Are You a Boring Franchise or Custom Cuisine?

So, you’re a great cook? On the level of any chef? (At least your friends tell you that.)

Your family eats well, and they say they’d rather eat at home than at any restaurant in town. You start dreaming. You want to open a restaurant.

You dream for a while. Your spouse has a great career and makes great money. You are still sitting on that inheritance money, too.

It’s go time!

Well, almost. First, you must answer a critical question: “What type of restaurant will I launch?”

Custom cuisine or franchise

You have a flair for French cuisine. And many friends say they’ve never had a better meal, even in France. You devour some old Julia Child videos and start sketching out a menu.

You dream of how you’ll decorate and search eBay for the right art for every wall. You select paints and hire a graphic illustrator to design the concept. You realize you’ll need a few investors. This shouldn’t be a problem. All your friends and that wealthy cousin will certainly want in (you hope!).

You start to look for furniture and hit a wall. You’ve got pictures of that restaurant from your anniversary trip. But their furniture must have been handcrafted. So, you start searching for a custom furniture builder. You get a few quotes, and it dawns on you.

This is getting real. And this will be a lot more expensive—and a lot harder—than you thought. And the cost of failure would be devastating.

And you still must do a hundred, no, a thousand other tasks in various realms where you have little experience. These include choosing a name, getting a logo and other graphics, legal and entity work, staffing, advertising, and so much more. Suddenly this romantic idea seems more like an uphill battle with an uncertain end. And you hear that a new French restaurant just opened in the same part of town. Arrrggghhh.

Another angle

You’ve expressed your growing frustrations to your new business coach, a retired serial entrepreneur. She started over a dozen small companies over three decades, then sold out in her fifties. She has a passion for helping others avoid the mistakes she made and get on the right track.

Your coach doesn’t seem surprised. It seems she expected you to come to this moment. But her proposed solution infuriates you.

“Have you ever thought of ditching the custom cuisine and launching a franchise instead?”

This is an outrage. You bite your lip and look around nervously. Thankfully you have a child to pick up after soccer, and you excuse yourself. You practically storm out of the coffee shop. “Franchise schmanchise! She must be kidding!”

Your spouse calms you down just before bedtime. As you lie awake, the thought hits you.

“What is my main goal here anyway? To fulfill my passions or build a profitable business and create wealth? And which path would most reliably get me there?”

Both are great goals. But they aren’t mutually exclusive. You could achieve both along either path.

With this in mind, you reluctantly Google “pros and cons of franchising” (secretly hoping the cons outweigh the pros). You learn a lot that night. Statistics on different sites conflict, but one website is particularly clear. You jot down a list.

Advantages of a franchise

  1. Most hard startup work is already done.
  2. You need little to no experience.
  3. Support from an extensive network of experienced businesses.
  4. Significant franchisor buying power.
  5. Financing should be more accessible, and in fact, the franchisor often provides it.

Disadvantages of a franchise

  1. Minimal flexibility. No choice of menus, pricing, colors, furnishings, name, logo, policies, and a thousand other issues.
  2. You’ll have to share a significant portion of profits with the franchisor.
  3. You won’t get to travel to France (or eBay) to acquire the beautiful furnishings, source exotic food, and more. Everything has been established by someone you’ll never meet.
  4. Business reputation partially depends on a corporation and other franchisees.
  5. Franchisors hold more renewal power. You could get fired, or they could raise their rates over time.

This list seals the deal for you. You can’t imagine decades chained to corporate suits who will run your life. Your plans for custom cuisine are back on track. Your coach must be mistaken.

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A wake-up call

You wake up to an email from your coach. She sends you statistics on the failure rates of new businesses. The Bureau of Labor Statistics says almost 18% of small businesses fail in the first year. Close to half tank within five years. And just over a third survive past a decade. “Over one out of three isn’t so bad,” you reason.

She reminds you that these stats don’t account for those who hang on but barely make it. Those who must continually borrow from a spouse’s income or their retirement to hang on. Entrepreneurs whose eager dreams turn into living nightmares that lead to burnout, missed decades with family, and a host of other physical and mental strains so common to startups. Yikes.

She points out that carefully selected franchises generally have much higher survival rates and profitability than their competition. And a higher quality of life for the owners. And a much higher likelihood of scaling into multiple locations. Plus, a higher probability of resale at the end of the line.

This throws you right back into confusion—so many questions to ponder.

What type of restaurant will you launch? Should you even do this? Maybe you should just invest in a restaurant. Or work for one first to learn the ropes.

There’s certainly not one clear path for everyone.

From restaurants to real estate

Rather than a restaurant, you want to succeed in real estate. Awesome! I’m 100% behind you. I wish I’d started sooner. And I wish I would’ve considered these issues decades ago.

Which model should you choose? I don’t have an answer for you. I’ve done both. I’ve made money at both. I’ve worked very hard at both. I admit I lost more money on the custom side, and I’ve built more wealth on the franchise side. But you’re not me. So let’s look at this custom vs. franchise real estate model.

Custom real estate business

This isn’t limited to one strategy, but it is often in the realm of single-family flips, small rental properties, or one-off commercial deals like mobile home parks, self-storage, RV parks, land developments, and more.

A boutique operation typically fits the realm of a right-brained artist or creative. Those who loathe all things corporate. Those who love HGTV and dream of creating masterpieces like Chip and Joanna.

