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Granville_Bean's picture

market driven levels

FFU says: "In general terms that means reducing the profitability of a zee either to break-even and forcing them to serve out the duration of their FA, or ..."

The above would only work for the short term, for a burn & churn 'concept' that specialized in fleecing a constant supply of newbies.  The rest of FFU's comment that came after the "or" begins to address what's needed.  For a longer term F'sor that actually wants to maximize profits from operations, they need good operators running the stores. In order to attract & retain good operators, they need to structure the deal so that the operators can make enough money so that they don't "vote with their feet" and go to competing brands or industries.

I don't know that there is a fixed percentage or ratio here. The respective levels of perceived opportunity would be market driven.

Well

"Jd, you and the "Guest's" have been spanked by everyone on this site"

Who cares what a bunch of partisan whiner former and disgruntled franchisees have to say? Oldsaw you chose poorly in your franchise investment, you chose a known crook of a franchisor and we have no idea what kind of operator you were. Successful franchisees don't post on BMM and why would they.

Oldsaw, I comment on your angst ridden polemic posts for the fun of it.

Oldsword

You are making yourself look foolish. When have I ever been in favor of SBA loans and why am i 'full of s&%*'? I could give quite a good explanation, but I'll let you answer that since you say I've been spanked by everyone including GB on this conversation.

As for your franchise, if I wanted to figure it out, you've given plenty of clues, like saying that they cracked the top 25 of the SBA failure list this year and the fact that you said that they had an Item 19 disclosure and your UFOC/FDD said that avg store sales were in the $460k range.

Old Sword's picture

Re: None of us would have (Fuwa)

Fuwa:

1.  NO, I did not deliberately submit inflated numbers (projections) to the SBA.  Once again, no franchisees were forthcoming and we all (yes 120+ borrowers out of 120+ borrowers) were given these numbers thru a third party that the franchisor sent us to (and the zor told us this they were not allowed to give us this info but this third party could and had all the finc'l info).  And I have documents showing other systems were doing the same exact thing.

2.  Yes, an accountant and a lawyer reviewed everything (and I have yet to speak with a franchisee who says they did not consult an attorney and accountant prior to purchasing).  And yet, all 3 of us were fooled.  Yes, we were played/fooled/taken/hoodwinked/(you get the picture).  So, while I may have been "sold" on the idea, my professional consultants also missed this info because it was not clear as to what was truly happening.

3.  Yes, all franchisees go in believing franchising is safer.  Think of your logic here Fuwa - if we believed franchising was fraudulent do you think we would buy into it?  No one going into franchising thinks of googling "franchise fraud".  BTW, does that make the fraud any less of an issue?  Is it OK to defraud someone because they didn't figure it out beforehand - is that your argument?

4.This is NOT about my system. This problem is pervasive in franchising.  It not only defrauds the franchisee;  MOST important, it defrauds the U.S. Gov't thru the gtees provided by the SBA.  The franchisors know, as do the IFA and the banks, that they are playing the current system whereby the banks give themselves a govt gtee knowing full well these system do not generate the cash flow necessary to meet SBA guidelines.  These three groups are in bed together making sure the application meets the minimum standards by using inflated projections and then fall on the argument that "projections are just projections" when in fact they know the projections provided have no basis in reality.

While I could go on with other points I will sum it up with this last one:

5.  You are wrong regarding your statement "experience would dictate the majority would still end up buying into the system."  With the numbers were clearly stated the franchisee, believing franchising is safer, will not only have a black and white picture of the true profitability of the system in front of them BUT. . .they will now have two/three additional objective parties (accountant, lawyer and, if applicable, spouse) telling them this system is no good.

Think of it this way (and perhaps the lawyers here would like to chime in):  If the accountant and lawyer clearly see that the system generates multiple year losses (based on first, second and third yr gross avg) do you believe they would allow their client to sign on without first obtaining a signed document stating clearly that the new zee has been informed that the system is not expected to produce a profit and they were advised to step away from this system?  Do you think the spouse would allow (think Century 21 lawsuit by the wives) the other to place their home, savings, retirement savings, college savings on the line for a system that clearly shows the average zee LOSES 6 figures in their first two/three yrs of operation and few obtain profitability after that?

No, Fuwa, in this instance, with real info (not just speculation) in front of them potential franchisees would be made fully aware of the "proven business model" put forth and the great majority (I will give you maybe a handful wouldn't) would walk away thereby making it impossible for the zor to continue their charade.

Old Sword's picture

Re: None of us would have (Fuwa)

Fuwa:

1.  NO, I did not deliberately submit inflated numbers (projections) to the SBA.  Once again, no franchisees were forthcoming and we all (yes 120+ borrowers out of 120+ borrowers) were given these numbers thru a third party that the franchisor sent us to (and the zor told us this they were not allowed to give us this info but this third party could and had all the finc'l info).  And I have documents showing other systems were doing the same exact thing.

