Subs by design: the case of a family business in transition.

Fuller, Barbara K.

CASE DESCRIPTION

This case focuses on the growth of a family-owned franchise from its inception in 1987 to 12 stores in 2008. The patriarch is now 70 years old and the succession planning for the business is just beginning. The background of the family and history of the company create a portrait of the current situation and provide the environment for making future decisions. The case first concentrates on the issue of growth by providing students with an opportunity to develop a profit and loss statement for a new store offered to the franchisee. All of the key figures available to the entrepreneur are provided allowing students to put themselves into the role of the decision-maker. Secondly the patriarch of the family, Ryan, is thinking about retirement. The case develops Ryan's personality as well as the characteristics and behaviors of his two children over the 20 years of the business. As the founder, Ryan must now decide what is best for the business as well as the family as he becomes less active and the business moves to the next generation. The case provides students with a unique perspective by extensively quoting Ryan and Greg Smith, the founder and his son, thus giving them insight into the thoughts of the individuals involved in the decision making. All of the events in the case are based on a true entrepreneurial experience, but the names have been disguised to provide privacy to the owner. The profit and loss statement uses actual figures and depicts the situation as it existed at the time the offer was made. The case has a difficulty level appropriate for junior to senior level undergraduate students. It is suitable for use near the end of an introductory course in entrepreneurship which is where small business growth is usually covered in entrepreneurial textbooks or in a separate entrepreneurship course that has more of an emphasis on growing the business and succession planning. Although not developed for a finance class, it could be use by emphasizing the purchase decision associated with the Rock Crest location. Depending on the emphasis at least some basic accounting background would be helpful. The case is designed to be taught in two class hours and is expected to required four hours of outside preparation by students. However, there is a lot of latitude provided to the instructor as to what direction to take the case.

CASE SYNOPSES

Ryan Smith, laid off from his position as plant manager for a textiles firm, begins a new career as the franchise owner of a group of sandwich shops doing business as Smith Enterprises. The case covers Ryan's startup of Subs by Design with the help of his family and the trials and tribulations of growing a family business. Startup financing came from some unique sources including from a fellow franchisee in a nearby territory. Early family support came from his daughter Bree who gave Ryan the confidence he needed to open the first two franchises. Bree and her husband, Brad, helped Ryan grow the business during it early days. Greg, Bree's younger brother, was not interested in the business, until an injury kept him from pursuing his first love, professional baseball. After the injury his father urged him to join the company. The case looks at the interaction among Ryan, Greg, and Brad as they continue to grow Smith Enterprises. The triangular relationship eventually results in Brad leaving to pursue a career in real estate.

After Brad and Bree's departure, the company continued to grow. Smith Enterprises is now looking forward to operating 12 stores which include two stores currently under construction. However, recently Ryan was presented with an interesting offer from the franchisor for a prospective store in a potential hot growth area. Ryan must make a decision on the offer within the next three weeks. If he doesn't accept the offer, the franchisor will offer the location to someone else. The case ends with Ryan who is now 70 looking at his retirement and planning for the succession of the business. He has to decide how to divide his estate and what to do with the business as it moves to a second generation of ownership.

INTRODUCTION

"I never planned to be an entrepreneur, but it's been an interesting 20 year detour. When you work for a corporation for practically a life time, you don't realize how much your identity as a person is anchored by the corporate experience. Being layoff at 50 years old was a devastating experience. But it opened up a new chapter in my life and provided me with a chance to build and grow a business of my own. Sure there were hard time, but now the business is thriving and I have people coming to me with new locations and opportunities. The biggest issue now is deciding which of the opportunities makes the best sense for the business as I become less involved and it moves to the next generation of leadership. Now that I'm 70, the thought of retirement does wander into my mind every once in a while. I'm still not sure when and under what conditions I'll retire, but I would like to slow down at least a little."

These are the words of Ryan Smith, CEO of Smith Enterprises. In 2008 Ryan is the owner of 12 sub sandwich shops doing business as Subs by Design in Stansberry GA, a town with a population of just over 50,000. Smith had purchased his first two Subs by Design franchises twenty years ago in 1987. At the time, the experience was both exhilarating and frightening. He was 50 years old and moving into the restaurant industry. What frightened Ryan the most was the fact that he knew nothing about restaurants and had no past experience upon which to draw. How had he gotten here after spending 30 years in the textiles industry? He remembers vividly the day he was laid off from Phoenix Textiles. He had worked for the company for 24 years and made his way up to general manager before he was terminated to make room for the owner's eldest son to take the top spot at the company. Although he understood how family businesses worked, he was left without a job in an industry that was seeing continued movement off shore and to Asian countries with lower labor costs. Thinking that textile industry was all he knew, Ryan was devastated. As he pondered his future he wasn't sure which direction to go. He had always wanted to start his own company, but had never found the right business or the timing was off. He felt this certainly was not the right time with children in college. But fate had put Ryan and his wife, Vicki in the job market with some very serious decisions before them.

