A Fintech x Franchises Crossover!
By Alex Johnson
I am incredibly lucky to get to work with the Wolf of Franchises, an industry insider who has spent his career learning the ins and outs of the franchise industry. If your knowledge of the franchise industry is limited to your personal experience with McDonald’s, don’t worry. I was in the same boat. That’s why I decided to sit down and chat with the Wolf about how franchising works, the economic opportunities it creates, and the problems that still need to be solved in the franchise industry.
OK, here we go. Owooooo!
Alex: OK, let’s start with the basics. What is a franchise business? And how many franchise businesses are there in the U.S.?
The Wolf: A franchise business is just a small business that you productize. It’s business-as-a-service essentially. You take everything that you’ve learned building and running a successful small business, and you package that knowledge into an operational playbook, which you sell to someone else while retaining an economic stake in the franchisee businesses.
There are roughly 3,000 franchises in the U.S. right now.
Alex: Excellent. Thanks. You just described the franchisor, correct? The person who builds the original business and then productizes it into a franchise?
The Wolf: Yep, exactly right.
Alex: Perfect. Can you walk us through the economics of the franchise model? How does it work?
The Wolf: Sure. So the big components are the franchise fee and the royalties.
The franchise fee is the upfront price that you, the franchisee, pay to license the franchise brand and get access to that operating playbook. It’s a per-location fee, which averages out to about $43,000, with discounts typically for each additional location.
The royalties are a share of your monthly revenue that you pay to the franchisor. Obviously, the rate varies, but 6% is a good rule of thumb.
And then you have a bunch of other, smaller fees, like a brand fee, which is usually a percentage of revenue as well, and that goes into a big pot that the franchisor spends on marketing and other expenses to help build the overall franchise brand. Some franchises will also charge a tech fee, which covers the standard tech stack that all the franchisees use to run their business, like if it’s a spa franchise, there likely is going to be scheduling software that they use.
Alex: OK, so that’s the franchisor’s perspective – it’s a capital-light model for growing your business in a predictable and profitable fashion. What about the franchisee perspective?
The Wolf: Put simply, it’s one of the best paths to building wealth for aspiring entrepreneurs.
It’s basically a de-risked small business in a box. If you want to open a coffee shop or a gutter-cleaning business but you don’t know where to start, there is probably a franchise playbook out there that can help you. And over time, you see a lot of successful franchisees expand themselves, opening up multiple locations for the same franchise and/or diversifying across multiple brands.
It’s really unsexy. It’s brick-and-mortar small businesses for the most part. Not a lot of tech. No VCs. But the people who do well in franchises – they don’t need to get a college degree or learn how to code or live in a big city – end up insanely well off.
Alex: I love that.
How do you become a franchisee? Like, what’s the most common path?
The Wolf: Well, one common way is through franchise brokers.
They work just like real estate brokers. They go out and find folks who might want to become franchisees, and they’ll spend time with them to understand their goals and financial situation, and then they’ll help them do some research into different brands and narrow down their options, and then they will make introductions to the brand(s). They might help the franchisee navigate the onboarding process with the franchise, maybe do a little consulting with them. And then they get paid a large portion of that upfront franchise fee.
Alex: I’m guessing there’s some potential for shadiness in this broker-led model, yeah?
The Wolf: Yep. One problem is that the brokers all have pre-established relationships with the franchises, which means that they are only going to pitch brands that are in their Rolodex. Like, let’s say that you want to buy into a franchise and Crumbl Cookies would be just a perfect fit for you, but Crumbl isn’t one of my brands. I’m not going to recommend them to you.
The second issue is cost. The broker is taking a portion of the franchise fee, which the franchisee is paying to the franchisor. It’s a lot. If the franchise fee is $40,000, you can expect to pay $30,000 – $35,000 of that to the broker. So, just from a price-to-value perspective, the franchisor is kinda getting screwed there.
Alex: Wow, yeah, that’s crazy. I had no idea.
I also wanted to ask you about the differences between good franchises and bad ones. Like, obviously, not all franchises thrive. Some seem to burn really brightly for a little bit and then flame out. What do you look for when you evaluate franchises?
The Wolf: One of the big keys is figuring out ways to leverage your scale, as a franchisor, to help improve outcomes for the entire franchise and make sure that you’re helping each franchisee really thrive because the better they do, the better you do.
Crumbl Cookies is a good example. As they’ve grown, they’ve actually become massive distributors to their own franchisees. Every bag of chocolate chips that a Crumbl franchisee buys is purchased from Crumbl corporate. Same thing with the dough and the napkins and everything. Crumbl sells all of that.