2.  Yes, I used an accountant and a lawyer to go over everything (and I have yet to speak with a franchisee who says they did not consult an attorney and accountant prior to purchasing).  And yet, all 3 of us were duped.  Yes, we were played/duped/taken/hoodwinked/(you get the picture).  So, while I may have been "sold" on the idea, my professional consultants also missed this info because it was not clear as to what was truly happening.

3.  Yes, all franchisees go in thinking that franchising is safer.  Think of your logic here Fuwa - if we believed franchising was a fraud do you think we would buy into it?  No one going into franchising thinks of googling "franchise fraud".  BTW, does that make the fraud any less of an issue?  Is it OK to defraud someone because they didn't figure it out beforehand - is that your argument?

4.This is NOT about my system.  This is how franchising is now established.  This problem is pervasive in franchising.  It not only defrauds the franchisee;  MOST important, it defrauds the U.S. Gov't thru the gtees provided by the SBA.  The franchisors know, as do the IFA and the banks, that they are playing the current system whereby the banks give themselves a govt gtee knowing full well these system do not generate the cash flow necessary to meet SBA guidelines.  THINK LIAR LOANS.  These three groups are in bed together making sure the application meets the minimum standards by using inflated projections and then fall on the argument that "projections are just projections" when in fact they know the projections provided have no basis in reality.

While I could go on with other points I will sum it with this last one:

5.  You are wrong regarding your statement "experience would dictate the majority would still end up buying into the system."  If the numbers were clearly stated the franchisee, who is thinking franchising is safer, will not only have a black and white picture of the true profitability of the system in front of them BUT. . .they will now have two/three additional objective parties (accountant, lawyer and, if applicable, spouse) telling them this system is no good.

Think of it this way (and perhaps the lawyers here would like to chime in):  If the accountant and lawyer clearly see that the system generates multiple year losses (based on first, second and third gross avg) do you believe they would allow their client to sign on without first obtaining a signed document stating clearly that the new zee has been told by them that the system is not expected to produce a profit and they were advised to step away from this system?  Do you think the spouse would allow (think Century 21 lawsuit by the wives) the other to place their home, savings, retirement savings, college savings on the line for a system that clearly shows the average zee LOSES 6 figures in their first two/three yrs of operation and few obtain profitability after that?

No, Fuwa, in this instance, with real info (not just speculation) in front of them potential franchisees would be made fully aware of the "proven business model" put forth and the great majority (I will give you maybe a handful wouldn't) would walk away thereby making it impossible for the zor to continue their charade.

I have seen this in my

I have seen this in my franchise system. The earliest owners got generous exclusive territories and possible more and have held off (so far) the open more stores or we will edicts. A few of the owners are the highest volume ones in the entire chain and have said they don't mind the franchisor making money, but it has come at the expense of the francisees (creating distribution companies between supplier and franchisee to take a profit). I also got the speel that corporate needs us more than we need them and they are committed to the franchisees making money. There are also many franchisees that think the franchisees should go along with anything the franchisor says because they know what they are doing; meanwhile their profit margins are decreasing and corporate is fostering competition amongst them and the owners close to them.

FuwaFuwaUsagi's picture

<i>none of us would have

<i>none of us would have bought into the system</i>

I doubt that is true.  Why you as an individual may not have, experience would dictate the majority would still end up buying into the system.

Point one, I have not seen you refute the allegation that you deliberately submitted inflated numbers to the SBA.   Why there can be some charitable and uncharitable interpretations of that, I'll go with charitable and run under the assumption your were lead into that action by the zor.

If my charitable position is true, this would indicate that you are also susceptible to pressure, misdirection, and salesmanship.

My guess is, you were already sold on the idea of owning a small business and you were sold on the idea that franchising was the way to go.  Which is to say: you were probably already psychologically damaged goods when you got to the point of doing your do diligence and thus very susceptible to soft sales tactics.  An dif this did not apply to you, I would suggest it applies to most.  

In the end, while it is convenient to label one factor as the inducement to buy, there are usually a myriad of subconscious and conscious factors that lead to the choices made.  Good sales people know this and manipulate the circumstances in their favor.  Invariably if one approach does not work, they will switch to another.  And they are excellent at knowing which approach is likely to work with whom.

In the past few years, several concepts emerged where the zor did not even have a concept built, and yet the found zees eager to hand over their money for what they felt would be the next hot thing?  How does that happen?  It happens because we are all too human and have many psychological frailties that can be exploited by the duplicitous among us

 

FuwaFuwaUsagi's picture

Jerry: That was a very

Jerry:

That was a very thoughful response and I concur with your overall assesement.  