Ryan: "I wanted my own business, but we were scared. I had written away for franchise information many times over the years, but we were afraid because of the family. We had two kids in college. Where would we get the money to start a franchise even if we were able to find a business we liked? We thought going into business meant we would have to go a year or two without making any money. You know that's what everyone tells you. We would have to live on Vicki's salary and if we moved to a new city to open a franchise, we didn't know if Vicki would be able to get a teaching job."

FRANCHISE OPPORTUNITY

As chance would have it while traveling on an interview in Calhoun GA, Ryan stopped in a Subs by Design Sandwich Shop for lunch. The product was so impressive that he located the franchise owner to discuss the business. The owner convinced Ryan to inquire further, which he did. The franchisor was just starting to grow and the product was not really proven in the south. But, Ryan had a very positive gut feeling about the business. In July 1986, he purchased two franchises and opened the first one in April of 1987 and the second one six months later. Today, he has 10 stores with two under construction. An additional two are run by his daughter Bree and her husband Brad. But he remembers trying to get the courage and the resources to start the first store.

Ryan: "We had a little bit of savings plus I borrowed money from anybody I could find. I coaxed a friend of mine who was in the banking business to help put together a business plan. When I went to the bank they said it was a good plan, but I didn't have experience in the restaurant business and 80% of the restaurants fail in the first year. If I had some collateral, they were willing to give me a loan against assets. But, I didn't have assets, my home wasn't paid for and I didn't have other property."

However, back on the job front, the prospects didn't look good. Ryan had several interviews, but nothing interesting. The small nest egg he and Vicki had saved was dwindling. They were going to have to make a decision soon. Ryan gathered his courage and sat down to talk with his wife, Vicki.

Ryan: "I told Vick that this was a good opportunity that would work. I had studied it very carefully and had spent a lot of time with the store owner in Calhoun, GA. He convinced me Subs by Design was an up and coming franchise and it was going well for him. He even offered to loan me $5000.00 to get started. Once Vicki was on board we got the whole family together and said, look this is what we want to do. It means moving to Stansberry, GA. Much to our surprise my 19 year old daughter Bree who was in college said fine, I'll drop out of school for a while and help out with the startup. Even with everyone's support, my gut was still churning, especially about the financing. I thought nothing is black and white and there is always risk involved in starting a business. The next step was to visit the franchisor. Bree agreed to accompany me to the national headquarters of Subs by Design. After several hours of talking with the franchisors, we both felt it was a really good opportunity. They were a new company and we would be getting in on the ground floor. Bree convinced me right there on the spot that it was the thing to do. So we bought two franchises that day and Smith Enterprises was formed."

Subs by Design provided two weeks of training for new owners to learn to operate and manage the store. Ryan completed his training at the end of 1986. In January of 1987, with the help of Bree he opened the first store and six months later a second store across town. They both worked in the first store for six months along with Michael, a young man that Ryan hired as manager because he had some experience in the restaurant industry. When the second store opened Michael took over as its manager. Bree stayed at the first store with Ryan. Ryan and Vicki's youngest son, Greg, was in the ninth grade when the stores opened so he helped out after school and in the summer.

Ryan: "When I went to school they taught me to calculate profit weekly. From the very first week, I took all the monthly overhead times 12 and divided by 52 weeks and had a formula for all my fixed costs (rent, power, water, debt service, gas, phone, labor). I determined after the first week I had made a $30.00 profit, so I paid my self $30.00. The second week, I made even more profit and it just kept growing."

The reality of his decision was beginning to set in and Ryan realized that he was now in the sandwich business. During his corporate years he had relied on standardized procedures that had been established through years of experience in the textiles industry. He had always felt safe under the protective umbrella of the company. If he needed something, there was a department somewhere in the corporation that could help solve the problem. But being an entrepreneur was different.

