Should Searchers Look More Seriously at Franchises?

You're listening to Think Big Buy Small, an official podcast from the Harvard Business School. Welcome to Think Big Buy Small, a podcast from Harvard Business School about entrepreneurship through acquisition. We're your hosts, Royce Yudkov and Rick Rubak. Rick and I are delighted to have as today's guest, Michael Horowitz. Michael is a former researcher who successfully bought, operated, and later sold a very successful restaurant franchisee and has since gone on to stay involved in the ETA community as an investor. We're going to learn about Michael's journey, but most of all, Rick and I are going to focus with Michael on franchising and assess what size opportunity this is for potential searchers. Should they be including franchisees in their search, what are the pros and cons of this opportunity? I'm so excited to have this conversation because for years now, you've been telling me about the great opportunities that are in franchising me. But I've always been suspicious, so I'm really looking forward to this conversation. It's going to be a great conversation because you're right. I've felt forever that it's been an overlooked opportunity in plain sight by researchers and quite reasonably, you've had the position show me. So we've got Michael Horowitz, who's going to show us. So we've got to show us. Yeah. Michael, let's start by just tell us a little bit about your background and your journey through life and careers so the audience gets a sense of who you are. Great. Thank you for having me. I've listened to this podcast regularly, so it's very exciting to be part of it. By background grew up in South Florida, a very entrepreneurial family. My dad was involved in several businesses growing up, and also I was fortunate that he worked from home. So as a kid, I frequently got to sit in, listen to calls, see what he was up to, and that sort of sparked a business bug from an early age. I ended up starting my creative college in venture capital. I had tried a hedge fund like internship, didn't really understand investing when you couldn't speak with the management teams and ask them all the questions you want to. Well, I had a great time in venture, also felt something wasn't quite a right fit there, and suddenly learned about search as I was thinking about applying to business school. You didn't like investing in crystal balls. I didn't like investing when the prices were very high and the people who were asking for money were saying we don't have revenue and we don't have a plan to get revenue yet, but it'll work out in the future. Yeah, hopes and dreams. It's a market for hopes and dreams. So came to HBS was student of yours in 2014, and I initially had no interest in franchising. I really just cared about living in New York City after I graduated, and so pitched traditional search investors on a New York City focused search fund. Rightly so those investors all said that's a bad idea. We won't give you any money for that, but I plowed right ahead and did it self-funded instead. I had a pretty difficult time, got a few companies to the L.O.I. stage, but nothing that was worth or able to close. Took a job in real estate, thought maybe that would be the entrepreneurial opportunity for me down the road, but had some classmates who had bought Burger King restaurants and were very successful, and so started shamelessly thinking maybe that's something I could do. And after another 18-month search found a 7-unit opportunity to acquire Wingstop restaurants in Columbus, Ohio, the two people that I was searching with were both at hedge funds at the time, so their opportunity cost to be the ones who quit, moved to Ohio and ran this business was much higher. I really wanted to run something, and by then my resistance to I must live in New York at all costs had been worn down. I was single, it had very little to lose moving there, and so said, "I'll operate, let's buy this, let's give it a shot," and move to Columbus and that kind of started the Wingstop journey. So I have to ask, how did you meet your spouse, because normally you'd meet your spouse in New York City and drag your spouse to Ohio, but it seems like you might have done the reverse. Yes, and those answers are actually perfectly intertwined, literally before the deal even closed when I was still living in a hotel, didn't know a soul in Columbus, I was going on dating apps and trying to figure out, this is how I'm going to meet people, and the first and only dating update I went on is my now wife, who was living in Columbus at the time. Wow! So that is, it's made in heaven, right? For five years before selling, I kept telling myself, at least if this doesn't work out, I got married, and that was a very worthwhile use of moving to Columbus. That was great. One of the things I love about the short recap of your life and career is the way you explored something, it didn't work out, you pivoted, you explored something else, until like on the third permutation, you found something that moved you to the next level of being a business owner, and I think that is part of the journey of search, that you have to have a tolerance for that. Definitely. Royce, one of the intriguing things about the way Michael describes his journey that brought him to Wingstop, was the number of pivots he made along the way. He kept on changing his approach. You always describe it as many ways up the mountain, but what was interesting about him is he'd take a road for a while, then he'd cut through the woods, then he'd find another road, then he'd do a switchback or two, and he ended up on top of the mountain, did great, but lots of changes in his approach along the way. You and I teach a lot of people who are evaluating whether search is right for them, and often they start with some calculation of will I make more money being a searcher or joining some big company, and it turns out that's a question that's almost impossible to answer. You can do fine either way. Really, the answerable discussions are, is this right for me as a person? What you've just described is such a dividing line where there are some people who have a willingness to accept a very uncertain, changing journey, and it may bother them, it may make them unhappy, but they can tolerate it, some even enjoy it. There are other people who lead the clarity of the path that say a big employer offers them, if you do this good work for three years, you become a manager, you do more good work for three years, you become a principal, and so on and so forth. And this kind of march through the