I will state while I think the overt comment you make about Buy, Sell, Hold seems like a good idea, I suspect you do not have certain market realities for retail operations in your scope of vision.  In "our" very recent past we have seen a couple of dramatic shifts.  One the ascention of the triple net lease, and two a rise in real estate valutions.    Simply put, you can have an awesome concept, and if you have hte wrong lease, it is not going to stop the inevitable.  Given the overall lack of due diligence we see continually manifested, I fear a buy, sell, hold rating would become yet another reason to avoid performing proper diligence and that would be zees would ignroe their local market conditions. 

Kindest regards...

Oldsaw the Magnificent

"Jd, you and the "Guest's" have been spanked by everyone on this site"

Who cares what a bunch of partisan whiner former and disgruntled franchisees have to say? Oldsaw you chose poorly in your franchise investment, you chose a known crook of a franchisor and we have no idea what kind of operator you were. Successful franchisees don't post on BMM and why would they.

Oldsaw, I comment on your angst ridden polemic posts for the fun of it.

Re: Re: Care less about SBA? It's their life blood!

"Jd, you and the "Guest's" have been spanked by everyone on this site"

Who cares what a bunch of partisan whiner former and disgruntled franchisees have to say? Oldsaw you chose poorly in your franchise investment, you chose a known crook of a franchisor and we have no idea what kind of operator you were. Successful franchisees don't post on BMM and why would they.

Oldsaw, I comment on your angst ridden polemic posts for the fun of it.

Re: Re: Care less about SBA? It's their life blood!

"Jd, you and the "Guest's" have been spanked by everyone on this site"

Who cares what a bunch of partisan whiner former and disgruntled franchisees have to say? Oldsaw you chose poorly in your franchise investment, you chose a known crook of a franchisor and we have no idea what kind of operator you were. Successful franchisees don't post on BMM and why would they.

Oldsaw, I comment on your angst ridden polemic posts for the fun of it.

Ray Borradale's picture

It would seem no one would

It would seem no one would dispute that those wanting to go into business but cannot get finance without an SBA loan aren’t ready to go into business or their business of interest is a dud.

It would seem that most people are therefore agreeing that SBA should not be backing loans to dud businesses or dud business operators however the SBA failure rates indicate SBA is doing just that.

It also seems that the SBA loan program is ideal for dud franchising encompassing all that dud franchising is including dud operators passing selection, FranWhacks and your average churn franchise.

Franchising is probably the most organized sector of small business to take advantage of the existence of the SBA loan program.

It seems that Oldsword argues that dud franchising passes bogus figures to the wannabe franchisees and they for whatever reason play along with franchising’s organized and professional ‘gltiz and glam’ approach to conning foolish franchisees and the SBA loan program.

It would seem others underestimate dud franchising. The ease at which much of the prospective franchisee market is conned is a given.

Based on the failure rates of franchise SBA loans I would think it more appropriate to howl down the many thousands of failed SBA loan franchisees who didn’t come out in an attempt to inform the stupid market that bogus figures equal failure. 

Given the cost of SBA franchising failure rates it seems clear that either those that oversee the program are blind or stupid or someone very senior saw the light and stuck a hand out. 

The problem I find perplexing is that I cannot think of any franchising entity that could possibly coordinate a generous industry response?

Ray Borradale's picture

It would seem no one would

It would seem no one would dispute that those wanting to go into business but cannot get finance without an SBA loan aren’t ready to go into business or their business of interest is a dud.

It would seem that most people are therefore agreeing that SBA should not be backing loans to dud businesses or dud business operators however the SBA failure rates indicate SBA is doing just that.

It also seems that the SBA loan program is ideal for dud franchising encompassing all that dud franchising is including dud operators passing selection, FranWhacks and your average churn franchise.

Franchising is probably the most organized sector of small business to take advantage of the existence of the SBA loan program.

It seems that Oldsword argues that dud franchising passes bogus figures to the wannabe franchisees and they for whatever reason play along with franchising’s organized and professional ‘gltiz and glam’ approach to scamming foolish franchisees and the SBA loan program.

It would seem others underestimate dud franchising.

Based on the failure rates of franchise SBA loans I would think it more appropriate to howl down the many thousands of failed SBA loan franchisees who didn’t come out in an attempt to inform the stupid market that bogus figures equal failure. 

Old Sword's picture

Re: Care less about SBA? It's their life blood!

Jd, you and the "Guest's" have been spanked by everyone on this site, including GB, with regard to this subject.  You keep trying to turn the subject to me when, in fact, it is a serious systemic problem where franchisors, the IFA and the banks are taking advantage of the SBA underwriting system.