Ryan: "As an entrepreneur you have to do everything. At least with a franchise, I had an operation manual, but in effect I was now out there on my own and I was responsible for making all of the decisions. There was nobody who could help. I knew that I could get opinions from people, and everyone had an opinion. I could call other franchisees all over the United States, but I still had to make the final decisions myself. I soon found I needed to be pretty calculating because there were consequences of my decisions. This was true especially in the beginning. When I started Subs by Design was a concept that had not been proven and I had to figure out if Southern folks would warm up to submarine sandwich which had mainly been sold in the north. At the same time, I was responsible for setting up my own business including administrative, operations, banking, legal, and accounting functions. I had to hire people and make sure they were paid every week. I had to deal with the IRS, as well as state and local government regulation and ordinances. It was a little overwhelming. In the beginning, I did it all myself until I understood how to do it. I paid all of my accounts payable and wrote checks for payroll every week. Within 6 months I found a CPA to help with the financials. He now helps me with all of the financial aspects of the business and stands behind me with the IRS if I have any problems."

LESSONS LEARNED YEAR ONE

Ryan learned a lot that first year in business. This is how he described his thoughts at the end of that first year as an entrepreneur.

Ryan: "You have to be a little cocky and have a lot of self-confidence. Those traits will tide you over when things start to go wrong, which they inevitable will at some point in the business. In other words, you have to feel like if thing don't work and you do get into a mess, you can work your way out of it. You can't be perfect all the time, you're going to slip. You also have to have folks that can serve as mentors that you can call and ask and hope they have been in the same spot or one similar to it. There are three people you have to have as friends: your banker, your lawyer, and your CPA. That doesn't mean you use them a lot other than your CPA. But you have to have some folks you can call on that you are comfortable with. In addition, you have to be the kind of person who doesn't mind asking questions that may make you feel a little foolish. I don't care if you have a master's degree in business; there are questions that you will never know the answer to unless you ask somebody. You have to have the drive and perseverance within you to find answers that are not available in textbooks, yet are extremely important to the future success of your business. Knowing the facts and doing your due diligence are important in creating a comfort level with your daily decisions that will eventually lead to the success of your venture."

Ryan was also aware that he had made a number of mistakes that first year that were costly to the company. Because of his inexperience many decisions felt right at the time but ended up costing the company in the long-run.

Ryan: "Early on we were too cheap with our money because we were trying to make a profit. We paid minimum wage, which is what others were paying. But, people cannot live on minimum wage. We had so much debt we could not provide any benefits. We grew so fast it was hard to keep up. In the beginning if somebody didn't do their job, I would let them go. Then I didn't have anybody to help me. I was too firm and expected too much of people. You have to understand if you're an entrepreneur, nobody is going to work as hard as you do. You can't expect your people to work half as hard as you do because they don't have any vested interest in the business. They are thinking about day to day when you are looking out five to ten years. My impatience caused a lot of turnover. I also made some bad moves with some managers. I hired people that probably could have done the job, but they didn't want too. I soon found that education was important, but so was motivation. Some of the early hires came to the job with vim and vigor for the first few weeks, but then decided that work was something they just didn't want to do and they would leave. As I got more experience in the industry, things got better. Now we have such a good benefit package that our managers never leave us. To help them understand our expectations, we put together a training program with the help of the local technical college. The program required them to do some role playing and learn how to hire, fire, and motivate people. The course was sixteen hours over a four week period and each manager receives a certificate of completion. After the training program, managers are responsible for hiring and firing, employee evaluations, giving raises, training and all daily operations. Every store is managed the same way. There is a little bit of difference in the personalities of store managers, but basically I delegate as much responsibility for daily operations as possible to the managers so that I can concentrate on the overall operations and growth of the business."

EXPANSION

The lessons that first year where many, but Ryan's goal was to grow the business beyond two individual stores. So when both of the original stores became profitable, he was ready to move on to a third store. He never saw himself making sandwiches for the rest of his life. He had bigger plans.

Ryan: "I didn't get in this business to make sandwiches, I got in this business to grow and manage the business and let employees make the sandwiches. I made sandwiches in the beginning, but that was not the master plan. I started in the store because I needed to know how to do every aspect of the business from the ground up."

Ryan knew that most of Subs by Design franchisees had three to four stores. They made a nice living, but were tied to the daily operations of the business. Ryan had run a large textile plant and knew how to manage people on a larger scale. His dream was to own multiple stores and he knew he would need assistance. He would need to hire one additional management person and arrange financing before Smith Enterprises could increase in size.