system is so typical in the corporate environment, but also as you point out, consulting firms, law firms, many of them have this hierarchical structure that you move through different levels, and people have a sense, oh, if I want to get to the next level, I have to build 2000 hours a year, I have to do this, I have to do that. It's not only that there are promotions, but the promotions have this kind of objective standard to them, at least in the early stages. Exactly, and very smart, talented, reasonable people will look at that and say, that's me. This is knowable through some self-examination. Could I thrive, or could I even endure an environment with changes as I have to pivot in response to the market? By the way, this happens in search all the time. It's not just the kind of pivot that he's made from different kinds of search and different partnerships and alike, but you're always pivoting from this target company and this state to that target company in a different state, and maybe I'll do this, and maybe I'll do that, and it's lots of uncertainty. If you're looking for another show to add to your listening cue, check out Cold Call, the chart-topping management podcast from our colleagues at Harvard Business School. Each episode, host and HBS Chief Marketing and Communications Officer Brian Kenney explores the real-world business case studies taught at HBS. You'll hear from the professors who wrote them and often the executives and entrepreneurs who lived them. From major media organizations to small businesses and startups, Cold Call breaks down the leadership lessons behind fascinating companies like Bombas or the legendary restaurant Elluli. Follow or watch Cold Call on Apple Podcasts, Spotify, or wherever you get your podcasts. And now let's go back to our conversation. And I want to go back to Royce's discussion about these iterations you went through. Tell us about how that felt personally. When you abandoned your search in 18 months, did you do that dispassionately? Were you down on yourself? Were you, oh my god, I'll never be successful in something. Or was it like, this didn't work out? I'm going to try something else. I think it was somewhere in between. I was definitely frustrated and emotionally down, having not succeeded in buying a business. I shut the search down after the last deal, which was the one I was the most excited about, didn't end up proceeding, and just felt like I couldn't summon the energy to start the search over and rebuild the pipeline. In some respects, like that felt, I failed at this, that's frustrating. I wasn't like my career is over by any means. And I still very much thought I would do something entrepreneurial, which might have made it a little difficult to get a job in retrospect, because I think I probably gave off some of that energy. And when I was looking for a job that in my head was just going to be a bridge to making some money and figuring out the next thing, I think employers saw through that. Yeah, they can see that. So that was a bit challenging. How would you describe it? Give some advice to the searchers who are similarly 18 months into their search and frustrated. What comes to mind is you really just have to know yourself. I have my own tricks for motivating myself to do things that I'm finding myself struggling to want to do. Or I think a pretty good sense of myself in terms of, is this really the end or am I just an emotional thing and I need to take a step back. I recall that the stats of the search had been gradually declining in my ability to wake up each week and think of something. new to try felt like it was getting tougher and tougher. But truly, I think it was just staring at the paper on Monday and thinking, "I've tried the things. I don't have another one." And I would just likely bounce around for three, six months, whatever it is, until coming to the same conclusion if I don't make that call today. So tell us a little bit about your wingsed up franchise and that piece of the journey and what brought it to an end. Yeah, so the business we bought was seven restaurants, all of the restaurants that existed at the time in Columbus, Ohio, about five and a half, a little more than five and a half million in revenue. We thought 700-ish thousand of EBITDA probably was closer to 625-650. As a public company, it was a public company then has performed better as a restaurant group over the last 10 years than probably any restaurant group in the last several decades. Certainly, of that size, has that obviously afforded some great opportunities to expand the business. So, in addition to buying seven, signed a development agreement to build five more, which preserved Columbus as my exclusive territory, built those all out, signed a new agreement to build another five. And they're still all in Columbus, Ohio. At this point, I started immediately looking for more acquisitions across the country because the goal was very much, "Can I build this big enough, fast enough that my two partners want to come operate it with me that each of us can make tens of millions of dollars one day when we sell this?" And realized that expanding a franchise portfolio, particularly a physical location based one with a scattershot approach throughout 50 states, is not a really great strategy that anyone pursues. There's a lot of advantages to having geographic density of your restaurants in terms of sharing management, resources, understanding the same local regulations, payroll, HR, labor laws, taxes, etc. So, I turned my attention to, let's just focus on the nearby big markets, Cincinnati, Cleveland, Indianapolis, Pittsburgh, etc. ended up closing a seven-unack position, buying all of Cincinnati, taking over a distressed store, and Dayton, and that was it until selling. So, I ended up with 20 restaurants when I sold all in Ohio. All in Ohio, and then I had territory that I hadn't yet developed in Northern Kentucky. I wouldn't think that there would be 20 Wingsstop restaurants in Ohio. It is a big sports state, so is that unusual density? Wingsstop has been figuring out sort of density as they go, I think. In 2017, they were saying 10 restaurants in Columbus by 2021 or two, they were saying 17 could fit in Columbus. And I think it was a function of just seeing the changing demographics and success of the brand. I don't know the exact number, but Dallas, where they're headquartered, I think there's 50 Wingsstop and Dallas, or something like that. There's a lot of opportunity for down city there. It didn't feel egregious. There's a lot to talk about for our audience that is considering