(The bank gets the loan application and decides whether it is deserving of a government gtee to protect its profit - gee, I wonder if the bank is going to say no - or look the other way when an obviously inflated revenue projection is put forth to them - on the 3rd try!!)

As for not caring - you're full of sh&#.  If it were not for SBA loans many of the systems that use this for financing new purchases would fold up and die - banks would never loan to these systems unless:

1.  The franchisor laid all the financial info on the table INCLUDING first, second and third yr avg gross revenues (which would only prove to the banks they shouldn't lend).

2.  The franchisee had assets totaling about triple the loan amt so loan repayment was certain should they default.

The IFA and franchisors rely on the SBA to keep the sales flowing.  Look what the hell happened to franchise sales during the credit crisis AND the subsequent tidal wave of sales after the SBA loosened the standards and gtd 90% of the loan.  The IFA, franchisors and the banks right now are pushing like all hell to get the SBA to loosen again.  The banks see this as easy profits. . .and so do the IFA/franchisors.

These three are lobbying Congress and the SBA heads hard right now.  They have to.  They are trying to kill something that they weren't supposed to be aware of - but the SBA are in their pockets -  (which would give you an idea of who my zor is and is possibly why you think you know who - because I have never named it - too convenient that now you think you know just as this inside info has been "compromised".

Accounting For Differences

Barristerista says:
"How does the system account for these differences? By breaking out the different franchisees by length of time in the system? Would this all wash out after taking new franchisees depreciation into account? EBIDTA measures would cover for some of that, but there are other areas where there are big differences and I'm not sure that a skewed picture would not be presented to a reader of the numbers produced by the system."

Interest, taxes, depreciation, and amortization are not relevant variables when calculating EBITDA. Length of time in the system is irrelevant because your retail only COGS should be the same as the newbies unless their coffee prices are different than yours.

Dunkin' is already a skewed system with the majority of locations concentrated in the Northeast. The law of averages would not be skewed. Rather, the reported number would be representative of the system. Further, if broken down by geography, the law of averages will once again be representative of the system's performance in the geography sampled.

It's pretty simple math that the Dunkin' franchisor already has since you're required to report very detailed P&L's as part of your agreement.

I could care less about the SBA

As GB and Fuwa have stated, why go to the SBA if you can't finance it on your own.  You talk about the SBA having all of the numbers, but the SBA only has the numbers for the stores they service.  Hey, how about a store that doesn't have debt (you know the ones that probably are successful), they only have to share with the franchisor (if the franchisor requests them).

You can't get over the fact that you signed your name to a document knowing that you were showing sales in excess of the Item 19 disclosure.  I'd feel more sympathy for you had there not been an Item 19 discloure and you were grasping at a number out of thin air. 

So, out of the stores that opened in your franchise over the last 10 years, what % have been through the SBA?  For those that weren't using the SBA what projections did they use?  Did they think for themselves or rely on the zor to do them and then just sign their name (and probably personal guarantee) like you did?

Dunkin' Brands: Taxation

"What types of penalties to you put in place if you find out that the franchisee hasn't eliminated the Bentley payments or the mistress on the payroll from what they submitted? Is it a fine, terminate the agreement, or what?"

Prior to their recent FA, Dunkin' Brands' preference was to collect a penalty and terminate the FA if the franchisee was expending the Bentley and the Panty purchases made on behalf of the Mistress on their tax returns.

Creating The Checks-N-Balances

Mr. Gordon comments,
"These values would be reported in the management analysis and discussion section of a publicly traded company's 10K."

"Since the FDD disclosure must be reasonably supported, the same basis technique can be employed there."

Excellent points!

The IndFA would be the voice of authority for Wall Street to verify management's analysis and discussion within the 10K. The IndFA can also be the point of reference for prospects conducting FDD due diligence. It's the franchisees that best understand the business; especially, when dealing with franchisors, such as Dunkin' Brands Inc, which have a revolving door in institutional knowledge.

BOD & Shareholder Value

Fuwa comments:
"The duty of the Board of Directors of a corporation is to MAXIMIZE shareholder wealth."

I agree.

"In general terms that means reducing the profitability of a zee either to break-even and forcing them to serve out the duration of their FA, or insuring there is just enough profit to make the acquisition of additional units attractive, or making it attractive enough to get the FA renewed."

You bring up a good point by addressing the conflict between long-term franchise sustainability and short-term franchisor profitability. Long-term sustainability requires finding a balance between shareholders and franchisees.Both parties seek to build their respective wealth. Franchisors sell franchises. Therefore, the franchise must remain attractive enough for prospects to invest in the brands. Finding the optimal economic point is a function of EBITDA and increasing same store sales is the common denominator for both the franchisor and the franchisee.