Or it may include someone like my friend who recently bought a handful of Gatlinburg, Tennessee, rental cabins and reports making 50%-80% cash-on-cash ROI annually. As a retired GM engineer, he has a careful process for selecting each home. He has loose procedures (such as Airbnb/VRBO check-ins, maintenance, marketing), but he doesn’t need massive staff or systems to grow and run this. I’d call this a boutique, not a franchise.

If you’re a real estate agent, this could look like going with the flow, using minimal systems and team. Custom boutiques are typically:

  • Hands-on. You pick the house and paint colors. You oversee (or perform) the labor and do the marketing to lease or sell your custom creation.
  • Potentially enjoyable. It’s hard work, but you get to see and touch the fruits of your labor.
  • An expression of your creativity. Just like their occupants, every home is unique. And you can bring out the best in each.
  • Bigger potential wins. Lots of kudos from your community. You may even land on the local home tour. And if you live in Waco and your name is Gaines, you may even make tens of millions with your own TV show. (It’s worth dreaming, right?)
  • Hard to scale. Most look at each deal as a standalone, custom boutique deal. They usually run a business they must work in rather than work on.
  • Freewheeling. This appeals to many entrepreneurs. Corporate restrictions are like handcuffs. Entrepreneurs groan, imagining a shelf of franchise manuals to read and follow.
  • Unpredictable. Generally, a less predictable way to systematically build wealth.
  • Unstable. Significantly more ups and downs in time. Unpredictable seasons of intense effort and dry times with no work.
  • Hard to do well as a side gig. Though it is absolutely possible to flip houses or own rental property as a side hustle, countless investors are highly stressed by this lifestyle, and many give up.

Franchise real estate business

There are many types of “franchise” businesses as well. I am in The Collective Genius Mastermind with hundreds of top real estate operators. The majority run a franchise-style operation. While a custom house-flipper I know has trouble doing a house a month, many of these franchise investors flip or wholesale 100 to 300 homes per year.

The group includes multifamily syndicators, self-storage operators, mobile home park funds, and more. All are operating systematically or well along a path to achieve this.

Here’s a commercial example of franchising. Our firm does due diligence and invests alongside investors in the best self-storage and other commercial operators we can find. Our self-storage operating partners typically acquire one-off storage facilities. Then, they rebrand them and add systems, software, standardized property management, policies, procedures, and more.

By assimilating dozens of former mom-and-pop assets under one flag, they make far higher profits than they would operating individually. And they create a target on their backs for institutional investors looking to write large checks to acquire portfolios.

If you’re a real estate agent, a franchise may look like operating by Gary Keller’s Millionaire Real Estate Agent with carefully designed and managed systems and a well-trained team. Franchised real estate businesses are:

  • Systematic. Can be run by a replacement if a key owner or staffer leaves.
  • Repeatable. The same processes that worked in Louisville, Kentucky, will be applied and produce a similar outcome in Dayton, Ohio, or Daytona, Florida.
  • Programmatic. There are one-year, five-year, and beyond plans to grow the business and eventually divest. The manager can tell you about acquisition plans for next year.
  • Junior partners. There is a national epidemic of businesses whose aging owners have no one to share the load and eventually step into their shoes. Many just shut down, leaving the older entrepreneur in a financial crisis. A franchise operation is a natural fit for a younger employee to join and eventually manage or acquire.
  • Acquisition targets. Institutional investors seek franchise-style businesses to write large checks for. Some even refer to these businesses as franchises. They often pay a premium above the norm, assigning a lower cap rate, which means a higher price per dollar of profit.

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A third option

I did the custom boutique operation for years. We had a lot of fun. Early on, I recall telling my partner, “I can’t believe we get paid to do this!” We made a lot of money (and lost some). We worked when we wanted to and bought houses and land with whatever equity and debt we could pull together at the time. Friends and family invested with us, and we made great memories. But we didn’t build significant wealth.

I’ve done the second path as well, though it was much harder to get far down the road without a skilled team and systems that were outside my wheelhouse.

I’m early in my third decade as a real estate investor/syndicator/fund manager. I could choose either of these options. For me personally, at this point, knowing my strengths and weaknesses, I have opted for a third path.

I invest in syndicators and funds that operate as franchises. These firms typically acquire boutique commercial assets from mom-and-pop operators. Then, like a master sculptor, they chisel away the excess and create a beautiful, profitable, well-running, franchise-like asset that contributes to their scalable syndication business or portfolio. This is my favorite model of the three.

This path holds many benefits for my company, my friends, and me.

  1. We benefit from the profits of the boutique to franchise transformation.
  2. We remain passive while experts and technicians do the heavy lifting.
  3. We happily pay “the franchise fee” in the form of profits to the operator. He locates better deals and generates significantly higher profits than we could ever dream of on our own.
  4. We diversify into multiple different asset classes, geographies, operators, and strategies.
  5. We get the cash flow, appreciation, and tax benefits real estate is famous for.

I hope this lengthy post provides issues to ponder as you create your future in the real estate investing realm. I made quite a few generalizations, and I hope you’ll bear with me since there are as many different strategies as BiggerPockets readers and investors. I wish you well in whichever path you choose!

2021-09-08 19:30:00

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