Advising clients who own fast-food franchises

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Brad Griswold’s Pennsylvania planning firm didn’t intend to specialize in serving franchise business owners, but when Griswold agreed to a strategic partnership with a local accounting firm some 15 years ago, the practice started moving in that direction.

The accounting firm had relationships with a number of McDonald’s franchisees. One client led to the next. Now Concannon Wealth Management works with McDonald’s franchisees in 11 states. This niche accounts for about 25% of the firm’s $425 million in assets under management.

Although franchisees face many of the same issues as other small business owners, some of their challenges are unique. Independent business owners, for instance, might decide to invest additional capital in their enterprises opportunistically — as they see the need and as profits and reserves allow. But when clients buy into a franchise, they must be willing and able to potentially spend hundreds of thousands of dollars on upgrades and equipment whenever the mother ship so dictates. Décor, training and corporate direction are also at least partly dictated by headquarters.

Franchise-operating clients also can’t simply change locations to cut rent, change the menu or decide that they’ll buy from different vendors. McDonald’s franchisees generally rent their stores from the corporation and suppliers must be preapproved. Changes to the menu are verboten.

Do clients want to leave their business to their children? Better chat with the corporate overlords before those documents are drawn up. Any transfer of majority ownership must be blessed by the corporation, too.

That isn’t a criticism of McDonald’s or any other franchise’s corporate operation, Griswold notes. The benefit and the challenge of a franchise are that customers know they will receive a consistent experience, no matter whether they’re popping into an outlet off a rural road in Indiana or if they’re visiting a location in the heart of a big city. To deliver that consistent experience, each franchise owner must assure the headquarters office that the food will taste the same and be delivered equally promptly and that the ambiance will meet the national standard. This demands standard equipment and restaurant configurations and plenty of training.

Indeed, before clients are even able to buy a franchise, McDonald’s headquarters will look closely at their economic wherewithal — the corporation is not interested in selling a franchise to someone who can’t afford to maintain it — and management will send them to Hamburger University to be schooled on the proper McDonald’s protocol. Once in, the operation is subject to inspection and sanction.

“Small business owners and franchise owners are similar in that a lot of their wealth in the early stages is concentrated in their business,” Griswold says. “But they’re dissimilar in that the franchise has another corporate entity involved. There is always another person sitting at the table.”

On some fronts, that’s an advantage. McDonald’s scale gives franchisees far more purchasing power, and the consistent experience makes it a safe choice for customers. Thus, where starting an ordinary business is a gamble, the training, seasoned business formula and marketing heft improve the chance that clients will succeed with a McDonald’s franchise, he says.

“I would argue that McDonald’s franchisees have less [income] volatility because of the brand and the consistency of the brand,” he says. “But when costs go up, you can’t just adjust by making your hamburger patties smaller.”

Indeed, if McDonald’s decides to offer salads and all-day breakfasts or to refresh the restaurant’s look, franchisees are expected to potentially pour hundreds of thousands of dollars into new equipment, furniture and upgrades. Since many of Griswold’s clients own multiple stores, one business owner may need to come up with $500,000 to $1 million on relatively short notice.

Additionally, Griswold says, most of his clients are looking to add locations to benefit from economies of scale — one can share managers among 20 stores just as easily as one can with five, he explains. Since buying each franchise can cost $1 million to $2 million, expansion and reinvestment demands suggest that franchise-owners maintain far more personal liquidity than the average client.

“When our clients see an opportunity to expand their footprint, we want them to be in a financial position to act on it,” he says.

“I would argue that McDonald’s franchisees have less [income] volatility because of the brand and the consistency of the brand.” — Brad Griswold, managing partner of Concannon Wealth Management.

However, the right solution isn’t always a pile of cash. In today’s low-rate environment, safe short-term investments pay practically nothing. Griswold says he currently addresses most of his client’s short-term cash needs with bond ladders, favoring municipal bonds for higher-income franchise owners, and corporate bonds for the newcomers, who have yet to hit the top state and federal tax brackets. However, he admits that returns are nothing to brag about, ranging from 1.5% to 2%, after tax.

As long as the cash flow from the business is sufficient to support it, Griswold advises experienced business owners to eschew big cash hordes in favor of borrowing for expansion and reinvestment. After all, low rate environments cut both ways, making lenders eager to finance franchise businesses at preferential rates.

He also counsels his franchise-owning clients to think early and often about their estate planning needs. That’s because it may not be possible to simply bequeath the businesses to kids. Although McDonald’s allows franchisees to transfer a portion of their ownership to whomever they choose, they cannot transfer a majority interest without a corporate blessing.

Moreover, many business owners need capital from the business to survive in retirement. Since a franchise owner also must pay royalties to McDonald’s each year, adding another cash demand can jeopardize the ongoing business. In some cases, it’s smarter to sell one or two locations to give the family sufficient cash to survive retirement — or sell the whole operation outright and leave the kids cash rather than an ongoing restaurant. Either way, planning early allows both the family and the parent corporation to look at a larger number of options.

“Many of the owners want to pass their business on to members of their family, but it takes some time and some thought to do it properly,” Griswold says. “You’ve got to be sure that the parents have the liquid assets to afford retirement before they pass their spatulas on to the next generation.”

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