However, the markets reward short term franchisor performance which means squeezing franchisee EBITDA in favor of franchisor short term EBITDA growth. This is an unhealthy proposition that the markets do not understand today. My view is that the IndFA's need to become more vocal in the marketplace by rating their franchisors with Buy, Sell, or Hold ratings to force a change in today's equitable arrangements.

Old Sword's picture

Jd, don't stop - keep digging. You'll find the same zor tactics

Aaaawwwww Jd, sounds like someone is scared.  You are trying to focus on me instead of the facts. 

Since I never stated who my zor is you must be very concerned over the truth of my statements for you to try to do "homework".   You are in way over your head.  You can try the typical zor strategies of blaming the zee but, in this instance, the sheer number of franchise systems that I have spoken with, the info I have been able to gather and ALL of them showing the same exact thing - inflated revenues on SBA loan applications - helps prove that this is a concerted effort on the part of franchisors, the IFA and the banks on defrauding the SBA. 

No incentive for a zee to lie about the numbers.  Who would want to tie up their life savings to buy into a system that has historical evidence proving it doesn't generate a profit?  But, research the SBA loan apps for almost any given system and you will see similar revenue numbers, almost all the loans from the same bank, and many times using the same loan consultants.  All one big happy family!!  Keep digging Jd!

spoken like a true professional

Uh hum, funbasher. Keep making that IAFD proud.

RichardSolomon's picture

Richard/IAFD financial metrics model

This is a really interesting approach to spreading basic information about the business of a given franchise system, especially a newer one.  I do forsee some twists and turns that might be presented by a mature system that has long term franchisees whose numbers might skew the results.

Established franchisees will have advantages that get baked into their numbers but which might not be obvious.  For example, they develop in house operations and equipment that newer franchisees typically oursource and which show up on their expense lines.  Take out of warranty equipment servicing or repair (or even trucks if your franchise involves them) as an example.  Established franchisees have extra equipment and have employees cross trained in maintaining and repairing it.  They have extra parts from older machines, can rebuild new ones from old ones, etc.  They aren't depreciating it (that has long since been done).  How does the system capture these efficiencies?

Another example for the northern US would be snow removal.  If you have a winter like the one just past, there is a huge difference in your net if you own your own plows and dump trucks to cart snow out of your parking lot.  Not to mention the lost sales of someone who has to wait for the giant snowpiles taking customer parking spaces to be removed versus the guy who just does it for himself before he opens for business.

A third would be a second or third generation inheriting the business as opposed to building or buying it.

How does the system account for these differences?  By breaking out the different franchisees by length of time in the system?  Would this all wash out after taking new franchisees depreciation into account?  EBIDTA measures would cover for some of that, but there are other areas where there are big differences and I'm not sure that a skewed picture would not be presented to a reader of the numbers produced by the system.

RichardSolomon's picture

You would not be using the model created by the IAFD unless

you had already vetted it for fit with your franchise organization. If you have vetted it, then you have already done that work.

The IAFD may eventually have a "bank" upon which one may draw down information that is franchisor specific, but that is a long way off.

If there is a time bind, then the IAFD system would not be available. Homework must have been done by someone.

I stopped at this...

' If I had known the actual average gross receipts for a first year new site for my franchise was $250,000 rather than the $500,000+ number that we all were given, none of us would have bought into the system (especially when seeing the $100,000+ loss that real number generated).'

You are leaving out the fact that your zor's Item 19 showing average gross receipts of around $430k (and you were all given that).  Instead of using that number, you used an inflated number to get the loan.  You felt that you were better than the current franchisees.  Out of curiosity, did the Item 19 disclosure go up or down each year in terms of gross sales? 

Richard...

serious question here.  Say you are representing a franchisor using the model that the IAFD is trying to create.  Your client wants to use this information in an Item 19 disclosure, but do to the timing cannot verify all of the information provided by the franchisees.  What types of penalties to you put in place if you find out that the franchisee hasn't eliminated the Bentley payments or the mistress on the payroll from what they submitted?  Is it a fine, terminate the agreement, or what?

RichardSolomon's picture

If I am representing the frachisor, someone competent needs to

be representing the franchisees. The sooner we get a competent metrics measurement system in place and in use the better off the entire environment will be.

I just hope that the unfortunate passing of Steve Ellerhorst will not unduly delay development of the IAFD project on this subject. It probably will, since that quality of leadership doesn't just grow on any tree. Also, unfortunately, my guess is that the IAFD may not have a budget for this, so it will depend upon por bono volunteers. We could do this at an outdoor patio table under the oaks at Muldoon's. I happen to know the owner.

