Why Franchises don’t work in fitness

A little over 3 years ago, I was the CFO of a large Fitness Franchise based in Las Vegas. They sold over 90 licenses and had 19 active locations. These studios weren't just cookie-cutter, automated businesses, they were very complex institutions that needed refined systems to be successful. Needless to say, the complexity hindered them and they stalled out in their growth.

This isn't unique to that Franchise, Xponential Brands (largest fitness franchise in the US) is being investigated by the US Attorney's office, F45 is involved in numerous franchise lawsuits and there are many more examples. 

Here is a typical lifecycle of fitness franchises:

As TLS eyes a scaling growth strategy, I thought it would be prudent to analyze why we chose to avoid a franchise model and focus on an owner operated joint venture (JV) approach.

1. The Anatomy of a Healthy Franchise

In most franchise models, there are three main ways a franchisor makes money:

1. Franchise Fees - Initial fees that franchisees have to pay to secure a given region, get access to proprietary operational data, and to utilize the brand

2. % of Revenue - Franchisors typically take about 7-12% of revenue; a portion of that is typically said to be for 'marketing' - we will get to that in a second.

3. Distribution - Constant sales of distributed items, usually consumables. For example, Subway makes a markup off the bread, ingredients, cups, napkins, etc.

2. The Problem with this Model

The last two components work for most industries, but they hit major roadblocks in fitness:

• % of Revenue - Unlike other industries, margins in fitness are typically very thin. If you have a 15% margin, you are well above the industry average of 10%. So if franchisees charge 8% of revenue, they are eating up 50% of the profit, leaving very little left to reinvest into growth.

• Distribution - There are no consumables in fitness. Equipment is usually a one time purchase. Everything else, like apparel, is so low turnover that there is no money in this major component. 

Bottom line, two of the three major pillars of a franchise model are broken in the fitness industry because of the nature of the industry. But it gets worse, the structure of the Franchise Model protects the Franchisor but exposes the Franchisee every step of the way.

3. The Franchise Trap

I didn't know this until I got involved representing a Franchisor that there are a series of 'steps' that are each (in my opinion) designed to slowly get the investor (Franchisee) more pot committed until it is too late for them to back out when they realize they are in over their head. You can see by these calculated steps it is like a boa constrictor around the franchise.

1. NDA - This basically restricts you from taking marketing materials and starting your own business. There is really nothing material provided during this stage other than generic performance figures by the best performing studios as well as projections that never seem to be realistic.

2. Franchise Agreement - Signing this document locks you into paying initiation fees as well as an extremely tight non-compete agreement. The boa constrictor is now locked on.

3. Fees Paid - Initiation fees typically range from $50-250k and go right into the pockets of the Franchisor. The investor is now pot committed

4. Personal Guarantee - This is the most critical phase. Up until this point, the only loss were initiation fees (sunk cost). Here is where the boa squeezes an unmovable grip and people get in over their head. The key with this stage is the majority of leases require a personal guarantee to be placed before the Franchisee even gets the exact design/costs from the franchisor!

5. Design Provided - This is where the 'oh crap' feeling sets in

6. Financing - This is the 'in over your head' phase where loans are typically taken out and the death clock starts.

7. Over budget - Our contractor said that 90%+ of franchised projects come in over budget. Why? Because it is not their money. This usually eats into the Franchisee's marketing budget and they are left with no money to drive the business to profitability. The franchisee is dead in the water.

Before the doors even open, the franchisee has 1) initiation fees deposited, 2) personal guarantees signed, 3) a marketing budget wiped out, 4) a full time job to make the business work and 5) a Franchisor that has no risk, fees in their pocket and says 'not our problem'. 

One last part that is just evil: in most franchise agreements, it usually states that if the franchisee is underperforming, in an attempt to preserve their brand, the franchisor has the right to: take over the business, acquire a portion of the profits and even clawback ownership of it. So in the end, the money came from the Franchisee but the Franchisor commands control.

I have spoken to hundreds of Franchise owners where this has happened to them. Ruined credit and sometimes broke up families. Not fun.

4. TLS's Growth Strategy: The Joint Venture Model

Let's lighten things up a bit. TLS plans on growing through what's called a Joint Venture (JV) model. We believe this is where interests are more aligned: investors put up the capital, we take on the personal guarantee risk, implement the intellectual property, impose a pre-disclosed management fee to run the business, and then we all split the profits pro-rata. In the previous section, we essentially eliminated steps: 1, 2, 4, 6, 7.

Splitting profits (not revenue) is key. It means that our fiduciary obligation is to get the business into profitability so we can make distributions. We don't get paid until investors do. We are all on the same side of the table. With a revenue split, one group is prioritized first and gets paid even if the business is losing money.

Our JV model will restrict our growth, but it will focus all of us on creating good, stable businesses that can be grown in a sustainable manner. We will have more competitors enter into the scene and open a ton of studios via franchising. If we continue to align interests with investors and focus on profitable businesses, TLS will grow to become a national brand and help thousands of people improve their lives through personalized routines.