← The Game with Alex Hormozi
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Had two different businesses that approached me, both had franchises open. I had almost an identical conversation with both. And I'll tell you one of them, which is a whitening teeth, whitening business. And a breakdown is how I help them walk through this decision of should we go more franchises or should go more privately owned? And it really comes down to four main variables. Number one is the cost versus the return of every dollar you invest in opening more locations. The second is the actual effort that it takes to open a location, which comes down to is it centralized or decentralized in terms of where the work is being done? Centralized. And it means that there's more oper drag at the franchisor level. If it's decentralized, there's more work for the franchisee. The third thing was actually looking at this at scale. If you have a number you solve for which almost every entrepreneur that I know who is in a local chain wants to solve for some big exit. Usually it's 50 or 100 million. And if you want to own it forever, totally fine. You still think about building it as an asset, even if you're never going to sell it just transparently. Like, we don't want to sell anything anymore. We want to hold and grow, buy and build, baby. That's what we do. But we also understand that some entrepreneurs do want to sell. And reversing your net worth goal into what you actually have to open at a location level between franchise and local, privately owned ones that you own, all of them is a good math number to know because it makes the decision much, much easier. And then finally is a little bit of a personal thing, which is which type of entrepreneur are you? Are you more of a promotional entrepreneur? So you love the sales, the marketing and selling the franchises. Selling the franchises. Or are you more of a product driven, operational leadership driven entrepreneur who's like cool with a longer time rise and just loves investing in people and building kind of a big thing. So break down all four of these. Here are the business metrics that are top line per location is about 500,000 a year. Bottom line pro location is 250,000 a year. The cost to open was 50. So I spend 50, I make 500. Top line, I keep 250 a year later. Really good numbers. If you have a business that gets like less than 100% return on capital, meaning it usually makes more sense to franchise right off the bat because the return on capital is too slow and not big enough. If you look at a McDonald's for example, it cost 1.1, $1.2 million to open a McDonald's. They make 150,000 a year on average afterwards. So you're looking at like a 15% rate of return, right, versus spend 50, make 250. You're talking to 5X, right? Very different. And this happens all the time. I've seen this with moving businesses that have crazy returns on capital. Same with gym business. Doesn't really matter what the businesses, but you have to switch from your business hat to your investor hat and start looking at your business investment. Because once you start generating real money, you have to think, where is the best place I can put my money? And if opening another location 5X is your money, every year you go from 1 million to 5 million 5 to 25, 25 to 125. That becomes a very attractive machine if you expand the time horizon. We have this business. These individuals had decided to do the franchise. So this is what their franchise economics looked like. They would get seven and a half percent of top line. It's a royalty on top line. And it's usually some sort of marketing fund that everyone chips into so they can get national branding. Some franchises do flat fees, some do royalties. Doesn't really matter. There's a certain percentage revenue that you're going to collect. Now these guys were charging seven and a half and so on 250. It was like $35,000 per year that they're making from the franchise. Okay, stay with me now. If the franchise runs at the same margins at the individual locations, at 50%, so $20,000 of what they're going to make in net earnings at the franchisor level per location that they open. Here's the kicker, and this moves us on to our second kind of variable here. You've moved past the first checkpoint and you're like, okay, our economics are pretty good. Like we're over 100%, we're in that line. But now it's like, well, how hard is it? If you have $20,000 in net earnings per franchise you open and you've got 250,000 DOL per location that you open on your own. The franchises get usually two times the multiple that a brick and mortar local chain will get. So they might get like 15 times earnings in terms of the enterprise value, what an investor might buy for it. Because franchises usually have a certain amount of open and usually more have yet to be open. And so an investor is willing to pay 15 times today because they already really know they're paying. If Nothing else changes, a 5x multiple because they know the other 200 are going to open. Guaranteed it's legal, has to happen versus getting 8x on the individual location. So 8x on 250 would be $2 million versus 15x on 20, which would be 300,000. Which means that for every location you open at the franchise level, you add $300,000 to the franchise valuation. For every location you open on the privately held side, you would add $2 million. So that then informs. How hard is it to open these locations? What is the constraint? If we have a super decentralized model, meaning the franchisees do most of the work, then that we could open 10 times more franchises for the same effort as opening one. At that point it might make more sense to open more franchise locations. It's super centralized, as in you're doing most of the work. Then sometimes it makes a lot more sense to actually just keep opening locations on your own, provided the return on capital is there. You don't need to open, spend $1 million to open a facility to make 200 grand. Right? And the numbers pencil out where you just look dollars and cents. If I want to have $100 million exit, which you can have an exit or not, but you can still always build as though we're a sellable entity. Like we will always build an asset so that it is sell, that we sell it. So 100 million means 50 locations open privately or 333 locations open with a franchise. And so you have to look at that and think, okay, if I can open, let's say one or two locations a month, which most franchise locations do, then it would only take me like two, maybe three years to get to this number. Now, what's my rate of opening at the franchise level? Oftentimes, especially with, when I talk to franchisors, they're usually limiting factors internal, not external. The problem is, is internal, then it means maybe they can open like three or four locations for the franchise, which means it would actually take them longer to get their ultimate outcome. And that's assuming they can sell franchises like Hotcakes, which is not always that easy. That leads to the fourth point on this checklist that I walk through mentally. The final thing is just personality wise. So if I look at an entrepreneur and they're super promotion driven, they love selling, they love, they love the sizzle, they love the hunt, right, of selling franchises. Then franchising when I'm at 50, 50 might still be the right play. On the flip side, if there's somebody who's A little bit more product driven, a little more leadership driven, like love the ops, all that kind of stu, then it might be more of a self sustained, lower number, higher value play. And here's the key difference. If you have a really stark difference between franchise versus private, let's say a super promotion driven entrepreneur, but all the math says that you should own it privately, then if you phrase the thing that you don't like as a deficiency in the business, then it becomes very solvable. So for example, staffing each of these locations becomes hard. You've got all these kind of low skill, low wage employees which can be difficult to manage, lots of churn, et cetera. So what do you do? You hire somebody who's ran a staffing for a franchise that's gone from 50 to 250 multiple times. That's what I would do. When we invest, it's exactly what the move would be. We can take somebody who's super promotion driven and then bring in one or two people to support them in the things that they don't like that are way better than them at it. And then you get the outcome where the math and the personalities work together to build the ultimate enterprise value. And on the flip side, if you're super like ops, product et cetera type entrepreneur, but all the metrics say that you should franchise this thing, then we bring a really hypey sales driven person into the business to go hunt for you to bring more franchises in so that you can scale faster, because that's the way that your model has been set up. Either way, these are variables that you can play with. And those are the four points that I look at as checklist of how I'm going to scale a local business that comes to us. We made a checklist that you can actually look through these four things for yourself, actually go through it and fill it out and look at both those things because you'll actually look at as an investor and it'll make you a better business owner.