Old Sword's picture

There is NO problem

I'll tell you what, Jd.  If I had known the actual average gross receipts for a first year new site for my franchise was $250,000 rather than the $500,000+ number that we all were given, none of us would have bought into the system (especially when seeing the $100,000+ loss that real number generated).  That goes with a new UPS store averaging about $230,000 in their first year but needing over $400,000 (according to a Boston Consulting Grp report commissioned by the franchisor) to be profitable.  Or, last night during my conversation with a Quiznos franchisee from a number of years ago who was given their proforma numbers by the franchisor and whose real numbers didn't come close (something Quiznos is known for given their 4000 failed sites in the last few yrs).  Another system (that I can't mention), did the same thing - even while knowing that only one franchisee within their system was profitable (I can't say more about this great system. . .yet) - but they made sure the proformas showed other wise by inflating the gross revenues.

You are trying to make it difficult.  Its not.  Actually, its very, VERY simple.  You can fudge alot of things but gross revenue is what it is. 

However, given the fact that the banks get the info (not just gross but net as well), its not too difficult to do WHAT YOU SAID WAS A GREAT THING ABOUT HUD!!!  Have a formula that cuts out certain expenses, etc. that can show a reasonable bottom line.  It won't matter, Jd.  It will show that most of these systems do not produce the revenues required for the banks to provide lending.  Which is exactly why the franchisors don't want it public and why the IFA and the banks are doing their best to bed the SBA and open up the spigot.

John Gordon's picture

Scrubbing data

JD: we did not, not advocate scrubbing the data.

Here's the problem...

You got Richard getting tax returns, scrubbing the data.  You've got Oldsword saying all they need is gross sales by year, and you got John saying that Unit level EBITDA (without scrubbing the data) is what's needed.

Here you have three different franchisee advocates (unless Richard is getting paid to represent a zor) and they all have a different way to get to the data. 

So, which one is it?

John Gordon's picture

Reporting Numbers

Richard and Jerry are right: FASB and the SEC have nothing to do with this academic issue.

I sense that GB just doesn't want to do the work, since he is a zor financial type, and the burden would fall to him. 

Every franchisor in the world needs sales, in order to calculate and test royalties. And every bank in the world needs EBITDA.  So does the franchisor, since they must approve sales and transfers.

The Franchisor's auditor must test sales to test royalties via a sampling technique. Unit level  EBITDA (no G&A) is then collected annually via the franchisor. 

These values would be reported in the management analysis and discussion section of a publicly traded company's 10K.

Since the FDD disclosure must be reasonably supported, the same basis technique can be employed there.   

Via common law development, this is non-GAAP data as the data is not embedded in the face of the income statement, balance sheet, etc. The must be reasonably accurate and supportable, and not created in an attempt to decieve and mislead.

 

John A. Gordon

Old Sword's picture

Richard and Jd: Taxes, Profitability and Lending

"For HUD, you were expected to transmit your financial statements to them within either 60 or 90 days after your year end."

Damn, am I loving this thread.  Guess what Jd?   The same rules apply to SBA loans!!!  FYI:  Financial institutions underwriting SBA loans are REQUIRED under SBA Standard Operating Procedures to collect ANNUALLY the Income Tax Returns/P&L's of every SBA loan borrower. 

Since approx 80% of all SBA loans are underwritten by 8 banks AND, if you know anything about SBA franchise loans, franchisors try to funnel their new franchisees to just one or two banks for all the loans you will then understand that these banks KNOW what the real first, second and third year gross revenue numbers are. (they have so many loans from each specific system they are fully aware of the {lack of} profitability of these systems).

Jd, we don't need EBITDA.  In order to determine if the system is even coming close to profitability a simple "average" of franchisee gross revenue (broken out by first, second, third yr) is all we need.  AND, once and for all, it will show the actual gross revenues do not even come close to what the franchisors are giving (whispering, writing on knapkins - you know what I mean) to new franchisees to use on their proformas in order to gain SBA loan approval - and, again, a number the banks KNOW is not consistent with reality based on those annual income tax returns.

"They had some formulas set up that if certain 'Miscellaneous' categories were over 10% of the total for that category of expenses, you would have to breakout those expenses."

The same can be done with franchisees.  BUT:

"If you open it up for prospective franchisees, then I think you create a situation where a prospective franchisee is relying on the information and the franchisor is going to be more critical of the information, and possibly audit the franchisee, which would create a hostile relationship."

its quite clear you don't want this information out there for franchisees to see.  I wonder why?

RichardSolomon's picture

No. Of course not. I am not backing away from anything. I use

tax returns as sources of information, like any other information source, except that it is prepared under oath and contains the most conservative possible statement of financial performance. It won't be "worse" than as shown by tax returns. The next step is to see how much better it may be by changing optional treatments and other things like non-cash charges and "perks" (the Bentley company car; the twin engine airplane; the cigarette speedboat used for "meetings"; the mistress who is on the payroll as a public relations consultant (that is a joke to honor former Senator Edwards who is being indicted today for doing just that); and other things to arrive at a rational comparison of gross income and costs that are real and that are functional variables rather than convenience variables. Then you are getting closer to zeroing in on what typical EBIDTA ought to be for this kind of business in this model operating under this franchise agreement.

