Asset Obligations and Capital Strategy

By Rick Ormsby
Managing Director

Every franchisee has to deal with the eventuality of updating their assets. It is an essential part of running a successful business, and I have too often seen franchisees who deferred remodeling expenses so long that their customers started going elsewhere.

Equally, I have seen franchisors who are blood-thirsty for updating their assets – on an inconsistent and sometimes unfair schedule.

Asset obligations are typically required by franchisors every 5, 7, 10 or 20 years. For some brands, these obligations are due at the mid-term of franchise agreement expiration dates. For others, they are required in order to get a new franchise upon expiration. Other times, these obligations seem to follow a pattern defined around a master franchise agreement, a territory, population density or other.

If you drive down the street and look at your local franchises, undoubtedly you’ll see some that are new and fresh while others are tired-looking and depressing. In some but not all cases, the tired-looking unit is actually one of the most profitable.

Remodeling can be expensive, and successive remodeling obligations with languishing brand performance can be the death nail on a profitable franchise. That said, many franchisees who update their stores expect to see a moderate to sizable increase in sales. Customers do want new, fresh and relatable buildings. And customers can be finicky if they don’t get what they want.

Future remodeling is a key component in determining the value of your company and the size of a loan a lender will finance. Failure to adequately project future remodeling expenses has been a longstanding issue for buyers of franchises.

That said, here are a few key pointers for all franchise operators:

  1. Make sure to do a detailed financial analysis before making a decision to remodel or not. If remodeling costs $250K, what is the return on investment? You own a business that has much higher daily risk than other investments – if you cannot see a return of 15%+ on your investment, I’d be shy about making it, even if it means shutting down the location, unless it is a defensive play to protect an already strong investment.
  2. Don’t be too attached to low-performing locations. You are likely making most of your money on your best units but spending too much time nursing the poorer ones.
  3. If you own the real estate, be constantly aware of the alternate real estate value in a separate use. Maximize your value.
  4. Despite popular opinion, I like to own real estate. Why? Flexibility to make decisions if your business doesn’t do well. I have seen too many operators perform sale leasebacks, only to be slaves to the locations for 20 years with no way out except bankruptcy.
  5. Locations with short-term leases and no extensions have questionable value. Negotiate heavily if you plan to remodel and stay. Also, no buyer wants an expiring lease.
  6. What is the franchisor’s policy for unauthorized store closures? Some franchisors penalize a closure with several years of royalties and advertising expenses.

Overall, remodeling has been an area in dire need of more attention in franchise discussions. It affects your wallet, your lending ability, your relationship with the franchisor and your long-term decision-making.

Personally, I spent over a year of my life looking at KFC restaurants and deciding, store-by-store, throughout the country, whether to remodel, multi-brand, relocate, sell real estate or close. As such, Unbridled Capital has unmatched expertise in location-by-location analysis of capital spending and asset strategy. Please feel free to reach out to tap into this expertise – it could help your business substantially.