One of the first questions (if not objections) about investing in a franchise focuses on the franchisor’s fees. “Why do they have to charge such a large upfront fee? And on top of it, every month they take a chunk of the franchisee’s revenues. Do you have to be a millionaire to become a franchisee?”
The easiest question to answer is the last one. No, you don’t have to be a millionaire to become a franchisee. Depending on the industry, new franchisees are typically not already millionaires.
As for the broader question, here’s how one American franchise expert would answer that:
“Franchisors are not non-profit charities. They charge fees because they have to pay employees to provide services to their franchisees. Anyone who doesn’t understand and appreciate that, shouldn’t be a franchisee.” So said Red Boswell, president of International Franchise Professionals Group.
It’s an accurate but curt answer, so let’s take a deeper dive into the topic to find out why franchisors need their fees.
Ken D’Angelo was a successful real estate broker in Dallas, Texas in the 1980s. He was neither a franchisor nor a franchisee and hadn’t given any thought to franchising. Through an unusual set of circumstances, he decided to buy an elderly lady’s house, refurbish it and sell it. Usually, he would have traditionally listed the house, facilitated a sale, and earned a commission, but this house was offensive. It needed too many repairs to be listed and, as D’Angelo said privately, “It was the ugliest house in the neighborhood.” He would be embarrassed to list it!
However, he felt sorry for the lady because she needed to get her money out of the property and after she attempted numerous times to get him, and others, to represent her, he asked how much money she wanted for the house? She gave him a number and he agreed to pay it. He then spent several weeks supervising contractors to repair holes in the roof, replace windows, paint the house inside and out, install new carpet, update the appliances, spruce up the landscaping and then, after investing about $10,000, he listed the house for sale. Asking price: It was the highest price for any house in the neighborhood. He transformed that property from the ugliest house to the prettiest house. And the house sold almost immediately.
D’Angelo was ecstatic because he enjoyed the entire process, but he was never certain it was going to work out financially. He loved seeing the contentment in the seller’s face when he agreed to buy her problem property. He enjoyed hiring contractors despite some false starts because contractors are not noted for reliability and dependability. He loved the compliments from neighbors, who visited the house once it was on the market and marveled about how beautiful it looked after years of decline. Ultimately – and this really grabbed his attention – he loved the money he earned on this single transaction. It was better money than a traditional commission. He wondered, “Could I do this again? And again?”
“I enjoyed my life as a real estate broker,” D’Angelo said, “but it was a business of ups and downs. One of the downs was dealing with the Realtors. They wore me out. And even though I collected commissions on their sales I put up with a lot of drama and at the end of the day it wasn’t enough money to make me feel satisfied. But transforming an ugly house into a beautiful house, and then reaping the rewards of selling that house, including the compliments and the financial earnings – that was exciting. There were other real estate investors doing the same thing at the time in Dallas and I decided to become one of them.”
Of course, he had a lot to learn. There’s no secret recipe to real estate investing, but lead flow helps determine success. There were other problem houses that couldn’t find buyers, or they weren’t selling fast enough, or the seller couldn’t find a buyer who’d pay a reasonable price, or a buyer who could actually close on the sale (real estate investors are not known for reliability). Finding the houses to buy was the challenge.
At the time, the local newspaper included many ads from real estate investors and D’Angelo was soon among them, but that was problematic. There were too many investors; some of them unscrupulous, and D’Angelo wanted to set himself apart. Anyone could buy an ad in the newspaper. D’Angelo thought about how to differentiate himself so that more sellers would notice him faster.
No real estate investor used huge highway billboards to solicit leads. Many of them tacked illegal signage on telephone polls and stuck them in the grass along the highway, also illegal, but no one used billboards because they were expensive. And they were not considered a direct marketing medium. Billboards didn’t include phone numbers. Until D’Angelo. Against the advice of his family who feared he would lose his money, he ordered a couple dozen billboards with the message: We Buy Houses. 800-44-BUYER.
Later, realizing that message wasn’t specific enough (it generated too many leads), he changed the message to: We Buy Ugly Houses. 800-44-BUYER. At first, the billboard company refused the revised message. They said it was offensive. They were not going to be party to insulting consumers by telling them they had ugly houses! But D’Angelo insisted and at the risk of losing his business, the billboard company posted the message. Thus began one of the most profitable marketing campaigns in American history!