Ryan: "Although I did have a lot of debt, the second store doubled our profits and the financials were looking pretty good. The Subs by Design franchisors were pressing me to open more stores. If I didn't do it, they would give the new locations to somebody else. So I went to the bank and showed them the profit and loss statement and said I wanted to open a third store. This time the bank was more agreeable and loaned me some of the money to finance the third store."

Money as with any startup was tight in the beginning. All of Ryan's money and everything he had been able to borrow from friends and family was tied up in the business. With the desire to expand and Subs by Design encouraging even pushing him to open another store, he used every financial option available to him.

Ryan: "For the first three stores Subs by Design leased the equipment to me. The lease was for a 5 year period and at the end of the lease period, for one dollar, I would own the equipment. This method of financing was expensive, but I had to bite the bullet on leasing because I had no other way of financing the equipment. One of my goals was to pay off the leases early on all three stores and own them outright. Within 3 years of each stores opening, I had reached this goal. After the third store I was able to borrow enough from the bank to finance both the building and equipment. I now had a track record and the interest I paid at the bank was half of what Subs by Design charged."

FAMILY ISSUES

Two years had passed since the first store opened and Bree, Ryan's daughter, wanted to go back to college. She had a boyfriend who lived near the college that she had previously attended in Bradshaw, Georgia and their long distance relationship was becoming strained. So, Ryan and Bree investigated properties around the college with the intent of building a store in Bradshaw that Bree could run while she attended college. They found a suitable property and opened a store the following year. Bree returned to school and was responsible for running the store in Bradshaw. Ryan returned to Stansberry and initiated plans for two additional stores in the nearby town of Landburg, GA. He had scoped out a couple of locations that he felt would be profitable. However, he was experiencing skepticism from family and friends and hadn't been able to find the right person to help manage the expansion.

Ryan: "Everyone told me I was foolish. Landburg could only support one store. Their strong opposition created some doubt in my mind, but my gut instincts told me to go ahead with two. I truly felt that there were two distinctly different communities based on the geography and demographic characteristics of the city. There was the uptown section towards the bypass and a more rural community to the west of Highway 603. The city was growing and a developer was building a new shopping center near the bypass, so I thought I'm going to gamble on two. I was beginning to get a feel for this business and my past experience gave me a pretty good feeling about these locations. I convinced the franchisor that the locations would be profitable and opened two stores in 1989. Both stores have done extremely well."

Ryan now had five stores, plus the one Bree operated in Bradshaw. With six stores, Smith Enterprises was stretched to its capacity and Ryan needed additional management help at the corporate level. So in 1994 Ryan convinced Bree and her new husband, Brad, to come back to Stansberry and help him build the business. By this time Brad and Bree had a new baby four months old. The solution was for Brad, Bree and the new baby to return to Stanberry and move in with Ryan and Vicki. Brad became the general manager at Smith Enterprises helping with the overseeing of the franchises.

The first few years were an adjustment period for Ryan and Brad. Ryan came from the old school and managed his business accordingly. He ran a tight ship and those around him had to adjust to his management style, including Brad. This is how Ryan described his management style.

Ryan: "Employees look up to me more as a fatherly type figure. I know the business and demand respect. I want things done my way throughout the organization from the top to the bottom. In the corporate office as well as the stores there are procedures that must be followed. I insist that store employees work hard and take care of themselves personally. I don't put up with any shenanigans going on during business hours. I don't care what they do with their personal lives as long as they don't bring it to the store. When I walk into a store everyone knows they better snap to. I start checking the store. I want everybody in uniform. I want everything done properly. They will also tell you, I am very benevolent. If they do a good job, they get rewarded for it."

Within the next couple of years, Brad adjusted to his new environment and helped Smith Enterprises open another store in a newly developing section of Stansberry. A strip center with the right combination of retail space, a convenience store and some specialty shops, created what Ryan thought was an ideal location for another "Subs by Design" location in the city. With this addition Smith Enterprises now had eight stores.

In the mean time Ryan's son, Greg, came back from college. Up until this point Greg had little interest in or contact with Smith Enterprises except for the few summers he had worked behind the counter at the original Subs by Design location.

Greg: "I was away at school on an athletic scholarship and wanted nothing to do with the business. I hoped to play professional baseball some day. However, because of some injuries, in the spring of 1995 I returned home. The business was growing and doing phenomenally well. So, I decided to join dad and my brother-in-law, Brad, in the business. The company owed a lot of money, but they were paying off the debt earlier than required by the bank and there were plans for further expansion. I knew that I would need to learn the business from the ground up, so I agreed to work as a manager in one of the stores for the first year."

