The Only 4 Ways To Scale A Service Business (PICK ONE)

Mozy Nation. The other day I was approached by a service based brick and mortar business and they have a very profitable single location model. And they wanted to figure out a way or what path was going to be the best vehicle for them to make the most money. And so we had a really good conversation about this and I broke down the different paths they could take. And for them it was really valuable and they were very happy about it. And so what I wanted to do was break down this exact same process for you. So if you have a service based business or something where you have labor of some sort that, that you rent out at a profit to other people to provide value, then this video is for you. And if you want to figure out a way to package those services in a way that is, that is, that has a lot of enterprise value, that has a lot of cash flow while you're growing, then this video is for you. Okay, so I'm going to break down the only four ways that I know of that you can package your service and the labor and knowledge that you have into a profitable business. Now, some of these have pros in terms, they provide more cash flow, have higher margin or lower operational drag. Others provide more enterprise value, but a little bit more difficult to create. So I'm going to show you the pros and cons of each of them. I have businesses, I own businesses that have three in three of these four categories, right? So I feel like I can speak to these with a decent amount of knowledge and not with a bias towards one or the other. All right, so the first is a privately held chain. All right, so I'll put private chain, everyone. You know, keep your PG hats on. So a private chain is basically like, you have one location and then you open a second and a third. And the specific business I was talking to was a person who had a salon concept. So they had a concept around hair, and it was doing very well. And they were like, man, you know, we're thinking about opening more locations and we want to figure out the best way to do this or ultimately make money with this model. All right, so the first is just you open another location, another location, another location. You return, you retain all the ownership rights, you take all the risk, you front all the capital, you hire all the labor, you control the brand, but you own everything end to end. All right, so this is a privately held chain. All right, this is the first of the four vehicles that you can use to ultimately build your wealth. All right, at the end, I'll show you the pros and cons of each of them. The second, some of you may be familiar with, hopefully you've definitely frequented one of these businesses is a franchise. So Subway, McDonald's, you know, Jiffy Lube, all of these are franchises, right? They are, they are a single model that has been franchised out. People buy in, investors typically. So this is a different person here. An investor who's outside, who just wants to find a good return of capital will buy into a franchise model. And typically, because franchises have far lower failure rates than starting your own business. And so that's the advantage of this, is that in theory there's lower risk. Now I could talk about the actuality behind that, which is very different. I can also tell you about the tons and tons and tons of franchises don't actually make money. I think it's like 90% or 95% of franchises never get past 100 locations. Which candidly, if you're doing a franchise model, you need to get past 100 to make any real money. And you were like, how is that even possible? I'll break it down in a second. All right, so that is the second vehicle that you can use in a service based business to make a fortune. Now number three, number three is a licensing model. And I'll tell you some of the pros of this one. A licensing model. You might not be as familiar with the businesses that use licensing because depending on how they structure the license, you have to differentiate from what a franchise is. A franchise has three components. You have name, business systems and fee. All right? So if you have all three of those things and people are using your brand, your business systems and your fee, then you are franchise. And if you're operating as a license and you're using those three components, then you are an illegal franchise. All right? Then you can get, you can get fined and you can shut down and all that kind of stuff. It's a pain in the butt. I'll talk about the pros and cons of licensing in a second. But that is the third vehicle. All right, so in a licensing vehicle, you're typically going to have two of those three things. So you could have, for example, CrossFit is a licensing, right? They give you the name and they have a fee, but they don't have business systems. A different version would be, let's say you had a model that worked really well, you license all the stuff, but it's white labeled. All right? So you have a fee and you have business systems, but you don't have a name or a brand that they have to adhere to. All right, that would be a licensing model. So there's different versions of this, but that is essentially what a third way that you could package your existing knowledge or IP in a way that scales to multiple locations and ultimately make an enterprise that is very valuable. The fourth, and it's felt worth mentioning is software. And, and I, and I bring this up because it depends on the type of service you offer. Now if you're cutting hair, you probably can't replace it with software, right? But if you are providing some sort of service that software can do, then this would be software slash, tech enabled service. All right, hopefully you can read that Tech enabled service. All right, so I'd say number four is either of those. For most people who have a service based business, it will probably be 1 through 3. And the reason I bring that up is because if you're not already really good at software and have a software co founder who knows how to code, knows user experience, knows how to build