Then you also take into account the impact of restrictive franchise agreement and ops manual provisions as well as the actual practices that may further inhibit cash flows. In this way you are not only getting to appreciate actual EBIDTA ranges, but also enabling the tracking of the proximately caused metrics impairment resulting from predatory franchising practices.

These projects have all sorts of potential benefits in addition to providing the underlying evidence upon which future "experts" will have to rely (that they could not generate for themselves when the time came and the data was needed but nonexistent.

The list of positives from doing this is almost endless. 

FuwaFuwaUsagi's picture

  Jerry: Granville has it

 

Jerry:

Granville has it correct in his retort below.

And I will state it in its classical form. 

The duty of the Board of Directors of a corporation is to MAXIMIZE shareholder wealth.

In general terms that means reducing the profitability of a zee either to break-even and forcing them to serve out the duration of their FA, or insuring there is just enough profit to make the acquisition of additional units attractive, or making it attractive enough to get the FA renewed.

Do anything other than the above and you are derelict in your duty to shareholders.

It is that simple.  And the sooner prospective zees realize this and the sooner advisor/consultants stop with the touchy-feely mantra of fairness the sooner market forces will compel a more equitable arrangement. 

 

So are you backing away from your taxes comment

That tax returns should be used for your metrics, and if so, I agree.  If business people were smart, they start looking at their taxes early enough to minimize their taxes owed.  It could come down to whether you want to purchase inventory now, or wait until the first week of your new year.  That's an easy way to skew your numbers for the year on a tax return.

I believe I mentioned 4 years ago that there were industries out there that had an effective way to gather and distribute data (HUD & Homebuilders, being the ones I had knowledge of).  For HUD, you were expected to transmit your financial statements to them within either 60 or 90 days after your year end.  They had some formulas set up that if certain 'Miscellaneous' categories were over 10% of the total for that category of expenses, you would have to breakout those expenses. 

With everything being all computerized, I'm sure it would be easier to compare data and look at specific line items to determine if more information would need to be looked at.

Now, getting compliance from your franchisees is the first step into using a similar format.  Will this information be shared with franchisees only?  Personally, I think this is the best way.   The franchisee shares and gets information back for use in their business.  If you open it up for prospective franchisees, then I think you create a situation where a prospective franchisee is relying on the information and the franchisor is going to be more critical of the information, and possibly audit the franchisee, which would create a hostile relationship.

RichardSolomon's picture

Measuring franchise performance metrics has nothing to do with

auditing anything. The goal is not to find pennies or to assure compliance with "rules", but to sort our the metrics of financial performance. You are going to be determining things like ranges, geographic and seasonal variations (think flip flops in MInnesota), time in service as a variable, single versus multi unit performance characteristics, and every other significant variable that comes up.

This is not tax practice and the people who attempt to do this project will need the flexibility to write new methods. This is now done with great effectiveness in other industries and to answer other questions. We used it years ago to identify niche markets - think idiosyncratic demand pools. When you embark upon new work it is often counter productive to tie your mind down with old rules. They are useful to some extent, but they cannot be allowed to become a sort of bible.

Ray Borradale's picture

JD, surely if you are looking

JD, surely if you are looking at P&L’s and tax returns identifying asset deductions and any creative expenses allows you to de-skew the result to usable performance information. That process begins with questions and ends with 'show me the evidence'.

Unaudited numbers is not the answer. Using tax returns AND

"The FASB has nothing to do with this discussion. Neither has the SEC."

Well not if we're talking about Dunkin after its IPO and for Wall Street to use this Zee to Zor EBITDA comparison.

I disagree Richard

'Tax returns are prepared under the tax accounting rules - and so should be the P/Ls (which they usually are if prepared by an accountant).'

Considering that I work on financials and used to do audits, almost all of our audits were based on FASB (very few were based on tax accounting). Where I work at now, our internal statements are accrual basis and our tax return is cash basis. The accounting firm I worked at did the same thing.

Tax numbers can skew just as well as audited numbers. Section 179 allows a taxpayer to immediately for tax purposes deduct a certain amount of fixed asset purchases all the way down to $0 taxable income.

Nanee Nanee Poo Poo

EBITDA is a very relevant and practical measure of financial health. It is the basis of valuation for most businesses. In fact, Dunkin' stores do trade on the secondary market and such resale valuations are determined as a multiple of EBITDA. Are you suggesting the valuations paid on franchisee to franchisee sales are bogus since they are not based off of audited statements?

