Beano's Ice Cream Shop

By Todd A. Finkle

Adapted from an Entrepreneurship Theory & Practice Article

Terry Smith has spent the last six months preparing to purchase a Beano's Ice Cream franchise. Because his personal assets were limited, Smith needed a partner who could finance the purchase. After Smith found a prospective partner, Barney Harris, they negotiated a purchase price with Beano's. Then, Harris gave Smith a partnership proposal. As the case opens, Smith is evaluating the partnership proposal. His three choices are: to accept Harris's partnership proposal, to make a counter proposal, or to try to find a new partner.

Two months ago, Terry Smith had been so confident that he would soon own his own Beano's Ice Cream franchise, that he had put an "I LOVE BEANO'S ICE CREAM" bumper sticker on his Honda. As he looked at it now, he noticed how faded it had become in such a short time. He wondered if in fact it had been a short timeor a lifetime.

Until recently, Smith had rarely second-guessed himself. After carefully researching an issue, he would base his decision on the facts and then proceedwithout looking back. Now, however, he knew he had to put all of the momentum from the past six months to one side. He had to forget about the months spent investigating franchises, selecting Beano's, writing his business plan, and looking for financing. He had to forget about the fact that he had found only one prospective partner who could finance the dealBarney Harrisand that he and his partner had spent several more months negotiating to purchase the franchise. He had to push away his own emotional investment in the deal now and make one more critical decision: should he go into partnership with Harris? If he signed the partnership proposal that Barney Harris had given him, Smith would get his franchise. If he did not sign the agreement, he may or may not ever see his dream come to life. It depended on whether he decided to make a counter offer, to look for a new partner, or to walk away from the deal altogether. It was that simple: sign it and get all the marbles, or risk everything for the chance to get something better. Now, as Smith looked at his faded bumper sticker, he realized that he had to evaluate the proposal in the context of the whole franchise deal. The question was not just, "Is this a good partnership proposal?" The real question was, "Given the potential of this particular franchise, and given my financial and managerial needs, will this proposal help me reach my goals?"

SMITH'S BACKGROUND

In the fall of 1995, Terry Smith, a 36-year-old marketing representative for a Fortune 500 telecommunications firm in Cleveland, was among the thousands of employees who were downsized. At first, he investigated the possibility of working for other major corporations in Cleveland. His education (a B.S. in biology and an MBA) and experience made him very marketable. In a relatively short time, be received several job offers for about $60,000 per year.

And yet . . . Smith felt reluctant to jump back into a large corporation. He realized that as a new employee, he would be among the first to be cut, if his employer experienced a downturn. Did he want to go through that again?

Smith had had a positive experience as an entrepreneur during the years he was in college. He had started a successful mobile music company. While it had not made him a millionaire, it had paid for his education and living expenses. One day, he found himself captivated by an article in Entrepreneur magazine. It pointed out that the number of downsized executives who were turning to entrepreneurship had doubled over the past two years. Smith decided that he needed to explore his options as an entrepreneur. He knew the down sides of owning a business: the long hours, the stress, problems with employees, paperwork, and a lack of benefits. However, he felt that these could be outweighed by the opportunity to make all of the important decisions himself. After several months of research, he decided to seriously explore the purchase of an ice cream franchise in Gainesville, Florida, called Beano's Ice Cream Shoppe, which cost $275,000 (see Exhibits 1-3 for the estimated costs and financial statements for a Beano's franchise). Smith had a net worth of $50,000 and a liquidity of $20,000, which meant that he had to obtain financing.

Exhibit 1

Investment Breakdown of a Beano's Ice Cream Shoppe Franchise

Expenditure Dollars

Franchise Fee $ 30,000

Design & Architecture Fees $ 15,000

Real Estate & Improvements $ 80,000

Professional Fees $ 2,000

Equipment $ 40,000

Signage & Graphics $ 15,000

Miscellaneous Opening Costs $ 7,000

Initial Inventory $ 11,000

Working Capital $ 75,000

Total: $275,000

The Beanos Company

The company used the finest, high-quality, all natural ingredients. They have differentiated

themselves from the competition with: (1) superior ingredients, (2) new product development, (3) new market development, and (4) environmentally conscious behavior. These strategies have allowed Beano's several competitive advantages over the competition in the frozen dessert industry. Beano's has held the number three market position in sales within the U.S.'s super-premium ice cream market for the past few years behind Haagen-Dazs and Ben and Jerry's.

The company had few franchise failures, with only five percent of its franchises having failed. The average franchise had $350,000 in sales a year. However, in more successful markets, average sales were closer to $500,000. The company's franchise agreements were generally for a ten-year term with an option for renewal. The agreements grant the franchisee an exclusive area to sell bulk ice cream and frozen yogurt, which the franchisee is required to purchase directly from the company. Beano's provided the following to its franchisees: (1) a seven-day training seminar, (2) on-going operational support, which included access to a territory franchise consultant, (3) phone support, and (4) help with real estate and site selection. An input committee, comprised of five of the most successful franchisees, was developed to assist existing franchisees. There was also an annual franchisees' meeting, which included workshops. Finally, Beano's sent field consultants to visit each franchise four times a year.