This is smart in a few different ways. First, it creates brand and product consistency. Going to a Crumbl cookies location feels the same, no matter where you are. Second, this is another way to generate revenue. You are requiring franchisees to buy from you. You literally have captive customers for your wholesale products. But it’s also good for the franchisees because you have a sufficient scale (Crumbl has over 700 locations) that you can get better prices on those chocolate chips than the individual franchisee would get going to their local grocery store.
But you want to be careful with this stuff because this is also where franchises get into trouble. Quiznos is the famous example. They were charging their franchisees above-market rates for the bread and the mayo and the napkins and stuff, and, at the same time, they were running these national advertising campaigns promoting sub sandwiches for $4.50. So foot traffic at all of their locations went through the roof, but all of the franchisees were losing money. At their peak in 2007, they had like 5,000 stores. Today it’s 180. So things can go really wrong really fast if you don’t ensure that your franchisees are doing well.
Alex: Holy cow. I remember having a Quiznos in the town I grew up in, but it was only there for like six months. Now I know why!
And it’s interesting because there definitely does seem to be, I don’t know what to call them, fads, I guess? In the franchise space? Like, sub sandwiches are big business, then they’re not. Do you see different trends emerging and then fading? What drives that dynamic?
The Wolf: For sure. We have these little bubbles in the franchise space that are totally disconnected from what’s happening, more broadly, in the stock market and the economy. Different brands and sectors will go through their own little hype cycles, and I’ll be sitting over on the side watching and going, “What is happening?”
Frozen yogurt is a good example. For a while, froyo was everywhere. Everyone was buying into these frozen yogurt shops, and you could just tell that the space was going to get oversaturated. And that’s exactly what happened, and a bunch of locations closed before the market stabilized a bit.
Alex: One question that I like to ask folks in fintech is, “What is the one thing about our industry that you would change if you could just wave a magic wand?” And I’d be curious to get your answer to that question for the franchise space.
The Wolf: We need to hold everyone in the franchise space to a higher standard.
Today, franchises aren’t required to disclose a comprehensive set of financials, which is just utter bullshit to me.
If you’re asking me to invest hundreds of thousands of dollars, you should have to share some standard financial information with me. The FTC requires franchises to provide a Franchise Disclosure Document (FDD), but FDDs are a mess. There’s really no standardization. Every franchise calculates things differently, and the accounting for a franchise can often be really complex. And the FDDs themselves are actually really hard to find. I’ve gotten pretty good at finding them and reading them, but the average person trying to make sense of them is going to have a hard time.
This is a big problem. It makes it really hard for aspiring franchisees to evaluate different brands and pick the right franchise. A lot of mediocre franchises can kinda skate by and look OK from the outside, but that just results in franchisees that never really see a lot of success. And that’s the worst of both worlds. You’re busting your ass as a small business owner, but your upside is capped because you bought into this mediocre franchise.
And on the flip side, it makes it really difficult for great franchises, especially the newer ones with a lot of potential, to stand out from the crowd and attract the interest from franchisees that they deserve based on their performance.
So we just have this huge data and discovery problem in the franchise space.
Alex: OK, last question. I asked you the magic wand question because I knew that, in your case, you actually have been working hard to build the magic wand. You built a solution to this data and discovery problem! Tell me about Krokit.
The Wolf: Krokit is the research and operations platform for franchises.
We’ve scraped all this data from the FDDs, so you can actually filter franchises by any financial criteria and get the actual information and location trends. You can answer questions like, “Is this franchise trending up or down?” “How many locations did this franchise close last year?” “How many new locations are they projected to open this year?” “How much franchisee-to-franchisee turnover did this brand see last year?”
All this information is in the FDDs, but you used to have to go through it all manually, looking at thousands of PDFs, and there was no aggregation of the data, so it made good analysis basically impossible. Krokit fixes all of that.
And beyond the data, we really want Krokit to be the go-to platform for all stakeholders in the franchise space.
If you want to buy a franchise, we want to be your one-stop shop. We are tying in all of the major small business lenders into the platform, so franchisees can easily apply and get approved for loans. We have a franchise attorney connected to the platform so that when it comes time to review the FDD, you’re not having your cousin do it. You’re having a professional who knows what to look for do it, and that’s going to help folks spot a lot of important red flags.
And for franchise owners, we want to be the operations platform. We have an API set up so that you can integrate whatever accounting software you’re using (QuickBooks, Zoho, Sage, etc.), and that will allow us to provide a KPI dashboard that tracks revenue, net income, cost of goods, etc. and the really cool part there is that then different franchise owners can start benchmarking themselves against each other and I can go, “hey Alex, it looks like your net income is significantly better than mine even though our labor costs are fairly even. How are you doing that?”
There’s just so much you can do once you pull all the data together, which we’ve done, for the first time ever, with Krokit, and I’m really excited to now have this platform out in the wild.
Alex: Wow. That’s incredibly cool. Congrats on the launch, and thanks so much for chatting with me!