Financial details of Charles Schwab & Co. Inc.'s branch-franchising program have been re-vealed, and the early reviews as to how franchisees will fare are mixed.
The company so far has de-scribed only general outlines of the program, but franchise documents filed with state regulators show further details about how much potential franchisees would pay — and how much money they might make.
Schwab hopes to sign up the first franchisees next month, with a goal of adding 20 more next year, 40 in 2013 and 80 a year by 2014.
The company now has 300 company-owned branches nationwide. The addition of independently run franchised outlets — a strategy unique to Schwab — has attracted widespread interest among the firm's financial advisers and competitors.
According to Schwab's franchise disclosure document, total startup costs are estimated at $46,650 to $109,910, including the $25,000 to $50,000 franchise fee, based on the number of existing Schwab clients that a new franchisee was given.
In addition to taking a share of revenue, Schwab is charging franchisees a number of other fees, including office rent estimated at $1,250 to $6,250 per month, a five-year monthly facilities fee of $3,000 to $6,000 for leasehold improvements made by Schwab, a technology fee of $900 to $1,500 per month and a client-servicing fee of $2 per month, per client.
Schwab franchisees will also have to pay for employee salaries.
The company will calculate branch revenue based on the assets at the particular location, multiplied by the average yield-on-assets from all of Schwab's franchised branches.
Last year, the average asset yield for its company-owned brokerage offices was 42 basis points, Schwab disclosed.
In order to help get the new branches off the ground, Schwab is adjusting the average revenue amount upward, by 100% in the first year of operation, 50% the second year and 10% in the third.
But beginning in the fourth year, that subsidy will end and Schwab will start taking 25% of franchisees' revenue. In year five and beyond, revenue is split 50-50.
Franchised locations will generally be located outside major urban areas and are expected to reach $100 million or more in assets.
A few observers have questioned whether the deal makes sense for franchisees, especially with Schwab taking half of the top line.
“I can see it work if [a franchise office] gets up to $300 million or $400 million” in assets, said Tim Hatton, president of Hatton Consulting Inc., a Schwab-affiliated advisory firm that manages about $180 million.
But $100 million in assets, after expenses, might not be enough to attract a person of the quality that Schwab needs, he said.
A $100 million asset base earning 42 basis points would translate into just $210,000 in net revenue for the franchisee, before expenses.
Andrew Salesky, senior vice president of Schwab's Independent Branch Services, argues that there will be enough growth potential in the branches to make a go of it.
The franchise model ”offers the potential for significant scale in each of these locations,” he said.
The company requires its branch operators to bring in $10 million in net new assets yearly until they reach $100 million in total.
In addition, Schwab anticipates that franchisees will put a larger percentage of assets in managed-money programs compared with its existing branches, Mr. Salesky added. Those programs earn higher revenue.
For the smaller independent adviser that Schwab is targeting, one with $20 million or so in assets, a franchise might be attractive, said Ryan Shanks, chief executive of Finetooth Consulting LLC, an advisory consulting firm.
Those types of practitioners are “already independent, covering their own expenses and probably not making a whole lot,” he said. “If Schwab bore some of the operational [burden], a 50% payout [less expenses] might not be too far off from where they are now.”
But larger advisers could join an existing RIA firm and get a much higher net payout of 70% to 75%, he said.
Advisers moving into an independent channel always need to understand what their total costs will be, and compare that against revenue, said John Furey, founder of Advisor Growth Strategies LLC, a consulting firm. “You've got to look at the details of the actual terms and the fine print,” he said.
Schwab's franchise filings also detail some of the limits on what franchisees may or may not do.
Franchisees will act as brokers, with no investment discretion. They will be limited to Schwab's current menu of products and pricing, and may not engage in any other business activity.
Territories will be defined by Schwab, and franchisees must concentrate their marketing efforts there. The company can change those territories at any time.
Mr. Salesky said that the person attracted to a franchise opportunity will be someone who sees “great value” in Schwab's products and pricing.
The company has received about 700 inquiries from potential franchisees, he said.
In its filings, Schwab also acknowledged that franchisees will be competing with company-owned branches and the firm's affiliated independent RIAs.
If a franchisee leaves and takes Schwab clients, he or she will have to pay Schwab 4% of the assets that move. Clients the adviser brings to Schwab upon starting a franchise can be exempted.
STEEP PRICE
That's a pretty steep price, equivalent to a recruiting incentive of about 400% of trailing-12-months' revenue, Mr. Shanks said, assuming an average adviser earns 1% on assets.
Mr. Salesky doesn't expect many franchisees to bolt.
A lot of the potential recruits the firm has been talking to are midcareer individuals who have “been affiliated with multiple firms and are looking to make this their last transition,” he said.
Email Dan Jamieson at [email protected]
