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Due Diligence: Not as Easy as 1, 2, 3

Due diligence calls for serious attention to concept economics, leadership, product offering and the franchise disclosure document.

By John C. Draper II

 

Here are some first steps I’ve used in developing my businesses that will help experienced franchisees and multi-unit franchisees to choose the best concept for them.  These steps include giving serious attention to such areas as concept economics, leadership, product offering and the franchise disclosure document.

Concept Economics.  You have to ask yourself what is the best use of capital.  Given the change in the economic landscape, most new concepts are in the fast casual segment.  And in most cases the fast casual segment is more in line with today’s consumer.  In our process we look for concepts that have a clearer picture of profitability which is a lot different from an old philosophy that drove our capital toward the mature QSR space.  Today’s fast casual segments can offer a three-to-one (sales vs. investment) which is closer to the matrix we like to operate within.  This comparison gets us closer to profit, provides the ability to spread risk, and allows us to use smaller portions of leverage.  The process of elimination starts here.  If a brand cannot measure up to this standard at the time of review, we simply move on to the next.

The required square footage should be taken into consideration.  A smaller square footage allows flexibility in available real estate, but most importantly lends itself to a smaller labor force that, in turn, lends itself to better economics.

Leadership.  The knowledge base of those in charge is a critical aspect to consider.  Who’s behind the brand?  Is this a start-up with little experience? Is this an off-shoot from a mature brand? Or is this a well-funded high growth machine?  Brands that are well funded by larger companies are in the position to adapt and make changes when necessary.  Take a close look at real estate, marketing and construction departments.  Knowing the leadership and financial health of the company is a key component in your deliberations.

Real Estate.  There are three things to consider when evaluating real estate: the development rights, the development schedule and the real estate selection and approval process.

  1. Brand development rights are assigned differently depending upon the brand.  Your development rights can be calculated by ZIP code, households or by city/state boundaries.  It is important to know how your brand calculates your development rights.  We typically conduct a broker search for real estate prior to specific development right discussions.  Make sure to understand what your rights include before negotiating any other points of the potential deal.  Brands (although they might not admit it), will sell rights to areas that potentially are not developable based on real estate inventory.
  2. Development schedule gives you the time frame in which you must sign a lease or develop a restaurant.  This can be critical in understanding what is needed in your upfront capital and how you should structure your finances. It is also important to understand the flexibility of this schedule as to not lose your investment.
  3. The real estate selection and approval process can be critical to your development rights and schedule.  In addition to our pre-screening of territories with our dedicated broker, we also like to test the water in terms of a real estate developer’s appetite for the brand or if we can get deals done.  However, the most important factor here is the selection process.  There are several ways sites are evaluated.  Brands can potentially assign you a preferred broker in your designated territory or they can allow you to hire your own broker and use him in the deal flow process or they could also find sites for you with no franchisee inclusion.  The most preferred of these, of course, is to have the ability to hire your own broker.  However, preferred brokers can be something of an advantage if they understand your given market, so don’t walk away yet.

The last thing to consider is how the sites are approved.  Seasoned real estate departments may have the authority and flexibility to approve sites, but also must have the foresight to understand the franchisee’s knowledge of the territory.  Will these sites be approved in the field?  Are your sites approved through some form of committee vote? Be careful to ask these questions because this could determine the overall success of your development.

Marketing. Social media is a big part of today’s marketing strategy.  It is important to consider the relevance of your brand or its connection to today’s consumer.   We ask ourselves such questions as: How fluid is the message from website to app to social marketing platforms?  How young (or cool) is the marketing department? What tools do they use for branding and marketing of their concept?

This part of the evaluation is not a deal breaker in most cases, but you need to know what support you have in the fight against all the new concepts.  Great companies will be in tune to what their consumers’ needs are today and in the future.

Construction. Knowledge of the construction department lends itself to a better investment. What you are looking for in a construction department is a professional who understands the process.  More knowledge makes for easier maneuvering around construction design flaws or through delicate municipalities.   Knowing that you have a resource base to refer to during the already challenging construction phase of your development gives that brand an “up” in your due diligence process.

Other questions you should ask:  What is the build out time/construction time?   How much flexibility will you have in the selection of vendors or contractors?

Product Offering.  Consistency. Consistency. Consistency.  How simple is the product? How difficult is the production process?  In this very competitive fast casual segment you must have a great product for a reasonable price and most of all must be consistent to continue to maintain its market share.

Review the FDD!  The franchise disclosure document contains valuable information on 23 points of information.  Whether you are a first-time or longtime franchisee, always review items 1, 3, 5, 7, 11, 15 and 19 of the document.

John C. Draper II is managing partner of Cottrel Coliseum Group LLC with more than 16 years of retail and food management experience managing multiple brands that have included Auntie Anne’s Pretzels, Burger King, Coffee Beanery, Haagen-Dazs and Pizza Hut.  Independently, he is working on a development agreement with Wingstop and recently opened the third store as part of his aggressive instate expansion plan that includes 28 locations over seven years, and four over the next 12 months.  Soon, He will also be closing on a three state development deals with Pie Five. Find him at fransocial.franchise.org.

 

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