Little Guy Needn't Apply

By Mike Vogel, Review Staff

Miami Daily Business Review, The Newspaper of Enterprise, Real Estate and Law, Vol. 71, No. 44, Friday, August 9, 1996

Look no further than south Florida's own Pollo Tropical, Inc. for confirmation that, under the rules of the new franchise industry market place, small business hopefuls need not apply.

Callers inquiring about franchise opportunities hear a recording saying the company wants only developers who can open at least 15 restaurants, at $800,000 apiece for building and equipment, not counting land.

The message advises that it will take $2.5 million in cash to get going and, in case anyone missed the point, repeats, "We do not offer at this time a franchise of less than 15 units."

"It's to screen out the zillions of callers who think [Pollo Tropical] is a good idea and love it and want to put a store in Dubuque," explained Daniel W. O'Grady, the company's franchise development vice president.  "Our criteria is sophisticated operators who already are in the food service business who have shown the ability to open multiple units.  That lets out 98 percent of the population."

And it puts Pollo in the ranks of those changing the landscape of franchising.

The appeal of the traditional franchise strategy, where growth comes street corner by street corner as small-business wannabes open a store or two at a time, is waning fast among new franchisers.

Those companies believe franchising to mom-and-pops is too slow and cumbersome.  They prefer dealing with large, well-financed "area developers" who agree to build large numbers of stores that would, in most older franchise systems, make them instantly among the largest players.

Area developing also plays well in a market place that puts a greater premium on a fast rollout of stores.  It has become the favorite growth plan of franchisers, even smaller ones.  And its likewise loved by the powerful new breed of franchise that has come to the fore.

Take the example of Lucor, Inc., a Boca Raton-based area developer for Jiffy Lube.  "The company started as a side investment of a few people," said Lucor's chief executive Stephen Conway.  The "side investment" now has its own listing on NASDAQ's Small Cap market, 800 employees and 63 stores in five states.  Lucor plans to have 100 stores by the end of the year. (It has only a handful of employees in Boca Raton and doesn't have area rights in Florida.)

Franchising historically was a way to buy a job and opportunity.  Now it has been targeted and invaded by more ambitious types who see the ownership of multiple units as the path to riches.

These new players include formerly small franchise operators who have expanded to own multiple outlets, have excess cash but no territory left to exploit, and so sign up for much larger territories with new, non-competing companies.  Indeed, two of Pollo's area developers each own at least 100 Burger Kings.

But this confluence of ambitions between franchiser and area developer also means the elimination of start-up opportunities for small business hopefuls who have found buying a franchise to be a first rung on the entrepreneurial ladder.

"If the only way you can get a franchise is by opening 20 [outlets], we've kind of killed small business franchising," said Susan P. Kexios, president of the advocacy group American Franchisee Association Area developing could be "the beginning of the end for the mom-and-pop buying a franchise."

A Two-Tier Industry

Existing franchise systems have already been providing less opportunity to startup as consolidation among franchisees takes hold, making the country's biggest franchise-holders bigger.  Trade publication Restaurant Finance Monitor, for example, reports that the nation's 100 largest restaurant franchisees control 9,100 units last year, up from 7,000 in 1991.

Franchise experts say the result will be a two-tier industry.

In the top tier will be outfits headed by proven financial whizzes with strong backing from venture capitalists or Wall Street.  Its franchisees will be area developers that have the acumen, contacts and capital to handle entire states, pay thousands of employees and roll out hundreds of outlets.

For people long on desire but short on capital, opportunity will be largely in a second tier of small, often start-up franchisers that have less capital and lots more risk.

But even many of those smaller franchisers see area development as the way to grow.

Brothers Keith and Brian Laudanno just signed their first franchisee last week for Poultry Brothers Enterprises, Inc., their two-store company that offers 100 different take-out offerings of ready-to-heat entrees for people who lack the time or talent to cook.

The Laudannos started Poultry Brothers eight years ago in Sunrise by maxing out on their credit cards and raiding savings.  Their first franchisee will open a store in Aventura.  But now they are negotiating for much more: an area developer that would open as many as six stores in southern Palm Beach County and North Broward.

Keith Laudanno recognizes they're looking for the kind of investment he and his brother wouldn't have been able to make starting out.

But, "from an entrepreneur's point of view, you wan big, you want secure," he said. "I would love to see it go as an area developer where we could open five stores at a shot.  If we can get that going, it's a possible step toward going national.  The goal for us is to be big.

Citing Efficiency

Buying a franchise has long had appeal as a way to venture into small business with a safety net: a proven business concept and the ability to draw on an experienced franchiser for help in finding real estate, training workers, marketing and developing management systems.

In return for an up front franchise fee and royalties, the franchise holder got a particular market area and, with luck, a workable business concept.  The franchiser, in return, expanded its geographic reach and brought in revenues without much work or new capital

It's been a booming industry and, for many, lucrative.  Soft-drink bottlers are viewed widely as having a license to print money.  The septuagenarians who originally signed on with Ray Kroc's McDonald's aren't heard complaining about their choice.

But area developing now has more appeal for franchisers as diverse as Jiffy Lube, Kenny Rogers Roasters and the food chain Papa John's International.

"That's really the most popular method of franchising today," said consultant Ken Maguire, co-founder and executive director of the Florida Franchise Association, a 60-member trade group.

Area development allows for rapid expansion, more cost effective advertising, makes system wide changes easier to implement and reduces the effort and potential friction that comes with dealing with hundreds of individual franchisees.

Area developers normally contract with a franchiser to build a set amount of stores in a region in a set time frame.  Typically, they pay half the franchise fee up front for however many stores they've committed to build and a non-refundable down payment on the fee for the others.