becoming a franchisee, acquiring franchisees as a path into ETA. So, maybe a good place to start on that topic is if you give us a bit of an overview on the advantages of acquiring a franchisee and what is the disadvantages, and then maybe we can talk a little bit about how you navigate your way through the franchisee universe. But let's start at a high level. So the first high level thing I get this question a lot from prospective searchers is, I think you got to start with, what's your goal in all of this? Are you doing this to do a really successful private equity deal, sell the business in five years, make as much money as you can and move on? Are you doing this to live in your preferred geography, build a business in your local community, end up in a place where you make a really nice regular income and can spend minimal time on work and other time on family and hobbies and anywhere in between. And probably all of those are possibilities as a franchisee, but they might only be possibilities in a certain segment of the franchise market and some of them might be more likely than others. As far as advantages of being a franchisee, far and away that the biggest one is the power of the brand that you're operating under, and you can really clearly illustrate it by when I was opening a new wingstop, we would always try to put the signage above our store up as early as we could and get people in the community to start driving or walking by and seeing it. And so when we were finally ready to open our doors, we would have really big first weeks in terms of weekly sales, the pattern for wingstops actually generally at least when I was operating was super high first few weeks, then it would tail off as that novelty wore off and then build back up over the next year or so. And that pattern just wouldn't exist in a Mike's wings place that I opened that no one had ever heard of before. So the power of that brand, the advertising dollars that are getting spent behind it, that's far and away the biggest thing I would point to. The second thing that I think most people go to, which I would actually value a little bit less, is the operating playbook of how to run this business. I think if you're listening to this podcast, I'm willing to bet you can figure out how to run the operations of a restaurant, of a barbershop, of a gym, of a landscaper, what not, without somebody handing you a playbook, where the playbook turns into maybe a more proprietary advantage is when the franchise or is offering access to something that you couldn't replicate as an independent business. In restaurants, that might be as simple as you can sell a burger, you can't sell a whopper, you can sell a lemon pepper seasoning, but people want wingstop flavored lemon pepper or ranch dressing. In a disaster restoration franchise, you can offer disaster restoration services, but it's going to be a lot harder for you to get the attention of a national insurance company to funnel you leads that a national brand like ServPro or Service Master might be able to help you get. Finally, from an investment perspective, franchises should be more predictable in their operating performance because you have a large data set to look at and understand and make your own predictions. And you can optimize operations, right? That you see how the best restaurants in the franchise are performing in what they're doing, and you can copycat. Yeah, that's a really good point. You've got hundreds of other people operating in the same business you are in a generally not competitive way. And so there's a lot of ability to learn from somebody else who's happy to help you because you're running a successful restaurant, only helps the perception of the brand and maybe their restaurant down the road. And most franchises are actually facilitate that through some sort of data that they share. I don't know whether that's true, but wingstop in particular, but they'll certainly share benchmarking data. That's right. That's what I mean. Yeah, like who is it? What is a first quartile gross margin? What is a first quartile staffing level look like? Yeah. Sometimes seeing the business model is the most important part of the entrepreneurial journey that if you have to invent the business model, you're making lots of mistakes along the way, not because you're a dodo bird, just because you don't know you got to try it. But when you have hundreds of cross-sectional experiments existing at the same moment in time, that's a huge, powerful tool. Absolutely. They know what works. So I guess taking the con side of it, first and foremost, is it costs a lot more to be a franchiser. You're going to pay upfront fees as well as ongoing royalties as a percentage of your sales. And it's important to call out that those royalties are on top line revenue, not on profits, which creates a little bit or maybe a lot bit of misaligned incentives between you and the franchise or the franchise or would love to see you open another restaurant just down the street because every amount of sales that that generates is additive to them, but that restaurant probably steals a bunch of business from your other one while adding a bunch of costs and doesn't really deliver much for you in terms of bottom line profitability. Number three would be the franchise or is going to exert some control over your ability to sell that business. So you can't just sell it to any person who pays you the highest price, but the franchise or is going to have to determine that person is qualified to buy your business and is somebody that they want to see operating it. And that's going to create a bit of a lid on what you can eventually sell your business for. And then finally, this isn't unique to franchisees, but probably most will have this attribute. You're generally dealing with businesses that employ low-skill, low-wage labor, which is a very difficult set of employees to manage compared to some other more knowledge-based businesses. Great list. So when you step back as you both know the world of search and you know the world of franchisees, do you feel that this is an overlooked opportunity? Because I think Rick is this fair that a relatively small number of the searchers we see spend a meaningful amount of time looking at franchisees, not zero. And it's worth pointing out that while Wingstop is what we would, I think, call a B to C business, right? You're selling to consumers. There are lots of B to B businesses that are also franchises, cleaning services, trash services. Some searchers might say, "I don't want to be in a B to C business." And so I'm