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Log In / Register | Aug 14, 2018

Prospectus Offering: Lake Woebegone

Over the past two days, the Wall Street Journal released two articles related to the franchise industry.  So, why not bring them here.

..  One of the articles discusses some sort of global deal with the Russians... that’s very big business…for me.  The other article is titled "Financing Programs Aimed To Help Franchisees" and is certainly more relevant to Independent Joe’s circle of competency.  The importance of the latter is that it speaks the story on the Lake Woebegone Securitization.

As bank lending continues to be sparse, a number of corporate franchisers are providing financing arrangements and other aid to potential franchisees. Though business owners say they're grateful for the assistance, many of the programs do come with strict terms.

The franchised brands discussed are Edible Arrangements, Dunkin’ Donuts, and Quiznos.  However, only one Franchisor is named – QIP Holder, LLC.  The issue of concern here is that the discussion is very broad and ranges from small business lending (SBA), to private equity hedge funds, and ultimately, institutional investors.  Given the scope, it’s as big as the Russian’s, and certainly worth shaking the “salt” over.

For those who know me understand the views crafting my prior commentary.  My goal here is to provide a broader understanding since these issues are being discussed on the Hill today.  When one looks to understand the economies of industry, one is looking for the “Invisible Hand” that moves the market.  More importantly, the journalist – forget about the underwriters, for now…  must have come across some “issues” in their due diligence process to question before going to press. 

As a businessman, I found myself in tears when I read the story of this “extraordinary” franchising soldier: Mr. Bob Baber.  Quite honestly, it wasn’t that hard to figure out when I strapped my jeans on this morning.  And, when I’m running on “Levis” - because it’s an American legend - then Mr. Levis better be able to explain how he has “won” his battles and shaped his franchise culture given that soldier’s story.  My impression is that Mr. Baber “trusted” his franchisor – and, when that failed, the system failed….

The securitization of Lake Woebegone was underwritten by a bunch of “brokers”.. for a fee, of course… without valuing the quality of  “emotion” behind the assets being collateralized.  “Emotion” is not a credit score..  The “maestro” understood that the market between 2005-2006 was only listening to the “GotRocks” family - because they can afford expensive “suits”… and, they will show up on game day armed with the “greatest” of war stories.  Whilst others are simply satisfied when they look “good” after a hard day in their “jeans”.  Finessing the wrinkles, is about finessing the equity when experienced money is experienced at making money.  Hence, “greed” will destroy the market before the invisible hand will “see” itself through.

As spoken by the market maestro “extraordinaire” himself:

In 2006, promises and fees hit new highs. A flood of money went from institutional investors to the 2-and-20 crowd. For those innocent of this arrangement, let me explain: It’s a lopsided system whereby 2% of your principal is paid each year to the manager even if he accomplishes nothing – or, for that matter, loses you a bundle – and, additionally, 20% of your profit is paid to him if he succeeds, even if his success is due simply to a rising tide. For example, a manager who achieves a gross return of 10% in a year will keep 3.6 percentage points – two points off the top plus 20% of the residual 8 points – leaving only 6.4 percentage points for his investors. On a $3 billion fund, this 6.4% net “performance” will deliver the manager a cool $108 million. He will receive this bonanza even though an index fund might have returned 15% to investors in the same period and charged them only a token fee.

The inexorable math of this grotesque arrangement is certain to make the Gotrocks family poorer over time than it would have been had it never heard of these “hyper-helpers.” Even so, the 2-and-20 action spreads. Its effects bring to mind the old adage: When someone with experience proposes a deal to someone with money, too often the fellow with money ends up with the experience, and the fellow with experience ends up with the money.

His comments are specific to the "outcome" on the state of trade today.  They are driven by his intimate understanding of “protection” derivatives (super-cat risk) which create “tradable” markets.  No big money has ever successfully "proven" a whole business securitization "sustainability" case built off of “emotion” - remember, self amortizing..

In trying to figure out financial reform you cannot take away the very financial “innovations” that have helped create social betterment.  Goldman Sachs sent one of their “quant’s” to explain “strategy” to the House this week.  When I tuned into CNBC my first thought was – why are they sending the “quant”?  It’s the “wrong” guy – he understood the “risk” and presented a “structure” to his decision makers.  Those are simple answers. – why are they making it complex for America?  The concepts of “chattel” paper and “securitization” are sound when they are long term instruments, say – 20-30 years – they can be structured to self amortize by shifting the relative components of “risk” – equity & credit – over time between the counter parties.  If you’re a public PR spinner, it is easy to say - these instruments were set-up to “self destruct” in the event of a debacle – and that type of reaction is not fair when we are trying to evolve the market from where we are today

Here’s a way to think about it:

“Great” franchise systems are a pathway to wealth creation and “social” betterment.  Success and failure of franchise brands are spoken over time.  To understand a successful franchise “model” we must look at how their franchise agreement has changed over the course, of say, least, three generations – assuming 10 year FA terms.  The changes in the contract will tell you a Franchisors strategy and an indirect “management” opinion on the business model.  “Changes” made to the FA are intended to balance the “equity”, as they are “promised”, on the trip down royalty road.  Assuming three generations is enough - what has the market said over the course of the past 5 years?  If you “find” people screaming, then a “great” franchise system will look to understand way they haven’t been helped before the screaming began...and someone else has to step in….

When “great” systems go to the market to structure a “securitization” – determining the balance of “franchisee” ownership is critical.  A system that is supported with a base of “wealthy” franchisee’s isn’t coming to the market for “seeding” purposes.  Most likely, the franchisees have their own strong network of financial relationships to tap.  Therefore, the “franchisor” might be shopping for equity “liberation”.  Nothing wrong with equity “liberation”.  So, how should this franchise be structured to achieve the franchisor's “liberation” goal?  I’d recommend self amortization serviced by a “franchisee” organization.  The “franchisee” organization must have 100% support to communicate with all franchisees.  This is easier said than done when the intention is “illusionary”.  This would be good discussion..

As “money” trades, finding system’s in their 3rd generation is not easy to build an emerging financial market upon which can “transparently” support the industry.  So, in the context of “growing” sectors of the industry, under “sound” financial practices, - would it be prudent to have a “financially” strong franchisee umbrella watchdog as a check-n-balance function for certain sectors of the industry to become savvier?  To pull this off today - Is there a fund of “philanthropy” willing to set up the infrastructure to guide the truly “invisible” which will evolve us towards a policy of “social” betterment for all?

Show me something “Built To Last” – not a family of “GotRocks” in a pool of “GotKnots”.

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Managing a Franchise Network