY

TIPS AFTER 200 SUBMISSIONS TO THE SBA

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Timeline from review to posting on the Franchise Directory can be two weeks to three months.

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If a business owner signs a contract to operate his business (or many contracts), and that contract is not a part of a Franchise Disclosure Document, 99% it isn’t a franchise. (except for the gas station and automotive manufacturers.)

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WHY? Because if they don’t have an FDD and they meet the FTC definition, they are violating the Federal Franchise Rule.

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Make sure that the submission to the SBA specifically addresses why they aren’t a franchise, otherwise, it will be a longer road to the finish line.

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FRANdata can help your clients or they can go direct. If FRANdata helps, it is small part of a larger service called the Verified Franchise Registry Member that makes their franchise system easier for you to work with and finance.

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If a Franchisor is listed on the Directory as using a negotiated addendum, they may also opt to use the standard addendum form 2462 if they choose

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If a listed brand is using the standard addendum, they do not have to go through annual recertification process

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If a brand has no addendum OR wants to use their 2015/2016 addendum, then they have to submit docs to SBA to certify

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The Franchisor is responsible for providing the negotiated addendum to the lender. Whatever the franchisor gives the lender is the correct document with the SBA and Franchisor assuming any liability for an incorrect document.

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Sticky Points for Franchisors - SBA asks for Operations Manual. Some will refuse. Encourage them to send the TOC and ask SBA to request the sections they needed rather than sending the whole thing.

ADDITIONAL TIPS

ADDITIONAL TIPS

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If the Brand is listed on the Directory, it is approved for SBA financing

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The Brand does not necessarily need an SBA Code…if the brand is listed as “not a franchise”, it will not have an SBA Code

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The Brand need not have an addendum (negotiated or standard), to be eligible. If it is listed on the Directory as “not a franchise,” it may well not require an SBA addendum

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SBA changed the text of Addendum 2462, and will not accept the 2017 version. This change was not announced so many franchisors do not know.

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Since Addendum 2462 is subject to change, we encourage franchisors to have their own version created.

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Uncover first whether the franchisor is willing to work with SBA if the brand isn’t on the directory

• Ie. McDonald’s

WHAT’S THE DIFFERENCE BETWEEN SBA’S FRANCHISE DIRECTORY AND THE FRANCHISE REGISTRY

 The Franchise Directory Tells

You That You Can Do The Loan

 The Franchise Registry Helps

You Decide Whether You SHOULD Do The Loan

MAKE SURE THE FRANCHISE BRAND YOU FINANCE IS A VERIFIED MEMBER OF THE FRANCHISE REGISTRY

Verified Franchise Registry Franchisors

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Understand how lenders evaluate franchise credit risks

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They have seen their FUND Report (franchise credit score) and have been counseled on how to improve.

• The franchise credit score (FUND) is the best predictor of franchise success
• There are close to 100 franchise brands with a 0% charge off rate that have subprime

franchise credit

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Brands that have made it easier for lenders to find and evaluate their franchisees

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They provide their contact details, FDD and other information to help you under their franchise

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Demonstrate that they support their franchisees from the start of the relationship

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Provide lender support through FRANdata by monitoring and resolving any affiliation/eligibility documentation issues

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They are better performers than non verified members!

LEGAL SYMPOSIUM – PRIMROSE SCHOOLS

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Primrose Schools has a 900 credit score out of 950.

• 340 Franchise Schools. It has had very high annual unit success at over 97% for the past eight years; it closed ten schools along with

a total of 150 openings. The schools also have strong revenues, profitability and they continue to improve. The same is the case for the franchisor. They have a superior support organization. Franchisees aren’t selling because their businesses are doing well!



You would be so happy with me this week where I was attending the IFA Legal Symposium – they had a break out round table to discuss the new changes to the SBA process and the attorney they had at the table was “clueless” all he knew was the difference in the loans, nothing else – I ended up running the whole session, explaining the changes and updates, forms, etc... and how FRANdata was still the best resource for lenders and franchisors (I seriously sounded like a commercial…ha) – afterwards, everyone thanked me and said I was so helpful and they so appreciated the practical processes for dealing with everything AND for those who were not on the registry, they were going to be reaching out as they now see the value!