not going to buy a franchise, but that doesn't really explain the failure to look at franchises because there are plenty of B to B franchises. I think the biggest reason that searchers don't look at franchise concepts is that a lot of the success or lack thereof of their venture in a franchise is going to have to do with did that franchise resonate? Did it continue to be successful? Did the franchise or make a decision that adversely hurt the brand or not respond well to a competitor or whatnot? And my Wingstop experience as a perfect example, I wrote an incredible tide of a brand that was just firing on all cylinders, growing really quickly, hit the zeitgeist, unique product, all this stuff. And I would say, I may be responsive. for 10 or 15 percent of that, but the vast majority of it was happening, regardless of how well my business was being run. On the flip side, there are instances I know of people who, I think, are great operators and very smart business people who bought units in a brand that wasn't as successful, and despite their best efforts, it's just swimming against the tide, and their businesses ended up failing. That's a big reason that investors, I think, don't spend as much time backing franchise searches. We generally want to back you and your abilities and not be beholden to your selection of a brand and that brand's abilities. Yeah, let's dwell on this a little bit if we can. So if you think about what determines the success of any business, but particularly a search business, I always think you have the global situation, whatever that might be. Is there a global recession as there a war? Is there something getting in the way of the normal flow of trade? Then you have kind of national uncertainty, right? What other issues are going on in the country? But then you also have, of course, your industry variations. Am I selling something that people actually want to buy? Is there any need for what I'm selling? Even in the B to C world, there's always moments where there's more demand for particular products and less demand for particular products. And then this how well you're going to run the business, but you would add yet another level of uncertainty, which is particularly I would think B to C. Maybe if you were dealing with selling to businesses, this would feel less raw. But it seems if Wingstop, Burger King, McDonald's, whatever the franchise is, if they're not selling to the ultimate consumers on TV, if their ads don't work, all that other stuff, you suffer. No fault of your own. You're not running the marketing campaign. Yeah, think about Subway, one of the biggest franchise brands out there 10 years ago if you had decided Subway was going to be your entrepreneurial venture over Jersey mics, which is performing quite well. You might have been an awesome operator. This is really an important point that you're raising because this is a risk that's not as simple as just go with a proven franchise or partner, not with a unproven franchise or partner. Because when you look at the major established franchise or is like in Quick Service Restaurant, McDonald's Burger King, Wendy's and so on, they're like professional sports teams. They all can be very good, but from year to year, some teams go into the shade for several years and other teams perform. We've seen that in the QSR business. Absolutely. Burger King has been on fire, then McDonald's has been on fire, and you either benefit from a tail winder. You face a headwind for years. Yeah, I often say that franchisees and really coming from the perspective of operating restaurants specifically are long term durable, but short term surprisingly fragile, and that short term fragility is in two parts. There's the short term fragility of I was astonished how quickly a great restaurant location run by a great manager can turn into a complete dumpster fire in the matter of a couple of weeks if that great manager or a couple great employees leave, and you can't replace them with someone because customer service collapses. Customer service collapses, just following the procedures, the food quality might suffer, the safety, the cleanliness of the restaurant, the proper ordering, maybe the sales are good, but no one's controlling food cost or labor to cost, it can spiral very quickly. The good news is I would argue that if you've seen a restaurant consistently performing well in a particular spot, and that happens, there is a very high likelihood that once you get the train back on the tracks, that restaurant will return to good performance that it had in that location. As long as none of the other variables have changed, but it's a lot easier to rack a restaurant quickly than it is to correct it quickly. And it speaks to a point you made earlier, which is the benefit of geographic density, because if you have a dense geography, you might have a superb number two. Yeah, and as a general manager, and you could say go over this location, okay, yeah, you're also going to see it, you're also going to see it, you're going to drive by and say there's usually cars in the parking lot. But why are there no cars in the parking lot, whereas if you own the one a thousand miles away, you're going to see it at the end of the month or maybe at the end of the quarter. And you know, it's really interesting on that point. I opened the first franchised ghost kitchen for Wingstop, so ghost kitchens are delivery only locations. It was a concept created kind of around COVID where someone would buy warehouse, create 40 small kitchens, people would share some common resources like walking coolers, storage areas, cleaning resources, stuff like that. They would just take online orders. They would bring them out to a centralized pickup area and drivers could just come through. Yeah, so we could staff this with two people in 250 square feet, and that was far and away the most challenging location for us to operate. And I think a huge part of it is that no customers have eyes on what's happening in the four walls of your little kitchen. And so if the cleanliness is terrible and food quality is suffering, if they're mixing up bags, the feedback loop actually is quite long and also involves two new parties, your delivery partner and the ghost kitchen operator on was the bag handed off right did somebody spill it, did it sit out too long all this other stuff, so we really struggled when we didn't have a clear. It's a harder business than it sounds right the ghost kitchen business I get in the public brands, like in quick service restaurants I get why franchising makes sense because in some sense