engineering teams, if you don't have someone like that, do not try and outsource it to a third party team. I promise you it will probably not work. All right, now you, I promise you it won't work. All right, just please, just 2 million, $3 million of development later. I've made the mistakes. Let me give you a $3 million gift. Don't do it. I told you that I have three of these, four. And so let's go through the advantages or disadvantages that I walk through with this particular business. All right, so a private chain is going to have the highest costs of opening each location. So there's incremental costs. Every new location, you have to do the build out, you have to negotiate, you have to find the location, you have to negotiate the leases, you have to build everything out and then you have the risk of the lease for the duration of the time. On top of that, you have to staff it, you control the employees, etc. Now when is a private chain something that is worthwhile? So I would say I'm looking at two main things where a private chain would be worth considering. First is that they have low costs of build out, right? So if it doesn't cost a lot of money to build a new location. So let's say if it costs less than, you know, 40 or $50,000 to build a location, now that's an absolute number. But relative to the income that it generates, let's say it generates 400,000 a year in profit. If it cost you, I should probably Put a percentage on this. But I would say if it costs you less than six months worth of profit in the first year to open a location, then it would make sense to open a private chain. So a great example of this would be insomnia cookies. All right, they have these tiny little locations. They just had, I think they were like 800 square feet on average. They're tiny. They just have to put an oven in there and a front window and they have lots of delivery. And for them they had tons of margin because it was cookies. They were selling flour and sugar for big margins. And the amount that a location could make was tremendous compared to the cost. All right? And so here it's very low to build, very high profit. And so it's worth owning the entire thing. All right, That's a private chain. So some of the biggest brands in the world start as private chains and then they go direct to consumer. So Chanel, Louis Vuitton, Christian Dior, you know what I mean? All of these are brands that had brick and mortar locations. They owned everything because the amount to build out a store compared to the amount of profit that it made was almost nothing. Now that is a product business, not a service business. But I'm still at least explaining the point. The third piece is that it's low service requirements. So the more specialized you are in terms of the types of skills that are required to do the business or provide the value, the more difficult it is to scale in a private setting. And that is because it is inconsistency of service will be a problem. So if you're very good at your thing and you have your location and it works well, if you are required to make that level of value provided to the end consumer, that it's not going to be a scalable model, alright? The reason that Subway for example, works is because anybody can make a sandwich that tastes the same way if you use the same recipes and use the same process. Right? Now if you can productize your service in such a way that you minimize the variability and you can decrease the skill requirements of the labor that is required to work that system, then you have a very scalable model, which is the goal. So private chain. So for example, for us, just as a side note, we have one of our businesses that is a private chain and they were actually, they were in a licensing model, right? And when they came in as acquisition.com portfolio company, I actually moved them over here because candidly, their licensees were making so much money using their system and it cost so little to Open new locations that I was like, we should just be owning all this revenue. It's not worth just giving all the revenue away and giving all the trade secrets, right? And so we transitioned the business over and in the last 14 months took it from a half a million dollar a year business to, to a twelve million dollar a year business. Pretty cool, right? So that is number one. The second is franchise, right? So pros and cons of franchises. Cons, very, very litigious, very expensive to start. Usually cost about $750,000 to start a franchise. Just in terms of the setup fees and legal and filings and all that kind of stuff that you have to do in order. And that's just, if that's just to get started, that's not even to get it going and to really build a franchise the right way. Most times it takes one to two years to really start seeing profits because you'll sell locations, but the cost of selling franchisees, that franchise upfront fee will typically only cover the cost of acquisition. So what it costs you to get franchise leads from franchise brokers or people who want to buy investments, it'll usually cost you almost the entire upfront fee, which is usually about 50 grand for many franchises. And so you're only going to make money once they open off of royalties from top line. So it's a very slow model. But the enterprise value of a franchise is extremely high. So enterprise value, the EV on both of these is very good. All right? For private chain and franchise, both of them are very good. But the franchise multiple only comes off of the corporate franchise revenue because technically you're selling LLCs to other people. So other people are the owners of the vast majority of the profit of the business, right? So you're only making your money off of the royalties that are coming in. And then you still have all of your costs of running your actual franchise, helping the franchisees succeed, et cetera. Now, when you would start a franchise would be something where you have very, very high buildup costs, right? If a new location costs a ton of money, like McDonald's, right? Costs whatever, a million bucks to open