With his son's decision to enter the business Ryan's thoughts again moved towards expansion. Once Greg got experience at the store level, he would be able to join Brad and help with overseeing additional stores. Ryan decided to begin looking in Longville, a small but thriving community located just outside of Stansberry.

Ryan: "We went to Longville, but we couldn't find available property suitable for developing a franchise. The only option was a convenience store. I ask the owner if I could put a Subs by Design shop inside of his convenience store. Creating partnerships with existing convenience stores was a new business model for Subs by Design but the co-branding concept had become a popular trend with a number of well known franchises as well and independent companies. So we made a deal, and built a store inside the local convenience mart. The store is still there today and doing quite well."

The success in Longville leaded to the opening of three additional stores within close proximity to Stansberry. Smith Enterprises was also able to purchase a store in Springfield, GA. Although the Springfield store was run down and losing money at the time of purchase, Ryan and his new management team was able to turn it into a profitable store within six months.

MANAGEMENT STYLES

For the past four years, Greg had been away at college and pretty much on his own. Now he has back working in the family business under his father. The first year he managed a store and was left pretty much on his own. But, the second year he moved into the corporate offices of Smith Enterprises with his father and Brad. He immediately had to learn to deal with his father's management style.

Greg: "The biggest thing with dad is that he is always so serious. When it comes to business he is all business. He tells it like it is and never beats around the bush with any niceties. He always wants more. That's his style. It got him to where he is today, so I have to respect him. However, he's tough to work for not only for me but for other people. Let me give you an example of how it was back then. He would walk into a store any day of the week at 6 to 7 o'clock in the evening. When he walked in, if the employees were playing around or the store was dirty or he just wasn't happy about something he would fire everybody right on the spot. Then he would call Brad and me and we would have to come down and run the store and close up. He's gotten better over the years. Now when he gets upset, he bites his lip and calls me. We talk and he lets me take care of the problem. Before he was the chief, and he would handle it his way. I'm not saying it was right or wrong, but it was tough. I didn't understand a lot of decisions he made, but we had to deal with them, and just keep going. There is nothing else we could do."

As Greg was learning about the family business and his father's management style, everyone especially the store managers and employees were testing Greg. What type of a manager would he be? Would they be able to walk all over him or was he a chip off the old block with the same hardnosed tactics as his father? Ryan described his son's management style as follows.

Ryan: "When Greg walks into a store, the employees just love to see him. They think he's a great guy. They are very comfortable, not nervous at all. When he finally starts looking around the store, he points out a few things and slaps them on the back. He asks how they are doing, or says it's good to see them. Eventually he'll get around to saying; you know we need to get that corrected because what the customer sees is important. He explains why they need to make the corrections. He goes on back through the store and talks to them about their families and gets really involved. In the beginning when I observed this type of behavior, I was very nervous. I thought he was too lax, and they were going to take advantage of him."

It took several years for father and son to appreciate each other's management style and conflicts still occur, as with most family businesses. Ryan confesses that he was very surprised that his son's laid back management style worked. After many arguments and reconciliations Ryan eventually gave in and let Greg try it his way.

Greg: "My philosophy is 'There are two ways to skin a cat.' What I mean by that is Dad wanted things to be done in a certain way, but the managers wanted to do things their way. Dad would argue with the managers and insist that everyone do it his way. But I've helped him to understand that if the end result is the same, then we need to be happy with the results and not worry about how the manager got to that result. Sometimes, it was stressful on everyone trying to make the transition."

Ryan: "We had some pretty strong arguments for a couple of years, arguments about Greg not being firm enough. I thought he should fire someone, but he chose to keep them. Or I thought he didn't follow up closely enough to find out who was taking money from the register. But, almost every time I got upset, I had to later back off because he had already quietly followed through. That was just his personality. During this time Greg made some mistakes, but I gritted my teeth and kept my eye on the situation to keep him from getting into major problems. He learned from making those mistakes and never made the same ones twice. That's what you are looking for in a good manager. If you have a person who repeats the same mistake from a different perspective then you have a person that you have to get rid of because they aren't going to do any better. With each new experience, Greg was growing with the company. He did tell me one time that he finally realized that it wasn't my job anymore to look after him. It was his job to look after himself and the business. Once he realized that, he seemed ready to take on more responsibility. Maybe it was only a mind set, but it made a big difference in our relationship. "

FAMILY ADJUSTMENTS

In 2003 after spending 10 years in the business, Brad decided he wanted to leave Smith Enterprise to move into the real estate business. Although Smith Enterprises had been able to thrive and prosper, the relationship between the Ryan, Greg and Brad had become somewhat strained.

