Franchise Investing: Considerations For Advisors

Kenny Rose is the founder and CEO of FranShares, an investment platform that makes it easy for anyone to invest in franchises.

Conventional wisdom says that market downturns are good times to invest in alternative assets such as franchises because such investments are divorced from public markets.

The footnote? Downturns can be good times to invest in franchises if you have the time and knowledge to manage a unit, or if you have enough capital to hire that out.

Luckily, the barriers of entry to franchise investing have changed significantly since the last recession. Passed in 2012, the JOBS Act allows nonaccredited investors to invest in private companies, including ones offering alternative asset classes. In March 2021, the SEC increased the yearly amount private companies can raise from the general public from $50 million to $75 million. It also increased the limit that companies can raise via Regulation CF from $1.07 million to $5 million.

These regulatory changes make it easier for nonaccredited clients to passively invest in franchises.

If the forecast recession takes place, it would be the first major one since the JOBS Act, and the first one where clients of all wealth levels have the ability to invest in this alternative investment. Below I’ll discuss some important franchise investing considerations for financial advisors looking to guide clients through turbulent times.

Franchises’ Structure Helps Them Weather Recessions

Franchises tend to be resilient during recessions because they generally fall in need-based industries. When the stock market drops, people still go to the gym or get their car washed. They’re more likely to dine at quick-service chains over fancy restaurants.

Franchises can also hedge against long-term inflation. Franchises can raise product or service prices accordingly when supply prices rise, thereby protecting profitability.

Another recession-era advantage of franchises is their independence from mainstream market influence. This helps investors to reduce portfolio volatility and shield themselves from fluctuations in the stock market. A well-diversified portfolio is essential to generating stable investment income, and franchises can provide diversification for the typical portfolio focused on stocks and bonds.

Finally, franchises have the potential to deliver consistent returns. Their business plans are based on data and metrics gathered from other successful locations, providing them with a proven road map to profitability.

Franchises Have Withstood Previous Recessions

In 2009, franchises generally outperformed other businesses. And between 2009 and 2011, a significant number of new brands began franchising.

Franchise growth metrics such as nominal dollar output, number of franchise locations and contribution to GDP experienced a decline during the brief Covid-19 recession in 2020. However, by 2021, all of these metrics had not only recovered but also surpassed the growth rates seen in 2019 before the pandemic.

There’s also anecdotal evidence from two successful investors who embraced franchises during a recession.

Warren Buffett has been a majority investor in Pilot Travel Centers (of Pilot Flying J truck stop fame), Dairy Queen, Benjamin Moore Paints and numerous home furnishing companies. His franchise investment strategy helped Berkshire Hathaway stay profitable during the early 1990s recession.

Shaquille O’Neal ventured into his first serious franchise investment during a recession. He bought his first Five Guys unit in 2008 and grew his ownership to 155 restaurants before divesting them. With investments in several other chains, O’Neal has created a franchise empire.

Establishing Client Fit For Franchise Investing

While most clients aren’t as capital-resourced as O’Neal and Buffett, wealthy investors have a large appetite for alternative assets. A KKR survey found that high net worth investors had 26% of their assets in alternative investments, and ultrahigh net worth investors held 50% in alternatives.

Demand for alternatives is growing among nonmillionaires, as well. A McKinsey survey found that the average retail investor had 2% of their assets in alternatives in 2020, and expected that to grow to 3%-5% in 2025. That may not sound like much, but it represents between $500 billion and $1.3 trillion in growth.

That said, some clients won’t be good candidates for franchise investing. If your client desires investments with high degrees of liquidity and short-term returns, they’ll run into some limitations.

Even owning a share of a franchise is a long-term investment. Shares will likely need to be held for five to seven years to ensure growth of the holdings. Fractionalized franchise assets are less liquid than crypto or a publicly traded stock but more liquid than a traditional alternative asset (real estate, for example).

As with any asset, there are risk factors to consider before investing in a franchise for the first time. Franchises may fall in essential and need-based industries that tend to perform well across market conditions, but they’re still susceptible to broader economic factors and external risks such as natural disasters or drastic shifts in consumer spending patterns.

Franchises can offer a level of involvement similar to a private equity fund, where investors are passive and have no control over the fund itself. For those seeking more passive participation, the semi-absentee franchise model involves hiring a location manager who is responsible for day-to-day business operations. The owners still maintain regular check-ins to ensure smooth functioning, address occasional issues and monitor key performance indicators.

Poor management or local market challenges at the franchisee level may impact the franchise’s performance. Before getting clients involved, it’s crucial to thoroughly evaluate the ROI, competitive advantages and management expertise of a potential franchise investment.

Clients will be looking for guidance in navigating inflation, rising interest rates and lower capital commitments. If a recession does materialize, it might be a good time to talk with clients about this alternative investment option that investors have used to survive past economic downturns.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Do I qualify?