building a brand requires large scale. And you need to be able to do national advertising and I get that, but what I've been struck by recently is there are lots of roll ups of small businesses into franchise operations. I wouldn't think we're naturally roll ups. I guess I would think in your own life when you've needed a service there's a lot of brands you might not know are franchised. I'm just thinking of brands like with the wing stops when we had drain clogs we often used company called roto router and no necessarily reason I don't ever remember doing research and concluding as opposed to local plumber Mike's Plumming somehow that brand had seeped into my consciousness or California closets as a design business that helps you build out nice closets. You might have just absorbed the awareness of that brand by seeing them as you drove around your town and then when you go to look for closets you're looking at the listings or whatever and yeah California closets I know that that's a big company. So there's definitely some brand benefit there so there's a set of pros and cons that you've articulated which are really balanced, but if you would wrap this together just price offset those pros and cons in other words is the price at which you can buy an established proven franchisee with oscillating cash flow but one that might be within guard rails a little bit more than a standalone business just price tip you one way or another in those concerns I always prefer and probably part of the reason that I've yet to make an investment in a franchisee business to be part of a bigger portfolio than a smaller one. Because a lot of the benefits that you get from being a franchisee in terms of the predictability of cash flows, the resilience through these ups and downs as you're talking about gets better with scale and so if someone says yeah I'm going to buy this one business for four times isn't that great my reaction might be over the next two years that four times could end up looking like seven times pretty easily but I'm not interested in that level of potential risk but if you told me you're buying a portfolio of 10 or 20 locations the amount of variability in those is going to be a lot lower the problem is a lot of people recognize that math works that way. And the pricing I found while lower than a lot of other search on required businesses often scales fairly quickly to recognize that there are some big advantages to having a bigger portfolio. This is particularly true in larger brands where there are other people looking to acquire because the advantage of adding a few locations into an existing platform is really strong. And if you're bidding for three sites against someone who already owns 50 that person can have those three sites with basically no increase in corporate overhead you need to add an entire business worth of corporate overhead on those three sites and so what looks like four or five times to you could look like two times to someone else who doesn't have to add all those costs to it. And so for people contemplating buying a business and evaluating being a franchisee is one take away that maybe the way to play this is to buy a franchisee with five to 10 sites and part of your value creation is taking that to 20 sites. That would absolutely be my argument for sure the other piece of the price equation is that likely the lower the entry prices and the brand that you're considering the lower the exit prices are going to be in that brand unless something happens over your holding period to make that brand more appealing can't bet on that though. I wouldn't underwrite any difference in it but I'm just saying if you feel like great I can buy these auto repair shops for three and a half times cash flow when you go to sell them you're probably not selling that for eight times cash flow no matter how big you are because that brand is just not in favor as much as evidenced by the very low multiple you paid for the small businesses you might sell it for five times but you don't have that home run outcome in all likelihood. If you're looking for another show to add to your listening cue check out cold call, the chart-topping management podcast from our colleagues at Harvard Business School. Each episode, host and HBS Chief Marketing and Communications Officer Brian Kenney, explores the real-world business case studies taught at HBS. From major media organizations to small businesses and startups, cold call breaks down the leadership lessons behind fascinating companies like Bombas or the legendary restaurant El Uli. Follow or watch cold call on Apple Podcasts, Spotify or wherever you get your podcasts. So let's step back and talk a little bit more about these multiples. First of all, I just want to clarify what you said in response to your previous answer. When you said if you're buying three and you're going to do it as standalone, you may be thinking the price is five times, but somebody else will say, "Wow, that price is two times," and what you mean by that is it's the same price. They're not getting into lower dollars. It's just that they're not going to have to match the overhead. Exactly. And so they're going to have lower cost. They'll have higher EBITDA. And so because they're EBITDA from the exact same assets might be two and a half times higher, the price is going to be two and a half times less. Yeah. If you thought about, say, let's go back to that three unit that's selling it four or five times. So if it was three units of not necessarily wingstop, but a typical quick service restaurant would be, I don't know, three would be about a million dollars of EBITDA, would you say? Those would be some pretty good for three restaurants. A million would get pretty high. I think three restaurants doing 150,000 at the store level each, so that's 450. And then you got to subtract some. You probably need at least 100,000 of overhead top rate. That's pretty meaningful. Well, I'm going to pay yourself, right? Absolutely. And so you might be that 100,000 of overhead. You might be that 100,000, but so in the end, you're probably talking about 250. Yeah. I'm going to buy something with three restaurants, 250 in a franchise that seems stable. I'm likely to pay three X, four X. Seam stable is a tricky way of describing it. I meant that it's not, it's not Chick-fil-A or a wingstop. I definitely follow what you mean. I think it's very brand by brand. What popped into my head when you said that is rallies and checkers, but around forever, they make last I looked maybe a million bucks in average unit volume or AUV per location. Let's