When a prospective franchisee buys into the Dunkin' system they must put together a proforma statement for their financing banks to determine cash flow and potential profitability. By suggesting that an aggregate system wide franchisee P&L could never be properly audited means the collapse of the financial market for franchise financing as a whole. Now, to me, that is a foolish bonehead idea to think franchisee P&L's would never pass muster with a regulatory agency.

RichardSolomon's picture

Unaudited numbers is not the answer. Using tax returns AND

P/Ls allows you to come up with rational numbers. Tax returns are prepared under the tax accounting rules - and so should be the P/Ls (which they usually are if prepared by an accountant). Unaudited is not a valid criticism when you are looking for comparability. Audited numbers can skew everything to the same or worse degree as unaudited numbers. Audits versus unaudited is not the valid issue here.

The FASB has nothing to do with this discussion. Neither has the SEC. Those are totally useless references.

Back at you...Bonehead

It's about practicality and relevance.

Bonehead Guest

It's big picture thinking, something that your shallow little mind lacks.

Jerry Kickapoo - Another Bonehead Proposition

How would you be able to take the various reported unaudited EBITDA numbers from franchisees and prove their validity under FASB and the SEC?

Operations Management

Yes. Quality operations management is the key to a successful business. Quality management is needed on both sides of the franchise fence. An effective IndFA and an independent 3rd Party data mining service is needed to create the metrics that will support the theory on EBITDA correlation. Dunkin' would be an ideal system to test the theory.

GB, You're So Silly...

"The bank provides the capital. The franchisee provides the operating management. So should creating shareholder value be "linked" to creating bank value?"

GB - In our multi-unit network we maintain a 40/60 capital structure which means for every dollar we invest we leverage an additional $1.50. The banks share the risk with us and not our franchisor. We "invest" because we seek "returns" on our dollars invested. Our risk is tied to the franchisor's initiatives to drive sales that build our profitability. The more profitable we become - the more my businesses are worth. Therefore, our "risk" is tied to the long term financial performance of our franchisor.

I believe Jerry has a point that EBITDA "should" be a reportable financial performance metric for a publically traded franchise system. Most publically traded franchisors have this data but choose not to report it because they know they can squeeze the franchisees when times are tough to hit their quarterly financial targets.

Granville_Bean's picture

If franchisees are merely operators...

Not MERELY.  As OWNER operators they enjoy the profits of their good operations.  Someone who is merely a Manager might get a bonus but they don't obtain all the profits nor suffer the losses. If you want to use a joint EBITDA metric, you need to demonstrate a correlation, not just a belief.  It would be convenient to your position but I consider it as yet an unproven assertion.

We have been 100% leveraged for some time.  Our successful operations pay for our cost of renting the capital from the banks and repaying it on a rolling basis.  Our expansion has nothing to do with our own capital but with our operations which satisfy the bank to advance us capital.  If our operations failed we would be on the hook, but ironically if our operations failed we wouldn't have the assets to make good on the guarantee.

Jerry overrates capital and underrates Management.  Management is the key to an operating business.  Without management, having more capital would merely increase tha amont lost before final failure of the business.

Granville_Bean's picture

The Franchisee "Link"

Granville, If franchisees are merely operators, then why not just get a job at your local McDonalds and aspire to become a store manager? There is no reason for any franchise to set a financial requirement if it's the banks that risk all the capital. Let's not forgot it's the franchisees that guarantee the bank loans.

I used the word "should" to keep it simple. To expand a bit further, I believe there is a correlation between franchisee EBITDA and franchisor EBITDA. These 2 components can be linked together by an effective IndFA to benchmark performance. This is a gauge that can be applied to a publically traded franchise to determine the overall health of the system. Wall Street rewards performance by enhancing shareholder value. Franchisees are happy when their profitability remains intact and grows. The world can become a better place for all.

Granville_Bean's picture

so how do you "link"?

Jerry says: "After all, who contributes the capital to create shareholder value in a 100% franchised model?"

The bank provides the capital.  The franchisee provides the operating management. So should creating shareholder value be "linked" to creating bank value?

Yes in an ideal world the Happy Zees make money for the Benevolent Zor and the Zor wants to keep the Zees happy so they keep producing.  However when push comes to shove, whose company is it?  The same might be said for the way the Zees treat their employees.  You want good employee morale but how does that translate into action?  If you pay them all $12/hr. to start plus free Health Insurance and 4 weeks' paid vacation each year, they would like that.  But would the Zee make money from it?

Just to say "should" isn't enough.  You have to have a reason WHY somthing that makes the Zees happy is good for the Zor, not just that the Zor SHOULD.  WHY "should" they is the question not answered by mere assertion.

(Hey Fuwa, good to see you're back...)