From: alexhormozi
For service-based businesses looking to scale, the franchise model is one of four primary vehicles for growth and wealth creation [00:00:46]. This model involves allowing investors to buy into a proven business concept [00:02:16].
Defining a Franchise
A true franchise legally requires three core components [00:03:09]:
- Name/Brand [00:03:11]
- Business Systems [00:03:12]
- Fee (e.g., royalties) [00:03:12]
If a business operates using all three of these components without being registered as a franchise, it can be considered an illegal franchise, leading to fines and potential shutdown [00:03:19].
Examples of well-known franchises include Subway, McDonald’s, and Jiffy Lube [00:02:05].
Advantages of the Franchise Model
- Lower Failure Rates (in theory): Franchises are often perceived to have significantly lower failure rates compared to starting an independent business from scratch [00:02:23].
- High Enterprise Value: The enterprise value (EV) of a franchise is extremely high [00:08:50].
- High Margins: Franchise royalties, when collected, come with high margins [00:10:33].
Disadvantages and Considerations for Franchisors
Despite perceived advantages, the franchise model comes with significant challenges for the franchisor:
- Litigious and Expensive to Start: Establishing a franchise is highly litigious and costly [00:08:02]. Initial setup fees, legal costs, and filings typically cost around $750,000 [00:08:05].
- Slow to Profit: It often takes one to two years for a franchisor to start seeing profits [00:08:21]. The upfront franchise fee (around $50,000) usually only covers the cost of acquiring franchisees [00:08:24]. True profit comes from ongoing royalties from the top line once locations are operational [00:08:44].
- Operational Costs: Franchisors still bear the costs of running the actual franchise operation and supporting their franchisees’ success [00:09:13].
- Profit Distribution: Franchisors only earn a small percentage off the top line, as franchisees own the vast majority of the business’s profit [00:09:08]. The franchise multiple (valuation) applies only to the corporate franchise revenue, not the total revenue of all franchisee-owned locations [00:08:59].
- Scale for Profitability: For a franchise to be genuinely profitable for the franchisor, it typically needs to have 100 or more locations [00:09:52].
- Reality Check: A significant challenge in the franchise model is that 90% to 95% of franchises never reach 100 locations [00:09:57]. This highlights that simply “franchising your business” is not the end goal, but rather the beginning of a complex journey [00:10:08].
“As much as people have service-based business and think that the ultimate goal is to build a franchise so that someday they can franchise their business, the franchise is not the end goal, it is the beginning of the next journey.” [00:10:03]
When to Choose a Franchise Model
The franchise model is best suited for service-based businesses with:
- Very High Build-Out Costs: If opening a new location requires a substantial capital investment (e.g., millions of dollars for a McDonald’s), franchising allows the franchisor to offload this capital risk to individual investors [00:09:20]. This is essentially “crowdsourcing” the ownership of new locations [00:09:35].
- Productized Service: The service offered must be highly standardized and “productized” [00:07:14]. This means:
- Minimized Variability: The service should taste or perform the same regardless of who provides it, like making a sandwich at Subway with standardized recipes and processes [00:07:06].
- Decreased Skill Requirements: The labor required to operate the system should not demand highly specialized skills, making it easier to train and scale [00:07:17].
If the service requires specialized skills or depends heavily on the individual’s expertise, it becomes more difficult to scale via franchising due to potential inconsistencies in service delivery [00:06:41].
Overall Strategy
Choosing the right scaling vehicle, including franchising, depends on various factors such as required cash flow, upfront investment, time to market, and the entrepreneur’s risk appetite [00:12:40]. A franchise model might be considered if you know a new location will be highly successful but requires significant capital, leading you to crowdsource the ownership and take a royalty cut [00:13:05]. This aligns with choosing the right opportunity vehicle for long-term success.