Greg: "When I first moved into management and started overseeing the stores, I would go to Brad for advice. He had more knowledge. We were doing the same job, but he had been around longer and had more knowledge. However, it was not long before my relationship with Brad became more strained. Looking back I was somewhat naive. I thought we would all be doing Subs by Design together forever. There were days when Brad couldn't say or do anything right in dad's eyes. You've seen the movie--"Meet the Parents." It wasn't quite that bad, but dad was constantly on him. A guy in town presented Brad with a business opportunity in real estate. He decided to take it. From my perspective it was strange being the person in the middle. I always hoped that I would be playing ball somewhere, and didn't really want to come back to Smith Enterprises. However, when the ball thing didn't work out and dad needed some help, I decided to come on board. I didn't think about my role as opposed to Brad or any of that type of stuff. Looking back there were so many signs, but I was too young and naive to understand the family issues."

At the time that Bree and Brad left the company, Ryan deeded over two stores to them Bree's original store in Bradshaw and the one in Springfield, GA, which was only 19 miles away. The two stores were worth $1.2 million at the time.

Ryan: "On the one hand, I was hard and let Brad and Greg compete to see who would be the strongest leader at Smith Enterprises, but on the other side when Brad & Bree decided to leave I gave them two stores. The two stores would provide them with income until they got their other business up and running. I felt like Bree and Brad helped to me get the business going when I needed them."

Brad moved into the real estate business and Bree took over the two Subs by Design stores. With Brad gone, Greg began to take over more of the responsibility at Smith Enterprises and became the president in 2005. Ryan still remains as the CEO.

Greg: "The business is open seven days a week and we now have 8 stores with two more close to completion. There is always something happening. If someone breaks in I have to go down to the store in the middle of the night. In the beginning, I saw myself as an employee working for dad. Now I'm looking more from the perspective of an owner. That has helped me. If a problem arises I used to just jump and handle it. Now I try to get people to take care of the problem for me. One day I woke up and said I can't keep putting out fires all the time. It used to be if someone failed to show up for lunch or there was no one to close at the end of the day, I would jump and go do the work. Corporate planning and development would have to wait and I would get all backed up. I just said I can't keep going on like this not getting anything done, so I delegated more responsibility to our managers. Now I have people that have been in place for a number of years and they are at the point where they can handle more decision making at the store level. That gives me more time to think about the future of the business."

As Smith Enterprises grew, Greg learned how to manage his time more efficiently by delegating more of the responsibility for day to day operation to the store managers. A few years ago, around 2006 he began handling the opportunities and challenges presented by the business in a much more professional manner. This allows him more time for his personal life and family responsibilities. He cherishes the flexibility that he has to spend time with his daughters at after school activities or dance recitals, but understands he is responsible if something goes wrong in the business.

Greg: "I have two children 5 and 3 years old. I feel lucky that I can attend a lot of their school activities. It all comes back to having good people to run the business. Today ninety percent of the store's issues can be handled over the phone. But there will always be issues to resolve. Keeping my wife involved somewhat in the business helps her to understand if I have to go to the store on a Saturday night because of an emergency. It doesn't happen often, but it probably will never completely go away. Entrepreneurs are always on call. Our biggest disappointment was a trip to Hawaii that we planned a year in advance, and at the last minute I had to let a manager go. It was a situation where I couldn't wait. The family was really disappointed. That was really tough for all of us."

Ryan also comments on Greg's development over the past few years. He gives credit to Greg when he talks about having ten franchises rather than the average three or four held by most Subs by Design franchisees.

Ryan: "We have learned a lot about operations over the years and have really good people in place. Greg is good at what he does. He handles ten stores like I handled four and has plenty of time let over. Greg's management style is very laid back, and he gives employees a lot of leeway. He's not liberal, but he is very understanding. He has a lot of credibility with the employees and knows how to deal with people. He also knows everything there is to know about the business and can make a sandwich faster than anyone I know."

CONTINUED EXPANSION: AN OPPORTUNITY AT ROCK CREST VILLAGE

Now in 2008, the business is growing and Smith Enterprise has two additional stores under construction.