IFA’S EMERGING BRAND STUDY

• Over 1,740 brands have started franchising since 2012, with an average of over 300 brands entering the market each year.
• In 2016, emerging franchise brands contributed an aggregate total of over 15,000 franchised and company owned businesses

to local economies across the country

100 200 300 400 2012 2013 2014 2015 2016* 2017* # of brands

New Brands Entering Franchise Market Each Year

Note: projected 2016 & 2017 numbers due to the lag in data collection

Before 2000 26% 2000 - 2005 11% 2006 - 2011… Emerging Brands 42%

Franchise Market Based on Year Brands Started Franchising

Future Franchisor

 Entrepreneur and small business

• wners that runs

their business with either a spouse or with a business partner.  In business for

• ver 7 years.

 No franchise experience.  Considered other growth methods.  3 corporate units  Start with an average of 5 employees  No real estate background

Typical New Franchisor

 Franchisee training is performed by a cross section of existing employees.  Used their own capital to fund the franchise business.  Start selling franchises in-house and offer franchisee training in-house.  A dedicated employee for franchise sales  Open one franchise location in their first year.  Very high

• expectations. Plan to

grow their franchise into a national and international franchise within 5 years.

Typical Franchisor After 5 Years

 Are planning to

• utsource the following

functions to suppliers  Real Estate  Technology  Construction  Brokers  Added dedicated staff to focus

• n training and support once

the system has reached the threshold of 6 units  Sold franchises in neighboring markets where they already have a presence  Still struggling to manage corporate stores and manage the franchise at same time.  Realizes culture alignment between franchisor and franchisee is critical

Typical Franchisor After 5 Years – By The Numbers

 Average continuity rate of 93%, with an average of 5 franchised units that left the system  On average they have 30 franchised unit –Median of 15 units  Is not recurring revenue self sufficiency  Reached positive operating cash flow  Franchisee profile has changed multiple times

Deviation From The Typical

• Concepts with low upfront capital requirements are more accessible to a larger pool of

entrepreneurs, and generally faster to get the business operational

• Concepts with higher investment levels are slower to open, but generally keep those locations
• perational more consistently, while concepts with lower investment levels have lower continuity

rates

95.5% 96.0% 96.5% 97.0% 97.5% 98.0% 1 2 3 4 5 < $101,200 $101,201 - $233,000 $233,001 - $433,800 $433,801 - $64,817,501

continuity rate # franchised units initial investment range

Unit Growth & Success by Investment Level

annual franchised unit openings continuity rate

Experience Matters

40% 50% 60% 70% 80% 90% 100% 2 4 6 8 10 12 14 Year 1 Year 2 Year 3 Year 4 Year 5

continuity rate # franchised unit openings Franchise Experience Accelerates System Growth & Results in Higher Continuity Rate in Early Years

first time franchisor unit openings experienced franchisor unit openings

Proof of Concept Sells More Franchises

2.6 2.0 1.7 2.4 4.0 3.2 5.0 1 2 3 4 5 6 0% 5% 10% 15% 20% 25% 30% 35% 0 units 1 unit 2 units 3 units 4 units 5 - 10 units 10+ units # franchised units opened annually % of emerging franchisors # of corporate units in operation at franchise start

Proof of Concept Sells More Franchises

TAKE AWAYS ON EVALUATING NEW FRANCHISORS

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Risk is higher

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Do not expect a lot of support

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Evaluate the mix of skills between the franchisee and franchisor

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Evaluate the executive experience

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Consider the culture combination of the franchisee and franchisor

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Credit risk can be lowered by a number of factors such a more company owned units

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Look at where the franchisor money is coming from

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Evaluate a brand against peers that have gone ahead of them at their stage in the business

EMERGING INDICATIVE CREDIT REPORT

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FRANdata is launching an indicative report for Emerging Brands next week to ease your time investment and to bring more information to bear. If you’d like a copy, give me your card or email franchiseregistry@frandata.com

WHAT DID WE LEARN?



Insights on how the SBA Franchise Directory process is working, and an easy way to understand navigating the new rules with practical tips.



Understand the role of the Franchise Directory and the Franchise Registry in your lending process. What you don’t want to do!



Insights from a study on over 1,700 franchisors to help you understand and assess emerging franchise brands credit risk.

What else?

31 FRANdata is the only source of comprehensive information about franchising:

Fact-based research and analysis World's largest database of franchise information – 40,000 FDDs and growing Tracks and analyzes more than 3,500 brands in 30 sectors and 235 industries Manages the Franchise Registry with over 8800+ lender members

FRANdata ta ‘s capabilities are unique in the franchise world

Custom Research: Addresses questions/needs with timely analysis Reports: Data, analysis, trend forecasts Complete objectivity: FRANdata receives no advertising or referral fees

Edith Wiseman CFE President FRANdata ewiseman@frandata.com