say you can make 150 on that, although that's probably high for a million dollars to have a 15% profit margin. If you told me that brand was KFC or Burger King, probably a little bit higher would be my guess maybe four times just because those are much bigger, stronger brands, even if their trajectories at the moment might be flat. And which brands are at the top? Obviously, wingstop these days, but Taco Bell, wingstop, Duncan Donuts, Chick-fil-A's off in its own category because it doesn't really operate as a true franchise. I don't know what McDonald's sell at, but that's a very insulated market for buyers, same with Domino's. And stuff, it was one of those higher quality franchises was they might sell at five times for the same 250. Or potentially, I could honestly even see more if it's going to somebody who can just tack it on to a. Oh, because it's going to go into a strategic. And then as you go from three to six to nine to 12 to 15. So you get up to 15 restaurants. What's the multiples like? I think of the multiples as adding one times more multiple at different stages. So under a million bucks maybe is tier one, a million to two million of cash loads, tier two, two to four or five is tier three, five to ten is tier four, north to ten is tier five. This isn't revenue, this is EBITDA. This is EBITDA. Okay. And so with each of those, you might get 0.5x to 1x more on your multiple as you can move through those two. So my 15 if the threes are 250, I got five times to 50, I'm a million and a quarter. A million and a quarter, but maybe a little more overhead, but I might run them better because so maybe it's a million and a half. Yeah. So now I'd say if you bought those three for four x, now you're probably somewhere in the five x six x. I don't know if I'd go as high as six because five x. So I've always thought that one of the problems with buying franchisees is it's hard to get much multiple expansion because the franchise or puts a cap on it. As you said, you have to get your buyer approved. That's true for major league sports teams, but that doesn't seem to affect the pricing of them. But why is it that this is limit? A very savvy investor once said six x. It's really hard to sell any collection of franchisees from one six x. I think that was you, Royce. You're kind to me to describe me that way. Let's hear from Michael Horowitz. His view on sort of limits on multiples. There's absolutely limits. That number six x maybe was true a decade ago, but the explosion of kind of financially minded capital in franchises I do think has driven multiples up. So a couple very large wing step franchisees have sold in the last few years and have sold at multiples in the 11 to 12 times. Wow. Wow. Now we're talking businesses with 50 million of EBITDA kind of thing. Oh, wow. Okay. So I do think more than six x. But we're also talking about the most in demand brand in that occasion. Taco Bell's routinely today of some scale, self or nine or ten times with a few million of cashflow. Wow. So it's definitely higher, but there is certainly a limit as you can see getting to 50 million didn't take you from 4x to 20x. It took you from 4 to 11 or 12. Whereas if it was a typical B2B service business that you took from $500,000 to $10 million actually, it's rare to find a B2B service business that has some customer stickiness that wouldn't sell for what would you say 8, 10. Sure. Yeah. In that range. Yeah. Sure. So you don't quite get the bump that you would get outside of franchises. Yeah. I think so. And big part of that reason is the bigger and bigger you get the exit opportunities for the owner grow smaller and smaller. So the group that I sold my restaurants to is a multi brand restaurant operating platform called Sizzling Platter. They have 7, 800 restaurants across five excellent brands. They were acquired by Bane Capital last year. And one of the things that I had heard about that transaction is that they were of private equity size. But the problem was all the private equity firms simultaneously had to think about what's the next private equity firm that would buy this business. And the bigger it gets the smaller that pool of buyers is and the less competition. Not to mention that it's not necessarily business that you can take public based on the franchise or's requirements for owners to be involved in guaranteeing the performance like a team principal back to your sports analogy. And as you get bigger in any one particular franchise, the franchise or's get more concerned about having such a big franchise. Absolutely. We've talked about buying the businesses. So there's an operating franchise E that you're going to acquire. You could also buy a franchise from the franchise or and we've not talked at all about that. And I'm assuming that's just far riskier than buying an existing business. Yeah, I think that's closer to a venture investment than buying an established franchise. It's still much closer to a private equity investment overall than a venture investment. Maybe the best way to illustrate it would be of the six new locations I opened or five if you exclude the ghost kitchen. The best performing location made north of $200,000 in its first year. The worst performing location lost 20,000 and everything in between. It's back to this point I was making before. If I like to see some more scale because if you tell me you're going to open 10 of these, I'm much more comfortable underwriting. Hey, whatever the median unit profitability is in this brand, you'll probably land there across your 10. But if you're telling me you're going to open two, I'm taking a pretty big risk on whether you open two that lose 20,000 or two that make 200. Because some of its stuff that you can't predict, it's the demographics. It's what street you're on. It's how the parking goes, how the traffic light in front of you work and all that other stuff that's so hard to predict from the outside. Whereas when you buy a business that's running, you know the business is running. Yeah. And it's also back to why the multiples creep up as you deliver 20 units, not four units because you're averaging away the variability you get with even existing individual units, right? They open a McDonald's across the street. Suddenly your Burger King loses a share of its revenue. They close the highway for six months to renovate it. That goes away. Yeah. How does someone enter the franchisee game like you did? You were able to go in and buy a handful of wing stops. They aren't all absorbed by existing franchisees. Even though those existing franchisees have a big economic