Franchising vs Taking VC Money: How to Finance Your F&B Business

The coronavirus pandemic, along with technological advances, has immensely affected the food and beverage sector, perhaps permanently transforming the way customers buy what they eat and drink. That being said, the overall F&B industry has always been resilient, because even with an ongoing crisis looming, people still have to eat. According to Indonesia’s Ministry of Industry, amid the Covid-19 pandemic, the F&B industry was able to record a growth of 2.95% in Q2-2021 and contribute 6.66% to the national GDP. 

While the country’s F&B sector experienced major slowdowns due to enforced lockdowns in both 2020 and 2021, the demand for good, affordable meals is now higher than ever. A handful of F&B businesses are still thriving, as evident with new brands that are popping up here and there and many existing ones too opening new outlets. One of the country’s largest F&B group CHAMP Resto Indonesia (IDX: ENAK) is also finalizing its debut on Indonesia’s stock exchange this month. 

With the rising demand and need for innovation, now is the perfect time for entrepreneurs to venture into the F&B sector. But if you are starting your F&B business, you might be wondering - what is the best way to scale my startup into a full-fledged food empire? In this article, we are looking at two of the most popular growth strategies in Indonesia’s F&B sector. 

The Franchising Model

One of the more common routes to scale up a business is to exercise a franchising model. This business model is not really a new concept; In fact, franchising is an ancient distribution model in China, where the local titled landowners would grant rights to the peasants to hunt, hold markets, or conduct other lines of business within their domains. With the rights, came also rules, which include profit-sharing agreements, among others.  Modern-day franchising is believed to have started with Benjamin Franklin, who in 1731 entered into the first franchise agreement with Thomas Whitmarsh to provide printing services in Charlestown, South Carolina. In the early 1850s, Isaac M. Singer also relied on the franchising model to distribute his Singer sewing machines. However, it would be another century after Singer before franchising would become truly popular, thanks to Ray Kroc and his McDonalds hamburger stand, which today has become one of the biggest household names in the world. 

In a nutshell, the franchise model a contractual business model whereby an established brand, known as the 'franchisor,' allows an independent business owner, or ‘franchisee’, to use its branding, business model, and other intellectual property. In exchange, a franchisee will pay a franchising fee to a franchisor for the right to use a company’s brand and operations. A franchisee will also share a percentage of its sales or profits to the franchisor, also known as royalty fees, depending on their initial agreements. A franchise essentially serves as an individual branch of the franchise company.

Many of the biggest F&B businesses in the world earned billions of dollars in annual sales by utilizing the franchise model – the list includes:

Pros to Using a Franchise Model

Quicker Brand Expansion

With a franchise model, businesses can grow rapidly with lower risks as the franchise owner does not have to build each outlet and hire new employees themselves. Direct managing responsibilities become the franchisee’s obligation and allow the franchisor more freedom to focus on other things, such as making the most of their existing assets (e.g., your system, brand, and know-how) by developing a ‎system that can be easily replicated in other locations.‎

Growth without Sacrificing Control or Quality

The franchisor can maintain the consistency and quality of its franchises through wise and fair contract provisions. With the franchisor’s predetermined brand in mind, franchisees are limited from exploring, altering, or making additions to the company’s business model. There are also restrictions placed on where they can operate, what products they can sell, and the suppliers they can use because of the predetermined business model.

Stable Revenue Stream

Franchisors are entitled to steady franchise and royalty fees, notwithstanding the performance of each franchisee, even in tough economic times. 

Savings on Capital Expenditures and Operational Costs

Opening new outlets requires high capital expenditure and operational costs. With the franchising model, franchisors share this burden with their franchisees, allowing them to scale up their business with minimum costs. In addition, having multiple outlets enables them to have collective buying power when negotiating with suppliers and vendors. 

Cons to Using a Franchise Model

Decreased net receipts

When sales are doing well, franchisors will make less than fully owned businesses because they are only entitled to a fixed franchise fee and royalty fees, which are only a percentage of the unit revenue. McDonald’s, for example, made $93 billion in systemwide sales, but only booked $19 billion in 2020. 

Independence of franchisees

While contracts are in place to maintain the quality and standards of the franchise branches, franchisees are not the franchisor’s employees, and thus the franchisors do not have direct management control over them. With franchisees owing full control of their respective business’ outlets, franchisors have limited control of said outlets, making it harder for franchisors to oversee all outlets and ensure each operation is up to the business standards.

Differences in Company Cultures, Leadership Skills and Business How-Tos

As franchisors only have the right to regulate core quality standardizations, franchisees are allowed to determine the operational management of their branch. As such, different company cultures, leadership skills, and business how-tos may affect customer satisfaction, employee retention, and the overall sustainability of the branch. It may also affect the long-term relationship between the franchisors and the franchisees. 

VC Investments

Venture capital (VC) is a form of funding in which investors provide capital and business expertise to startup companies and small businesses that are believed to have exceptional growth potential. In recent years, they have become an essential force of innovation and a popular source of raising money, especially for newer companies which have limited operating history and lack access to more conventional debt instruments, such as bank loans. In return for taking on these high-risk investments, VC investors are entitled to equity and voting rights of these startups. That being said, venture capital investors expect something different and demand continuous innovation from its portfolio startups; they will not invest in a conventional restaurant food chain. 