LOCAL ENVIRONMENT

Gainesville is located in north-central Florida. The city was ranked as Money Magazine's "Best Place to Live" in the U.S. for 1995. Employment growth in the 1990s had averaged 6.2 percent, which was nearly double the national average. Gainesville had a low cost of living compared to other cities of similar size in the U.S. In the past three years, Florida's economy has surpassed the national average. Florida was also one of nine states without a state income tax. Some of the statistics of Gainesville can be seen in Exhibit 4. Prior marketing research efforts in Gainesville showed wide acceptance for Beano's products. Beano's had two promotional events in Gainesville, where ice cream was given to consumers. The feedback about the quality of the products was very positive, and the company had experienced success at selling products in local supermarkets. Additionally, research showed that franchises located in college towns had sales averages that were surpassed only by resort areas. This made Gainesville very appealing, because the largest university in the South was located there. The University of Florida had an enrollment of 38,000 students and employed 15,500 people. Other institutions of higher education in Gainesville had a total enrollment of 20,000 students.

EXHIBIT 4: Statistics for Gainesville, Florida

Gainesville population (excluding students): 91,000

Area Population (Alachua County): 191,000

Total Labor Force: 114,346

Cost of a Three Bedroom House: $82,000

Property Tax: $1,618

Retail Sales Tax (excluding food and medicine): 6%

State Personal Income Tax: 0%

Franchise and Inventory Tax: 0%

Unemployment 2.8%

Robberies/100,000 301

Annual Sunny Days: 242

Mean Temperature (degrees F): 70.1

Average Sunshine/Day (hrs): 7.8

Annual Rainfall (inches): 49.9

Percent of population over 65: 9.3%

LOCAL COMPETITION

Fifteen local dipping store competitors are listed below, which includes information about each store's age, number of employees, and estimated sales. It should be noted that of these fifteen, three stores have sales of $500 thousand to one million. In addition to these dipping stores, the local market also included supermarkets, convenience stores, restaurants, and an ice cream truck that parked near campus. Of these sources, three were seasonal. The ice cream truck, the campus food court, and a campus Freshen's Yogurt all operated only during the school year.

Four features were missing from the local competition. First, there were no national competitors of superpremium desserts in Gainesville. Second, no competitor had a place for customers to sit outside. Third, no competitor had a policy of "giving back to the community." Fourth, there were no Haagen-Dazs stores. This was significant because Haagen-Dazs had been one of the first and strongest competitors, with sales peaking at $560 thousand at one location. A decline in sales prompted their withdrawal from the market.

SMITH'S GOALS AND FINANCIAL OBJECTIVES

Smith saw an opportunity to obtain a franchise that had brand-name recognition and a history of success. Florida already had four Beano's franchises in Miami, Fort Lauderdale, Jacksonville, and Orlando. Smith's goals were:

* Phase I: Open one franchise in the Gainesville area in the fall of 1996;

* Phase II: Open a second store in Tallahassee in early 1998;

* Phase III: Open a third, fourth, and fifth store in consecutive years in Orlando (1999-2001).

The financial objectives were:

Objective 1: Pay off any loans to each store by the sixth year.

Objective 2: Maintain an average return on investment of 20 percent for each store.

Objective 3: Maintain a positive cash flow starting in year one for each store.

Objective 4: Have sales of 2.5 million at the end of ten years.

THE SEARCH FOR INVESTORS

Because Smith had already founded one company, he knew how difficult raising capital could be. He developed a list of people to talk with, and then proceeded as follows:

SBA Consultant

The Small Business Administration (SBA) consultant, Tom Hughes, was impressed with Smith's education, work experience, and business plan. He stated that Smith would have no problem getting a loan of $175,000 as long as he had one-third of the loan amount in liquid assets. For example, if Smith wanted a loan of $175,000, he would need approximately $58,000 in liquid assets. However, Smith's liquidity had dropped to $7,000 over the past few months, due to living expenses. Consequently, he needed an investor(s). Mr. Hughes also asserted that if Smith got an investor who owned 20 percent or more of the company, the SBA required that person to sign on the note. Smith realized that this could pose a problem because the investor(s) would be at risk for the entire investment of $275,000 if they put up $100,000. That could decrease their desire to invest in the venture. Mr. Hughes also explained that Smith could not receive an SBA loan in the state of Ohio. He would have to go through an SBA branch office located in Florida.

Banker

Smith's banker was Mike Tork. Tork was also impressed with Smith's credentials and affirmed that he should not have a problem getting an SBA loan for $175,000 if he got an investor(s) to put in $100,000. Tork stated the bank preferred to see the following before granting a loan: (1) quality management team, (2) likelihood of success, and (3) financial projections. Tork also stated that obtaining a loan would be easier due to Beano's successful track record. The bank required Smith to submit his business plan, tax returns for the past three years, and a current copy of his personal financial statement.