advantage, they don't need to add the overhead that you needed to put in. So how is it you could buy a bunch of those and they weren't sucked up by somebody else who's already in place. So the franchiseor is going to be thinking about their franchisee base and who they want growing based on their performance and who they want to be able to reinvest and who has that capacity and whatnot. And so the biggest weapon a surcher has in approaching a franchiseor is saying, I have access to capital and I want to grow not just by acquisition but by development because that's the most direct way for a franchisee or to make more money as more unit sales from more new units, they can't directly require the seller to sell to me, but they can certainly both through sort of soft leverage as well as maybe even some direct incentives, create a reason for that person to sell to me or make an intro to me and try to get me the opportunity to buy it before it hits the market or something like that. And they definitely do that. Let me see if I could briefly make the bull case for buying a franchisee and maybe both of you could say either, wow, that's a fantastic summary. We agree we're running out to buy one or no, this is the, these are the cautions. First, this is a huge fragmented market so you have a lot of shots on goal. Second, if you can buy a decent collection of franchisees, three to eight of them that established franchisee or you might be able to buy these at 5X or 6X EBITDA and if you buy them at five times EBITDA, they're throwing off a yield of 20% a year, one over five. And if you've borrowed a big part of the purchase price, say through an SBA loan, the return on your equity investment is quite high. If the franchisee or and you don't run this through the guard rails or run up against the guard rails, if the oscillations are somewhere in terms of what you expected, what's wrong with that as a justification for spending a portion of your time as an ETA or in looking through the world of franchising? A couple of reactions that the first one would be broadly I think that's true. The opportunity that you describe, you know, buying let's say three to eight locations and whatnot, like you're setting yourself up short of a very long 10 year running and reinvesting those cash flows in a business that's going to tap out without a lot of additional capital going into it at a million, million and a half, whatever the number is of cash flow. You are taking off the table in that scenario or at least greatly minimizing the chances that you buy some business that hits escape velocity is it an amazing industry sells for a crazy multiple. It's also true if you buy a lot of main street businesses, but just important to think about like what you are setting yourself up for over a five year operating horizon. You're not going to get a 20 extra term. Correct. You're not going to grow those eight and triple sales over the next five years. The next one I would say is if you're doing this approach with an SBA loan back to this short term fragility, you buy a couple locations and you think it's going to be very stable. There is very real risk that in a given year something goes wrong, you take a very meaningful hit. If you're a highly levered acquisition, that could be a lot riskier than a recurring revenue. You can analyze the retention of the customers type of business. I think the last thought on the positive side actually would be not only is there a large buying universe, but it's the easiest sourcing you're ever going to do because once you've decided on a brand that you are interested in, they are required to publish a document listing the contact info and location for every single franchise in their system. You know exactly which ones you want to target and what markets, how big they are, how to get in touch with them, as well as how to get in touch with the other operators that you might use for due diligence. Michael, we always end our podcast by asking if our guests have any questions for us since we've been asking you questions for a bit now. And of course, since you're a student, it's very scary because I'm a little bit afraid that what did we teach in 2014 and '15? I don't remember. I've been looking forward to asking this question, although I'm fearful it's going to make me sound quite cranky as an investor. We talk a lot about searchers and what path and what structure they should spend their time fundraising around. On the investor's side, I'm curious how you guys think about all of the various opportunities for investors. Do you either of you have a framework for deciding when the proposed searcher terms make sense or are off the map for you? Royce. There are many tricks Rick has, all of which I love and admire and one of them is on a particularly naughty question to pass it to me while he thinks carefully about it. I guess the first thing I'd say is Rick and I are active investors in this space and we have invested across all the permutations. So there's most, it would be hard to find other than sort of new permutations where we're still watching. We've always been very hesitant. So it's not as if we've walled off and so often we'll be saying the structure is okay. We really like the people or we really like the plan. But I think that as individuals, we don't have to think in terms of scale of dollars. The way an institutional investor would have to. And I think this has caused a bunch of excitement for us, not the exclusion of others, but in recent years towards self-funded searchers where the penalty you pay as an investor is you do the work and the dollars are relatively small, but maybe not for an individual. And you are able to participate with really scrappy searchers buying smaller, small companies that can be high quality businesses trading for really low multiples and facing less competition. And so I'm not sure how you'd react to this, Rick, but I feel like at the moment that's a particularly interesting area for us, although not to the exclusion of the other formats where we see merit. Let me just add a few things to what Roche said, and I agree with everything he said. But one thing I would say is for me, it really begins with the quality of the business. And the entrepreneurs fit with that business. So if I can't imagine the entrepreneur in that business, then that's kind of a non-starter regardless of how it's funded. Would much rather buy a firm with higher recurring cash flows and smaller growth prospects than the reverse. And not every investor agrees with that. Many investors prefer higher growth prospects. I look