While VC investing in the F&B sector is still a relatively nascent practice, we are seeing a spike in the number of F&B startups and F&B-focused VC firms all over the world. VC firms are investing in startups with tech-enabled products and services that aims to improve various stages of the food chain, from the creation of more innovative food and ingredients, the production and supply chain, food delivery, to the improvement of packaging and reduction of waste. Some of the more popular VC-backed F&B startups include:

In Indonesia, the most successful VC-backed startup in the F&B sector today is Kopi Kenangan, who recently became a unicorn following its $96 million Series C funding round. Started in 2017, Kopi Kenangan offers affordable ready-to-go coffee targeting a gap in the Indonesian market between the high-priced international coffee chains and cheap instant coffee. Through a technology-embedded model, Kopi Kenangan promotes accessibility as its number one selling point, ensuring that customers can order their coffee anywhere. Today, the company employs more than 3,000 staff and operates over 600 stores in 45 cities. The chain served over 40 million cups of coffee in 2021. 

Another popular VC-backed F&B business is Jiwa Group, which is more known for its flagship brand Janji Jiwa coffee chains. When it was first founded in 2018, the company initially used a franchising model to grow its brand to the giant it is today but then decided to buy-back its branches from its franchisee—this eventually led them to receive funding from Openspace Ventures and Capsquare Asia Partners in November 2021. Today, Jiwa Group operates 3 brands: Janji Jiwa, Jiwa Toast and Jiwa Tea, with over 900 outlets in 100 cities, selling an average of 5 million cups per month.

Following these successes, more and more F&B startups are popping up with new ideas and investors are more than keen to support their growth. Some of Indonesia’s F&B startups include: 

Pros to Using VC Money

Access to Alternative Capital

Due to a lack of reputation and limited operating history, startup founders often find that access to alternative capital like loans or revolving lines of credit is more limited—and when they do find credit lines, the interest rates and terms tend to be less favorable. This is where VC money comes in. Unlike traditional lenders, VC investors are expecting high returns in exchange for high risks. If their portfolio succeeds, they win big but if it fails, they eat their own losses. Founders are therefore not obligated to repay VC firms if their businesses fail, lowering their personal financial risks. 

Quicker Brand Expansion

Without VC funds, founders typically need to maintain a steady stream of revenue before engaging top-level management, hiring additional staff, increasing marketing spending and investing in major equipment and technology to advance their businesses. With an extra injection of VC money, they can do all the above immediately and take their company to the next level sooner rather than later. 

Connection to A Network of Investors and Market Experts

Since VC investors have stakes in their portfolio companies, it is in their best interest to connect their portfolio founders with anyone who might be able to help grow the business—this includes other investors that can help their portfolio fundraise, other startup founders that can help grow the business further through synergistic win-win projects, and industry experts that can help them improve their overall business models.

Increased Publicity and Reputation 

Since it is in their best interest to get more exposure for their portfolio, venture capital firms will utilize their PR group and media contacts to promote their startups, whether it be news on the startups’ successful fundraising round or their strong company performance. Often just being associated with a venture capital firm can also add a great deal of credibility to a startup. This increased publicity in turn will lead to increased interests from potential employees, customers, partners, and other venture capital firms.

Cons to Using VC Money

Dilution of Shareholding and Voting Rights 

Business owners must give up a portion of their shareholding to VC investors in return for their capital and technical expertise. With ownership, comes also the right to make controlling decisions for the business. Often in larger startups, the owners have given up a huge chunk of their shareholding to investors, limiting their freedom to make business decisions. 

Time Commitment Needed for Fundraising and Reporting 

Fundraising is a laborious task and founders will spend a considerable amount of time perfecting their pitch, shopping it around, and dealing with multiple follow-up meetings; the same time that could be used instead to do the actual running of the business operations. 

Pressure to Exit

Although VC partners tend to emphasize the importance of the company’s potential growth and future profits, they do not necessarily want to be a part of said future. VC firms eventually need to exit their investments by either selling the company in an M&A deal or taking the company public in an IPO. In either case, the future of the company is uncertain and relies heavily on the investors’ decision-making. If they decide to sell 100% of the company, founders may have no choice but to also say goodbye—which may or may not be in line with their wishes. 

Final Remarks

The rapid growth of Indonesia’s F&B businesses requires good financing support—whether it be through franchising or taking VC investments. Since there are pros and cons to both alternatives, the answer to which strategy is better really depends on how the owners manage their businesses and operations. If you are a startup running tech-enabled food-chains or meat-alternative production that aims to be the country’s next unicorn, the VC routes would be a better option. On the other hand, if you are operating the town’s best pizza joints or an aspiring pastry chef whipping up the town’s new it-dessert, franchising would be a better route for you. F&B business owners reading this, what do you think works best for your business? Would you rather take VC money or start a franchising business?