a McDonald's. That's a lot of capital, right? And so you would want to give, you want to give that risk, that capital risk to other people, you basically crowdsource, for lack of a better term, the ownership of these new locations and then you take a piece off the top. Now, McDonald's obviously owns the real estate too, because they're very smart cookies. That is the franchise model in a nutshell. Right. You're running on a very small percentage of top line and you have to have lots and lots of locations. And if you guys want a rule of thumb, you usually need to have 100 plus locations for a franchise really, to make sense. And here's a fun fact for you, 90 to 95% of franchises don't hit over 100 locations. All right? So as much as people have service based business and think that the ultimate goal is to build a franchise so that someday they could franchise their business, the franchise is not the end goal. It is the beginning of the next journey. All right? You have not yet succeeded. You might impress your parents and your friends, but you will not impress your bank accounts or the players in the game who really understand how it works. All right, so number one, private chain, number two, franchise opportunity, number three, licensing. All right, the advantage here is that it's the lowest cost, so almost no cost to license out a model. Typically you have super high margins, just like franchising does. The margins are high in franchising, it just costs a lot to start. So high margins. Now the problems with this is that it's not that defensible, it's very hard to defend and there's very little enterprise value. So very low multiples when you sell, unless you have a ridiculously sticky licensing agreement. Alright, so for you, for an idea, if anyone's curious, you would want to have 80% plus yearly retention on licensees for you to get a real really attractive exit multiple. Right? So we're talking, you know, six plus multiple on the exit. All right? And so now the advantage of licensing is that it doesn't cost you any money. It's very high cash flow throughout the process and you can pretty much make money day one. Right? And so when you're newer, sometimes licensing makes the most sense. Right? So gym launch, that business is a licensing business, right? And it was my first business. I didn't have tons of money, you know, to get it going and I wanted to start generating cash flow sooner. And so that was why I did that. The business that we have, I won't, I won't share what it is because we try not to get people to copy what we're doing. But in, in one of our niches, like I said earlier, we went from having a licensing model to owning a ton of locations. Right now we have 12 locations and we open a new location every month. It's pretty cool. Number four, software. So if you have a way, and this requires a ton of cost to build, lots of time Very low cash flow. You're like, why would I do software? It's because the enterprise value on the exit is usually the highest. But again, everyone likes to hear that, oh, I heard you can exit software for a ton. Yeah. But the same requirement of churn is still 80% or higher yearly retention. Right. And the higher you make that retention, it's got to be above 80% or no one's even going to consider you a software. They're just going to consider you a normal service that just has some tech element to it. All right. And so each of these has pros and cons. And so if you're thinking about scaling your service based business, I think of which of these four buckets do you fit in and which of these strategies makes the most sense for you? All right, and so this is how I look at service based businesses. If I'm going to come in as an investor and I want to help them scale or triple or 5x in a five year period, I'm going to say which of these vehicles is going to make most sense for the IP and the value that we are providing based on the model that exists, the cash flow that I require, the amount of upfront investment, the time to go and, and a lot of times just the appetite risk of the entrepreneur and how structurally sound the return is on the model. So if we know beyond a shadow of a doubt that when we enter a market we're freaking murder it and it costs us not a lot of money to open it, then we're going to own the whole thing privately now, same thing. If we know we're going to kill it, but it costs a million bucks to open a location, then we might franchise. Right. And if it costs no money, right. And we don't think that it's a really protectable ip. Right. Let's say it's a more offer based business like Jim Launch for example in the beginning was very offer driven business. Business offers very easy to copy. Right. And so how quickly can we take as much market share as we possibly can? So for licensing it's speed, right? You can absolutely outpace anyone else in the market on speed and you make lots of cash flow, but you're going to sacrifice a lot of money on the exit. Right. And so with licensing you make money throughout the process rather than having a big lump at the end. And probably the exact opposite of that would be like a software type thing. So if you take the time, develop the software, you put the cash up front to develop it, you figure out a way to do it and then ultimately figure out a way to make it as valuable as you have to achieve this 80% or higher yearly retention on the customers that you are selling, or it will not be valuable at all and it will be valued like the other ones, except you just wasted a bunch of money and time. So I hope this provided value for you. If you're thinking about how to ultimately create your enterprise in a way that has the most value, then I would think through each of these four different vehicles as monetization structures for the opportunity. All right, so lots of Mozi Nation. If you don't know who I am, my name's Alex Ramosi. I own acquisition.com, i'm portfolio is about $85 million a year in revenue. So if you like this, hit, subscribe. And if you didn't, I love you. Either way, I'll catch you guys in the next video. Bye.