An area developer doing the minimum commitment with Pollo, for example, will pay $187,500 up front franchisee fees alone.  The area developer also is looking at a $12 million expenditure -- before land costs -- to build and equip 15 units.

But area developing may be well suited to the desires of franchisers who have an eye toward scoring on Wall Street.

Boca Raton franchise lawyer Keith J. Kanouse says that for some franchisers, the quick rollout through area developers may be "more of a stock ploy than anything.  They want to get as many units out there as possible and then cash out in the IPO[initial public offering]."

Even so, he said, if a franchiser attracts strong developers it may be the way to go.

But for small-business people, "there will be fewer opportunities," Kanouse said.  "The single -unit franchisees will be relegated to smaller markets, if at all.  You'll get Pahokee instead of West Palm Beach."

16 Franchisees, 1,000 Stores

Blockbuster Video relied on area development to saturate markets.  Its franchisee for suburban Atlanta, Florida's Panhandle and other urban areas, for example, was a subsidiary of Cox Enterprises, Inc., the newspaper and broadcasting company that owns the Atlanta Journal and Constitution and the Palm Beach Post.

When Blockbuster vice Chairman Scott Beck left to join Boston Chicken, Inc. in 1992 as chairman, he pushed the area developer model to new heights.  Boston Chicken went from a company with 43 operators running 46 stores to 16 area developers with nearly 1,000 stores.

Boston Chicken, in turn, passed area development along to Einstein/Noah Bagel Corp., the bagel start-up company it financed.  Einstein went public last week.

In just four years, Boston Chicken's Florida franchise holder has put up 101 Boston Markets and plans to open more.  The local Einstein franchisee plans to add about 10 more stores to its 28 in Florida by the end of the year.

"We just opened seven stores in the last two weeks," Ellen Crane, marketing director for Einstein franchisee Gulfstream Bagels, said last week.

Einstein illustrates the area developer approach at its most potent.  The area developer program wasn't even finalized one year ago.  Today, area developers can tap $119 million in financing from Einstein and are contractually committed to open nearly 580 stores in the next three years.  Gulfstream Bagels, the Florida franchisee is committed to building 71 more stores in three years.  The local franchisees are indeed local, but they hardly are small town.

The owners of the Boca Raton-based Boston Chicken franchisee for Florida is Robert Hartnett, who ran 225 restaurants with $500 million in annual sales as general manager of the Bennigan's Restaurants chain, and shopping center developer Alexander "Sandy" Rappaport, formerly a partner with Outback Steakhouse in 13 restaurants.

Also, Hartnett is chief executive and Rappaport is vice president of Gulfstream, which shares corporate offices and support with Hartnett and Rappaport's Boston Chicken franchisee.

Combined, the local Einstein and Boston Chicken franchisee companies employ more than 4,000.

Einstein has the right to acquire a majority stake in Gulfstream, a right it has with all its developers.  That taps still another hot trend in franchising - systems taking a stake in franchisees.  Historically, franchise stores outperform company stores.  Franchisers, recognizing that salaried employees can't match the performance of franchisers whose own investment is at stake, now move to own stores jointly to benefit from the entrepreneur's zeal.

Gulfstream also has warrants to buy Einstein stock at $6.47 per share - just under one-third of Einstein's stock price when it went public last week.

It makes for a profitable loop: The area developer gets financing from Einstein and can cash in big if Einstein stock does well.  Einstein can take a majority stake in the developer in the future.

The financial ties between the two sides mitigate the growing problem of friction between franchisers and franchisees.  Also alleviating friction are the development contract terms.  Area developers don't face such nasty possibilities as having their territories encroached on by company-owned stores or hemmed in by other franchise-holders.

The ties also protect the franchiser.  In most systems, if the area developer fails to keep up with the development schedule and defaults, the franchiser can keep the franchise fees already paid for the unopened stores and, in some cases, even seize existing stores.

"It's a no-lose situation for the franchiser," said Robert Zarco, a franchise lawyer with Zarco & Pardo in Miami.

The difficulty in finding enough good franchisees motivates the push toward area development among less well-known companies as well.

R. J. Gators Florida Food & Fun Inc., a Jupiter-based restaurant franchiser for whom Maguire consults, plans to use area developing as it franchises.  Given its size, though, it would break Florida into as many as eight areas rather a single area as Boston Chicken and Einstein does.  It has 10 restaurants - seven owned by franchisees - in Florida, North Carolina and Virginia.

"A young company isn't going to attract the attention of a major player," Maguire said.

Its area developer likely will be less well-heeled but still will be able to afford - several times over - the as much as $750,000, not counting land and building, that's needed to launch a single R. J. Gators.

"It indeed is a structure where the area developer has to have a lot of substance," said Wayne L. Knyal, president of financial firm Franchise Mortgage Acceptance Co. of Greenwich, Conn.  "My concern is the top dog is less an operator than a financial alchemist and financial engineer."

Area developers say the answer is to hire the right help.

The background of Church's Chicken area developer Ben Feinswog, as is typical of area developers, isn't in the grease pit.

Feinswog, whose Miami-based Restaurant Development Corp. employs 350 at its 16 Church's in Broward and Dade counties, worked for Johnson & Johnson and Citicorp in fields such as information management and systems planning.  Before getting into franchising, he was in banking.  He started with the Hardee's system and now is in Church's thanks in part to financing Church's provided.

Feinswog began by handling the financial work, taxes and real estate.  To beef up operational oversight, he hired an experience operator and gave him an equity stake.

"You either need to be prepared to go in there and roll up your sleeves and be there long hours, or have someone you really trust or is a part-owner," Feinswog said, "or it's not going to succeed."