at the quality of the business and what I find is that as this market is growing, the market for search, I think about the fact that most first time entrepreneurs are better often smaller businesses than bigger businesses. Number one, and number two, I think if we're going to take a 35-year-old or a 30-year-old and put them in a business, it's just hard for me to imagine that that business can have five or ten million dollars of EBITDA. We've seen it happen. We've seen it happen really successfully. But it's wow. That's kind of a surprise, right, that your first managerial opportunity is in a business with hundreds of employees and so much capital involved. It's not that we turn the other way, but we really want to make sure that the deal works for the entrepreneur because if the deal doesn't work for the entrepreneur, it's not going to work for the investor. Michael Horowitz, it's been such a pleasure seeing you again and having you on the podcast with Rick and me. Thanks for having me. Yeah, thank you for coming. It's at the light. Royce, one of the intriguing things about focusing on franchises as a searcher is that it seems like it would be easier to close on a franchise than the typical one-off business. I agree with you, Rick. I think in franchising, there are at least three benefits you don't see in other market segments. Because there's just a huge, addressable market of franchisees. So when you settle on franchising, there are many potential targets. Second, because of the similarities, particularly with any franchise system, but even across franchises, there's a systematic way in which you can evaluate them, which makes diligence a bit easier. And third, if you include in the world of franchising targets, not just existing franchises that you'd buy out, but going to a franchise or, and say, I'll take this territory and I'll develop six new franchises. If you include that, there's 100% certainty you will close on a deal. Whereas as we know, the long-term record in search, funded search at least, is that about two-thirds close, one-third don't close. Self-funded is a little higher. I think about it as buying a condo in a large apartment building. You might have really looked at 13F and thought that was a great buy and a great place to live. And by the time you got your deposit check, organized 13F was sold. But fear not, 16F is going to come on the market any day now. You get great price transparency, right? You have a pretty good idea what 16F is going to trade for because you know what 13F traded for. It's just a thicker market and that makes it easier. Now it also makes it hotter as Michael talked about to have an outside success. But it's much easier to buy. The complexity I think comes so much of your success is driven by how the franchise law does. Yes. As we like to think about it, your franchise law is like your brand provider. And therefore, you have this concentrated supplier and I suppose if you're assembling some electronic thing and you have a microchip supplier that provides 80% of your microchips, you're dependent on the quality of that microchip. But one of the things we encourage our students to strongly avoid is customer or supplier concentration. And in franchises, when you buy a franchisee, it seems like you have supplier concentration inherently. Yes. Huge supplier concentration. On the brand name, but also sometimes on the meaning else. Yeah. The products, the marketing presentation, exactly. I guess where this leaves me. is that franchising is a target that's worth looking at. And that compared to the rest of traditional ETA, it has one feature, which is very risk reducing, which is if you want to buy a franchise, there's a virtual certainty that you can get that done. Whereas in the rest of the ETA world, you know, not so much, not so much. And so the question is, does the enormous risk reduction of being able to buy something for sure offset the supplier concentration? So that seems obviously true. And Michael's case, we're about wingstop, which is very much a quick service restaurant, B2C business. There are also B2B franchises. What do you think about B2B franchises? That's such a great question, because I think that reduces the risk of supplier concentration, because usually those are less about marketing and more about systems. They'll have a national sales force that will bring you national clients. Or in the disaster recovery business where these are prevalent, they will establish relationships with national insurance companies to direct their client flow to their local providers. They're not in a slippery, continuous marketing battle to gain and lose share like B2C is. I feel like the supplier risk of being stuck with someone who gets really bad at the business is less than it is than if you go to say a QSR franchise or? I guess the question to me then is what's the value out of the franchise or? It has to be, as you said, systems or some innovative gizmo or something like that. But we've seen B2B franchises in places where that's just not obvious. Michael touches on this and says why a franchise or you're a smart person. You can learn how to cook a burger. It's the brand and the marketing predominantly. And so yes, I think in B2B, you do need to ask yourself, is it worth paying 8% of revenues for something where it's my local presence is going to be good? It could well be because it has some system or some innovation or some technology. Whereas the QSRs need the brand, not necessarily. We have a better way to cook burgers. Yeah, that's right. With a great conversation with Michael Horowitz. Next week, we are speaking to one of the most experienced and active investors in search Jeff Stevens of Anacapa Capital. We're going to talk about how the search industry has evolved over the decades that Jeff has been involved in it, first as a serial researcher and then as a highly active investor in search. Rick, I think this should be a really interesting tour of the ETA horizon. Fabulous. Looking forward to it. At the end of each season, Rick and I take questions from our listeners. If you'd like to submit a question and have us wrestle with it, please send your email to Rick and [email protected]. We'll select from the questions we receive and have an interesting and spirited conversation in answering what you ask. You know how much fun that can be. You've been listening to Think Big Buy Small. We're your hosts, Royce Yudkoth, and Rick Rubak. Katie Zanbergen produced today's episode. Craig McDonald is our audio engineer. We'll be back next week with another episode of Think Big Buy Small.