Ryan: "The two new locations are good sites with heavy traffic counts, beautiful visibility, good rent, and different markets from our current stores. We are capitalizing on the benefits these locations offer. You always have to be aware of what your competition is doing in the marketplace. Right now we have at least four other sub franchises in town so we have to stay ahead of the game and know where expansion is occurring within the city. One of our new locations is north of the city, where we are seeing a lot of growth and increased traffic. We plan to put another store along this corridor before long. I already have a site in mind. You're in a much better position if you're ahead of the competition. Growth requires that you to look at the market and evaluate where you have opportunities to take advantage of the market.

How large we decide to grow the business depends on Greg. He says maybe 20 or it might be more than that. Greg is currently 34, so he's got a lot of years ahead of him. We are also looking into the commercial real estate business. We own some office space and strip centers. We are starting to diversify a bit. Putting all of your eggs in one basket is dangerous. However, Subs by Design is our bread and butter. If you can run 10 stores, you can run 100 stores. You just apply the same principles and procedures, and then follow them."

Although most of Ryan's expansion has been self initiated, there were times when the franchisor found an interesting opportunity in a particular geographic area and presented it to the franchisee for consideration. Subs by Design recently found such an opportunity and approached Ryan with a prospectus for a new store. The Rock Crest section of Stansberry had experienced significant growth with the completion of a regional mall two years ago. Numerous retailers moved into the area and residential growth was forming. Ryan outlines a call he received from Subs by Design.

Ryan: "Subs by Design will find a location and if it is in my general geographic area, they will call me to see if I'm interested. When they called I said, yes I've been watching that location. Let me see the lease and I'll work up some numbers. Having worked with Subs by Design over the years, I knew that the franchisor wouldn't appreciate my turning down an offer in my geographic area, but I needed to look at the figures. A lot of owners would take anything to keep competition out of their area, but I'm in this business to make a profit. I was certain rent would be high because of the type of development in the area, but I wanted to see the overall package."

Since day one Subs by Design had trained Ryan to look at the Profit and Loss Statement (P&L). So Ryan's first instinct when he looks at any new site is to develop a Weekly P&L for the store. (A copy of the P&L Form that Ryan uses in evaluating stores is provided in Appendix A of the case.) He received the following lease terms for a 1500 square foot site from the Rock Crest Village landlord.

Ryan estimates that sales in the new location would be between $7,000 and $10,000 per week. He did his first calculation using a $10,000/week sales volume since his costs were generally related to $10,000 per location in sales. If he needed to make adjustments he would have the established fixed expenses and make adjustments for the cost of goods, royalty fees and advertising cost. Ryan's expenses included the following: gas .05%, electric 1.75%, telephone .15%, garbage .25%, insurance .40%, labor and taxes 22%, repair and maintenance .8%, and miscellaneous expenses .8%. Cost of goods sold usually ran near 31% of sales. And of course, he would have to pay the franchise royalties of 8%, advertising expenses of 4.5%, and payback his loan for the purchase of equipment which was $500 per week to the bank. All Ryan needed now was to put the figures from the lease agreement plus his cost estimates into the weekly profit and loss statement. This would give him a picture of the potential profit or loss for the new location. The net profit margins for his current stores ranged from a low of 10% to a high of 20%. Ryan knew that a store would be opened in this location whether or not he decided to accept the offer. If he declined the offer, Subs by Design would offer the location to another franchisee, and he would have competition in the territory. If he opened the store it meant that he would be adding an additional store to the two he currently had under construction north of Stansberry.

As Ryan pondered expansion into the Rock Crest Village location he thought about the past and was proud of his accomplishments over the years at Smith Enterprises. Money was no longer the issue it had been in the early days when he was just getting started. With a good track record behind him, Ryan found he had the backing of the bank and could borrow money whenever he needed it. On the other hand, he felt that the decision as to whether or not to open the store in Rock Crest Village had to stand on its own. Would the Rock Crest Village store make a reasonable profit for Smith Enterprises? The location was great, but the developer had a reputation for very high rents. In addition, several national chain restaurants had already committed to the location including Cracker Barrel, The Olive Garden, Panera Bread, McDonalds, McAlisters Deli, Outback Steakhouse, and Applebees. There were also rumors of additional competition moving into the area as the development grows. This meant the competition would be pretty tough.

There were two other issues that Ryan and Greg thought were important to consider before making a decision on Rock Crest Village. One dealt with the size and configuration of the current management structures. Greg felt that Smith Enterprises had reached it capacity without the addition of another layer of management.

