Franchising The Inner-Cities: Leveraging Diversity & Legal Creativity To Incite Urban Development
January 21, 2020 by Benjamin Kamelhar
by Niko Papoutsis
The archetypal “inner-city” is a distressed urban locale characterized by concentrated levels of poverty, unemployment, and crime. Prospective business developers confront a consumer base with lower household incomes and discretionary spending habits as compared to non-urban populations. Moreover, the diverse demographic makeup of inner-cities can make it challenging for a business to meet the wide range of tastes and preferences. Franchisors, grounded in maximizing profitability and maintaining a quality image, have historically steered clear of these depressed urban pockets in favor of suburban or international expansion. However, franchisors with such a mentality overlook the latent capacity for business success within the inner-cities—success that spills over to benefit the local community and engender economic development in an otherwise blighted area. Inner-cities as a whole suffer from a massive supply shortage—with approximately twenty-five percent of the total $85 billion retail and service market being unmet by local businesses. Inhabitants are routinely forced to travel into suburban malls and shopping centers to satiate their demand. Moreover, population density generates huge aggregate spending levels despite lower income per capita; an economic study found that inner-city inhabitants generate an average of $76 million in income per square mile compared to just $8 million in the suburbs.
While the evidence demonstrating financial viability in these urban pockets is rampant, the greater concern is the selection of a viable franchisee to develop the business. A local franchisee is ideal, as he or she will have an established rapport with the community that can bolster the business’ growth and engender support from local consumers. Utilizing a local franchisee provides the franchisor with a unique “safety net,” as the local community “adopts the business as a community asset when the owner is one of their own.” Simply put, the community’s affinity for the franchisee as a neighbor assists in establishing a similar affinity for the business by association. Developing an inner-city location around a local entrepreneur also provides efficiencies that would otherwise be left on the table, as the franchisee has a better understanding of the local demographics, is able to connect with consumers, and can provide insight on how the business concept can be molded to best serve a specific neighborhood. This might even include altering a menu or providing certain services to appeal to the tastes and preferences of an inner-city neighborhood. As franchise consultant Jose Torres summarizes, “connecting to the community is as important as understanding the neighborhood demographics and data.”
Unfortunately, metrics confirm that the lack of access to capital is the greatest barrier to entry facing minority franchisees, and the rate of loan denial is almost two times higher for minority-owned than white-owned businesses. Irrespective of their business savvy and tolerance for risk, prospective minority franchisees are disproportionately undercapitalized and have fewer liquid assets than their white counterparts. This ultimately means that finding the right local franchisee also requires funding the right local franchisee.
The franchisor can take the initiative to fill-in these monetary gaps, making what is effectively an investment in the franchisee and his or her ability to take the business concept into an inner-city neighborhood and achieve great results; the upfront financing costs to the franchisor, therefore, should be incurred with a focus on long-term returns and faith in the local entrepreneur. In application, franchisors have historically fulfilled this role through direct loans, financial incentives tied to diversity initiatives, and creative ownership models. When offering direct financing to minority applicants, franchisors must keep in mind that the average inner-city franchisee will be undercollateralized and unable to service loans with high interest rates. Diversity initiative programs typically waive or reduce franchise fees, discount the total startup investment, and reduce royalties for minority applicants. Papa John’s, for instance, utilized its “Enterprise Zone Program” to waive both the initial franchise fees and all royalties during the first twelve months of business for minority franchisees developing stores in highly urban markets. Franchisees would still be required to fund construction, purchase equipment, and cover operational costs—but financial burdens alleviated through the program could be the difference between success and failure. Aside from direct financing or minority-targeted assistance, franchisors should continue to develop creative ownership structures available to applicants—regardless of race or gender—who “have the drive but lack the finances to invest in a franchise.” This could take the form of a Manage-to-Own structure, which companies like Little Caesar’s have implemented. Total initial investment for those accepted to Little Caesar’s Manage-to-Own program was a mere $10,000, which covered the program’s franchisee training and served as a substitute for the initial franchise fee. All expenses required to develop the franchisee’s store—upwards of $500,000 in many cases—were covered by the company. Though not full owners, Manage-to-Own participants receive a salary, a small percentage of profits, and the opportunity to gain full ownership of the restaurant over time. Alternative purchasing models like the one used by Little Caesar’s are a viable option for lowering the costs of entry for low-wealth community franchisees.