The phone never stopped ringing. It hasn’t to this day for the HomeVestors of America franchise network. In a matter of years, that billboard message would generate 250,000 leads a year for the benefit of the franchisees who would join D’Angelo’s network, a network that he never envisioned building.
In the 1990s, D’Angelo was buying 100 houses a year and people wanted to know how he did it. He didn’t mind showing them. It wasn’t just the billboards. He had created rudimentary systems for presenting himself to sellers, for quickly evaluating a house to know how much to pay for it, for working with contractors so they didn’t get the best of him, for dealing with banks and insurance companies, and ultimately for listing the houses.
“Could you teach me how to do it?” people frequently asked him. That’s when he decided he’d franchise the business. And suddenly he needed more money. He hired a franchise consultant who led him to a franchise attorney and in a matter of months he had invested nearly $100,000. This was in addition to money he had already invested to build his marketing, sales and operating systems – that intellectual capital came at a price, and he was now about to share it with franchisees. Fair question: What was that intellectual capital worth?
For years D’Angelo reinvested his money to build systems that solved problems and created credibility for real estate investors. He deprived himself of money to make sure he had enough to build his business. Another fair question: What was that sacrifice worth?
As a franchisor, D’Angelo quickly realized that his investment was never going to be a once and done proposition. It cost him money every time he attracted a franchisee, who he would then be responsible to train and support for the lifetime of their relationship. As every good franchisor should do, he took that very seriously. “The scariest thing,” he said, “was knowing that someone might invest their life savings, or risk their house, to become part of my network and their success would be up to me, at least initially.” Another fair question: What was that obligation worth?
When I met D’Angelo in 2000, he had sold 50 franchises at $25,000 each and he was losing money. Despite that, he was one of the happiest men I knew. He loved helping franchisees. He was earning less than $150,000 annually and he asked me if I thought that was too much! He could have paid himself more, but he was selling two franchises a month and he needed the money to cover his home office expenses plus pay commissions to salespeople and, most importantly, cover the costs of training franchisees. His training was a weeklong and costly because real estate transactions are governed by federal and state laws and his training team included two days of legal training by an expensive attorney.
With 50 franchisees and growing, D’Angelo also had to provide daily support and that was costly. Initially, he did it all himself. He spent hours every day of the week speaking to his franchisees, but eventually he had to hire professional staff. He also bought all the billboards for every franchise territory, because no one else knew how to do it, but he couldn’t keep that up either. More staff. More expense. Needless to say, he was no longer buying 100 houses a year for himself. His personal real estate investment company was defunct. And what was that sacrifice worth?
He could easily have become a multi-millionaire as a sole practitioner and never franchised his business. Instead, he chose to help others through franchising. Again, what was that sacrifice worth?
The expenses never ended, and they never do for franchisors. Yes, the franchisor collects ongoing royalties, i.e. 5% to 15% of the franchisee’s revenue paid monthly to the franchisor, or, at HomeVestors, $665 every time the franchisee acquired a house, but that money was also absorbed by home office overhead now including travel to multiple franchise locations to provide support, then bringing together regional meetings and conventions and covering the costs of those events. In 2008, the last time I orchestrated a HomeVestors’ convention, it cost nearly $500,000.
In D’Angelo’s mind, all the expenses, and the weight of the responsibility, was worth it because he created mostly satisfied franchisees – including multi-millionaire franchisees. And, of course, if all went well, HomeVestors would provide millions for him and his family. Knowing the story I just told you, could anyone even suggest that Ken D’Angelo didn’t need and deserve those franchise fees?
There are countless HomeVestors stories and each one explains why franchisors need franchise fees. Without fees, franchising ceases to exist.
Upon the untimely death of Ken D’Angelo, Dr. John P. Hayes, CFE, served as president, CEO and chairman of the Board of HomeVestors of America, Inc. from 2004 to 2009. He’s one of the few franchise professionals to have been a franchise supplier, a franchisee and a franchisor. For many years he owned a HomeVestors franchise. Today he is the director of the Titus Center for Franchising at Palm Beach Atlantic University in West Palm Beach, Florida.