Angel Investors and Franchising

Those interested in investing their own capital outside of the public markets, oftentimes in new ventures, are commonly known as 'Angel Investors.' These individuals are continually looking for new opportunities to invest in sound, well-managed companies. Many are focused in sectors such as technology, bio-tech, and real estate. However, there is another, often overlooked, opportunity that aligns well with their desired investment goals and that is franchise businesses. In addition to providing portfolio diversification, the attributes of many franchise organizations align well with the investment criteria of most angel investors.

What are the most important criteria for angel investors and how do they align with franchising?

The Likelihood of a Solid Return 

Angel investing involves more risk than other classes of investments so angel investors have the expectation of strong returns rather than just getting their money back when they invest in an enterprise. 

With Franchising, there exists a stronger forecast of likely returns due to what is called the ‘Item 19’ within a franchise systems ‘FDD’. Most franchise systems that have been in business over the course of time provide the financial results of their existing franchisees within their Franchise Disclosure Document, thus providing would-be franchisees and investors with a reasonable expectation for their pro formas.

A Compelling Reason to Invest 

Most angel investors are or have been successful entrepreneurs themselves They often enjoy the opportunity of helping to build and create a thriving enterprise.

While each investor has their reasons for investing, many enjoy the opportunity to participate in something they consider to be meaningful work. 

In Franchising, the support of an entrepreneur (franchisee) that is able to provide for customer needs in their local community can be attractive to investors that carry not only a desire for returns but also have an altruistic perspective in how their investment is used. For instance, consider in-home senior care providers, fitness and wellness gyms, childhood enrichment, and the many environmentally friendly businesses that aid in sustainability through recycling or enhancements via home services.

An Experienced and Solid Management Team

A solid, complete management team with leadership ability is a must. Essentially an angel investor is investing in people, so he or she needs to have confidence that the business is in the hands of people who are knowledgeable, competent, and trustworthy. 

When investing in franchisees, not only are investors getting an entrepreneur but also the experience, expertise, and support of the franchisor and his/her home office management team.

A Thorough Business Plan

Angel investors want to see a business plan that is both convincing and complete. They want to see things such as financial projections, detailed marketing plans, and specifics about the vision. 

Franchising receives high marks in regards to these items. There are few other businesses that provide the ‘comparables’ of other franchisees to gauge the future success of a new franchise location. The ability to not only forecast financials based on the franchisor’s FDD, but the visibility into past successes of marketing plans and operational initiatives that comes from a franchise system’s franchisee community is invaluable. 

An Investable Business Structure

While some angel investors invest by giving loans to businesses, more than half of angel investors are looking for minority equity ownership position. This means that the business has to be structured to allow for investment.

Franchising accommodates this need in a relatively simple way. Depending on whether the investor is passive, for example part of a larger fund, or relatively active through direct investment, most structural arrangements can be accommodated through a Limited Liability Company (LLC) accompanied by an Operating Agreement that outlines the plan behind the timing and amount of the respective distributions.

The Opportunity to Be Involved

For many angel investors, it is not only about the money; they want to actively participate in building the business. They want to serve as a mentor and potentially even to take an active role in managing the company. This often translates into an angel investor sitting in the role of a Board Director or serving in another capacity.

Like many other businesses, franchising certainly allows for this framework as well. While franchising involves following a systematic ‘playbook’ provided by the franchisor, there are still many areas for strategy development. These can include marketing, staffing, and expansion - whether through additional units/territories or through the acquisition of other brands that allow for cross-selling and/or cross-training synergies.

An Exit Strategy

Angel investors expect to see an exit strategy before they are willing to put their money to work in a business. While angel investors are patient and willing to make long-term investments, they need to see how they are going to achieve a strong return on their investment in time. Oftentimes this includes a strategic acquisition of the company by another market player or investor or the sale of equity interest by the angel investor back to the majority shareholder.

Resales of franchise units/territories to other franchisees or outside buyers is very common. Also, with the significant interest that large private equity firms have taken in franchise systems in recent years, the potential of a PE-backed franchisor’s interest in purchasing franchise locations is also a good possibility. Many are looking at this strategic move in an effort to convert franchise locations into corporate owned locations.

In summary, franchising not only support an angel investor’s portfolio diversification, its inherent attributes align well with their overall investment criteria. Franchising, though it has been in play for decades, is surprisingly an often overlooked arena for thoughtful investors. However, given the interest that large PE firms are now exhibiting toward overall franchise systems and the amount of capital currently on the sidelines, expect to see the ‘grassroots’ franchisee investment landscape begin to catch on with more and more angel investors. 

-Jon Ostenson is the Founder & CEO of 10Xbrands and serves as a Consultant with the FCC.