Franchising Insight Burned Investors Aim at Franchise Success

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While no one tracks which franchises are purchased by Wall Street Refugees, numerous chains are experiencing explosive growth even as the market lumbers toward its third consecutive losing year.

Forget restaurant stocks. Michael "Mickey" King is investing directly in restaurants.

With Wall Street on the outs, the Oxford, Miss., surgeon recently sold out of several mutual funds to invest in a McAlister's Deli franchise in Charlotte, N.C. It will be his seventh restaurant. He runs none of them, leaving daily operations to a team of seasoned restaurant operators.

"I've been taking a beating in the market, and with stocks down I just think there's a better chance right now of being successful in franchising," says Dr. King.

He has some company these days. A growing number of investors are shunning stocks to invest in franchises. Based on a survey, Franchise Opportunities.com, an informational site, estimates that between 25% and 30% of new franchise owners are investors coming from Wall Street. That compares to between 12% and 18% of owners in 1996-97, when the stock market was still heading up.

While no one tracks which franchises are purchased by Wall Street refugees, numerous chains are experiencing explosive growth even as the market lumbers toward its third consecutive losing year. Subway has been selling new franchises in record numbers--2,500 so far this year versus 1,000 all of last year. At Sign-A-Rama, a franchiser of sign-making outlets experiencing record levels of requests for information, new applications "are far more apt to list stocks as the source of investment money," says Christopher Simnick, vice president for franchise development. Meanwhile, haircutting chain Great Clips is actively recruiting executive-level investors who want to continue in their current jobs; it expects to add 150 new franchisees this year, the most in the company's 20-year history.

"Historically, people always asked us why they should put money into a franchise when they can get big returns in the stock market," says Charlie Simpson, senior vice president of franchise development at Great Clips. "We haven't heard that question once in the past 12 months."

Out-of-pocket investments for a franchise can range from $9,000 for Tax Centers of America to $35,000 for Great Clips to $175,000 or more for a Krispy Kreme doughnut shop. On top of that, franchisees often take out small-business loans for several times their cash investment to finance equipment and real estate. For example, to open a Krispy Kreme costs as much as $1.13 million, excluding land, but much of that is typically financed.

Expected returns vary enormously, depending upon franchise, location and the drive of the person running the store. Some franchisees recoup their entire investment in a year or two. Others, of course, lose money. Broadly, annual returns run between 5% and 40%.

Dan Olsen, who sells Fantastic Sams franchises in northern California, says the hair-cutting salons typically require a cash investment of between $30,000 and $35,000. Franchisees can earn profits between $20,000 and $40,000 in the first year and between $40,000 and $60,000 in year two, he says.

"If you can get a return in the first 18 to 20 months that comes close to your original investment, while paying you a salary, you've done well--and that's not hard to do in franchising," says Terry Powell, founder of BIZ Experiences's Source, a franchise-consulting firm in Southbury, Conn.

If you are interested in buying a franchise, the first step is determining how much money you can invest. Then check out Web sites like www.franchise.organd www.franchiseopportunities.com, which list franchises by required investment. Franchisors typically operate Web sites with investment information.

Certainly, opening a franchise has plenty of risks. In many towns, the best sites are already taken, particularly for location-sensitive chains like restaurants and hotels. And while many investors find success in passively owning a franchise, "passive investors by their nature often aren't as successful as those" who actively manage the business, says Janice Hall, vice president of sales and marketing at Franchise Opportunities.

Another drawback: Cashing out a franchise investment often isn't easy. Generally, a passive franchisee either sells to another investor or to the current management team, which can take several months.

Some chains frown on passive investors. "The last thing we want is someone who's wondering if they should invest $50,000 in mutual funds or a franchise," says Peter Holt, executive vice president of sales and development at Mail Boxes Etc., a unit of United Parcel Service Inc.

Other chains, however, embrace investors uninterested in running the business day to day. Great Clips, for instance, is geared toward people who want to continue in their current jobs. Only 2% of the chain's franchisees have a license to cut hair.

Cyndi Thompson decided to take the plunge a year ago. "My money in the market wasn't going anywhere but down," she says. So, in July, she and a partner who had restaurant experience opened a Huddle House, a 24-hour restaurant chain, in Oneida, Tenn. The store was profitable in the second month. "Now she and her partner are looking to break ground on a second store in neighboring Kentucky.

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