SCORE Counselor

Smith's last meeting was with the local Service Corps of Retired Executives (SCORE) counselor, George Willis. Willis had worked for Dupont for 30 years and had consulted with franchisees in the frozen dessert industry. Willis told Smith to obtain two partners with an equity interest of 20% or less because having one partner with a 33% or 40% interest would put you at his or her mercy if, for instance, the partner decided not to do the deal or if something happened to the partner. Also, that partner would have too much control because s/he has the money. If you have two partners, you would have more control. If one partner drops out, then you could get another.

Family, Friends and Savings

Remembering his days in graduate school, Smith sought out the number one source of financing for most start-ups: friends, family, and savings. He failed at finding resources there.

Business Professionals

Smith's next step was networking through his database of professionals in Cleveland. The first person he contacted was an acquaintance, Barney Harris, whom he had met a year earlier. Harris was a very successful restaurateur. Smith called Harris to arrange a meeting. Harris agreed, but wanted a copy of the business plan a week in advance. Smith dropped off a copy of the plan and a confidentiality agreement contract the next day. A week later, Smith and Harris met. Harris stated, "You know, Terry, most of the people who come to see me with business deals just talk. They do not have a business plan, and they expect me to invest hundreds of thousands of dollars with them. Your business plan is excellent. I like how you examined the business from broad and narrow perspectives. This is exactly what I like to see." Harris stated that he knew Smith had what it takes to become successful"a fire in the belly." Harris told Smith that he was interested in becoming a potential partner, not an investor, and would be willing to put up $100,000. After four months of hard work. Smith was excited at the opportunity of obtaining a partner. In his excitement, Smith stated that he was willing to give up 33% of the company in exchange for an investment of $100,000. No further business professionals were contacted.

BEANO'S SELECTION PROCESS

The selection process at Beano's required the potential franchisee(s) to send in an application form, psychological questionnaire, and personal financial statement. The next step was a phone interview that lasted one hour. After this stage, there was an interview at the company's corporate headquarters. This process lasted about six weeks. After Smith and Harris passed, they received a letter with a password that allowed them to contact any franchisee. Beano's also sent them a copy of their Uniform Franchise Offering Circular (UFOC), a legal document containing information on the company's history, management, finances, operations, and franchisees.

Smith took advantage of this opportunity. He contacted ten franchises and learned about sales, profitability, employees, and horror stories of partnership agreements. One of the franchisees, was kind enough to send Smith a copy of his financial statements. After examining the differences between the franchisee's numbers and his projected proformas, Smith made some changes (see Exhibit 8 for revised expected scenario). One of the most significant changes that Smith noticed was the cost of the franchise. Earlier, Smith estimated the cost of a franchise at $275,000. After talking with franchisees in college towns, he estimated the cost of starting a franchise in Gainesville at $220,000, including working capital. Smith also noticed that he initially overestimated the profitability of the business. In his original financial statements, Smith estimated the expected net income of the business at: $34,400, $91,800, $116,800, $135,700, and $138,300 for the years 1997-2001. He revised his figures to be: $29,000, $49,000, $67,600, $87,100, and $87,800. There was a significant difference, primarily due to his failure to include employee wages in the financial statements. This was a gross oversight. Smith realized that he needed to get the partnership agreement out of the way as soon as possible. Beano's had given Smith and Harris the green light. Now it was time for them to produce a partnership agreement and move forward with the construction of the franchise.

HARRIS'S PARTNERSHIP PROPOSAL

Smith went to Harris and told him that it was time for them to draw up a partnership agreement. They had previously talked about a partnership proposal where Harris's percentage of the business would be 33% for an investment of $100,000. Smith offered to write up the proposal. However, Harris insisted that he would write up the initial proposal. Two weeks later, Smith received it (see Exhibit 9). Smith found three surprises in this proposal. First, Harris changed the structure of the deal. Second, Harris charged him for accounting services, when Smith could do the book work himself. Third, the buy-out clause proposed three times the cash flow of the business, averaged over the number of years they were in business, divided by the ownership percentage. Cash flow was not defined. Smith was stunned. Quickly, he sketched the proposal that he had expected to receive, so that he could compare them side by side (see Exhibit 10).

CONCLUSIONS

Terry Smith winced as he turned away from his "I LOVE BEANO'S ICE CREAM" bumper sticker. He knew he had three choices: take what Harris had offered in the proposal, even though it was not the proposal Smith had expected; give Harris a counter proposal that included the three changes Smith wanted, knowing that there was a chance that Harris would back away from the deal altogether; or, start looking for a new partner. Smith started to walk across the parking lot, knowing it was time to make his next move.

Questions!!!!:

Directions for Harris

Question 1 - Why does Harris's deal seem fair (from his perspective)? Question 2 - Do you think this is a wise investment for Harris? What do you think about the earnings your partner, Smith, will make by working in the business (and through dividends)? Is it appropriate? Why or why not? Question 3 - Do you think Harris should form a partnership with Smith? Why or why not?