More widespread franchising in the inner-cities requires franchisors to increase flexibility regarding their models and financing options. Local entrepreneurs, though underfunded and inexperienced, can help galvanize a community around the business and solidify growth for years to come. I argue that the franchise model is a viable tool for mitigating poverty and improving inner-city conditions. As real-world examples demonstrate, franchising within indigent locales ensures that spending on goods and services can be kept within the community and employment opportunities become more plentiful. The model additionally promotes routine maintenance and cosmetic upkeep of the business’ physical structure—both of which have trickle-down benefits in low-income neighborhoods. Ultimately, creativity around the legal bounds of the model can achieve the financial gains to benefit the franchisor, franchisee, and inner-city neighborhood.
 Zachary K. Iacovino & Michael R. Daigle, Legal Consideration for Franchisors Expanding
into Inner-City Markets, 38 Franchise L.J. 513, 514 (2019).
 Erik F. Dyhrkopp & Andrew H. Kim, Prospecting the Last Frontier: Legal Considerations
for Franchisors Expanding into Inner Cities, 19 Franchise L.J. 89, 134 (2000).
 Id. at 89-90.
 Iacovino & Daigle, supra note 1, at 515.
 Eddy Goldberg, The Growing Potential of the Urban Market, Franchising.com (Nov. 7, 2006), https://www.franchising.com/articles/the_growing_potential_of_the_urban_market.html; see also Michael H. Seid & Kay Marie Ainsley, Starting Up in an Urban Market, Entrepreneur (June 26, 2001), https://www.entrepreneur.com/article/41692 (“Even where the average income in the area is lower, per-capita spending on certain products or services may actually be higher than in suburban stores.”).
 Nancey Green Leigh et al., Using Franchises to Revitalize an Urban Corridor, Improve Neighborhood Access to Retail and Services, and Promote Sustainable Local Economic Development, Ga. Inst. Of Tech. 16, 16-7 (Dec. 2016), https://serve-learn-sustain.gatech.edu/sites/default/files/documents/Toolkit-Docs/Exterior-Case-Studies/nine-franchises-for-the-hollowell-parkway-corridor.pdf ; see also Iacovino & Daigle, supra note 1, at 524 (“To find lasting success within inner-city markets, franchisors should, as a priority, take steps to identify and attract strong franchisees who understand the local markets and encourage franchisees to find employees who will support and advocate for the brand within their communities.”).
 Id. at 17.
 Jose Torres, Connecting to Hispanic Consumers Through Hispanic Franchisees, Franchising World at 71 (2012) (“Although a franchise uses the name of a big company, ultimately, the store or restaurant itself is a local business. That means a successful franchise must consider the locality before having any chance of success.”).
 Driving Inclusive Prosperity in Under-Resourced Communities: 2019 ICCC Impact Report at 9 (2019); see also Morgan Ben-David & Devona Reynolds Perez, Change Franchise Economics and Greater Diversity Will Follow, 19 The Franchise Lawyer 11, 12 (2016).
 Leigh et al., supra note 6, at 6. (“In 2013, on average, Hispanic families had saved $12,329 and African American families had saved $19,049, compared to an average white family savings of $130,472.”).
 Ben-David & Perez, supra note 10, at 11.
 Id. at 12; see also Carla Wong McMillian & Kelly J. Baker, Discrimination Claims and Diversity Initiatives: What’s a Franchisor to Do?, 28 Franchise L.J. 71, 72 (2008) (“To reduce financial barriers, numerous franchisors offer reduced franchise fees for women and minority applicants and reduced royalty payments during the start-up period. Others simply waive the franchise fee.”).
 Papa John’s Named One of the 50 Top Franchises for Minorities: Company Launches Enterprise Zone Program to Spur Development, Business Wire, https://www.businesswire.com/news/home/20071015005600/en/Papa-Johns-Named-50-Top-Franchises-Minorities (last visited March 4, 2020).
 Leigh et al., supra note 6, at 12.
 Leigh et al., supra note 6, at 12-13.
 Heather McCulloch, Building Assets While Building Communities: Expanding Savings and Investment Opportunities for Low-Income Bay Area Residents 38 (2006).
 Ben-David & Perez, supra note 10, at 13.