Greg:" At Smith Enterprises, Subs by Design is our bread and butter. The franchise has come a long way in twenty years. I have talked with dad about the possibility of having fifteen to twenty stores in the next few years. That would require moving two or three of our current store managers to regional positions. We could give each of them four to five individual stores to manage. Fifteen to twenty stores would be over my head. I'm 34 years old now. It is six years until I'm 40. I've started to think about where I want to be at 40 and what's going to be going on at Smith Enterprises in six years."

Would a management structure change have to occur before the addition of the Rock Crest Village store or could they absorb an additional store now? Another issue Greg needed to take into consideration was the fact that his father has just turned 70 and was starting to be less active in the daily operations of the business. In the past couple of years he has helped mainly with new store negotiations and openings.

Greg: "Dad is trying to take a lesser role in the operation of the business. I don't think he will ever be totally out, which is fine with me. Even today, I get a lot of advice from him. We'll go out to lunch and talk about different things. The last few years we have had a really nice relationship. We still talk about the business as well as him giving me personal advice. My role now is in operations. I handle all the managers and the employees. Dad has taken over the role of building out the new stores. We have to deal with corporate headquarters and negotiating lease agreements with landlords. Dad loves confrontation. He feeds off of the competitive environment. I wish I had more of those qualities in me. I'm more of a push over, but I can be strong if I need to be. So today dad basically handles building the stores and I take over the operations when their complete."

Based upon their calculation and knowledge about the area as well as the position of Smith Enterprises, Greg and Ryan must make a decision about whether to accept the proposal presented by Subs by Design or turn it down and allow someone else to open a store at Rock Crest Village.

SUCCESSION PLANNING

As with any family business when the patriarch begins to think about retirement, the succession of leadership in the business begins to become an important issue. Ryan is in the process of talking with his family and getting legal advice from his attorney on issues related to succession planning for the business and his estate. He wants to be fair to both Bree and Greg, but he is not exactly sure how to approach the subject. Death and estate planning are such difficult topics to discuss.

Greg: "Dad turned 70 this year and in the last few months he has been talking about his will. I don't want to think about all that. I'll be fine with whatever mom and dad decide to do with the business. I feel dad is trying to understand what Bree and I want and where we're coming from."

Ryan: "I have approached an estate planning attorney and have begun the process of putting together the paperwork to transfer the ownership of the business. The process is more complicated than I had imagined. There are many options with gifting, family limited partnerships, self-cancelling installments, private annuities, and grantor-retained annuity trusts. Not only do I have to decide on how to divide the estate but also the best way to pass it on taking advantage of all of the IRS rules associated with business succession."

Appendix 1: Student Worksheet

Rock Crest Village Weekly Proforma Profit & Loss Statement Comparison
of Sales Volume at $10,000 and $7,000

                                    $         %   $
Net Sales                           $10,000       $7,000.00
-Cost of Goods
= Gross Margin

Expenses
-Gas
-Electric
-Telephone
-Garbage
-Insurance
-Labor-Taxes
-Repair/Maintenance
-Miscellaneous
-Rent and other contractual costs
  associated with lease
-Royalty
-Advertising
=Total Operating Expenses

-Loans/Administration
Net Profit/Loss

Barbara K. Fuller, Winthrop University

Table 1: Lease for Rock Crest Village
Terms of the Deal

Lease Terms:                        Commencing on the "Commencement
                                    Date" and ending Sixty (60)
                                    months thereafter except that in
                                    the event the Commencement Date
                                    is a date other than the first
                                    day of a calendar month, said
                                    term shall extend for said number
                                    of months in addition to the
                                    remainder of the calendar month
                                    following the Commencement date.

"Estimated Completion Date":        November 2005

Permitted use"                      Full Service, with a drive
                                    through, Subs by Design
                                    Restaurant.

Minimum Guaranteed Rental:          $3700.00 per month ($29.60 per
                                    square foot per year) in Years
                                    1-5.

Initial Common Area Maintenance     $125.00 per month ($1.00 per
Charge per month:                   square foot per year).

Initial Insurance Escrow Payment    $18.75 per month ($.15 per square
per month:                          foot per year).

Initial Tax Escrow Payment per      $62.50.00 per month ($.50 per
month:                              square foot per year).

Security Deposit:                   Two (2) monthly payment totals to
                                    be applied to the 1st and 36th
                                    month of the lease term.
                                    $11,100.00

Summary:                            Initial Minimum Guaranteed Rental
                                    ($3700/month) + Initial Common
                                    area Maintenance Charge (
                                    $125/month) + Initial Insurance
                                    Escrow Payment ($18.75/month) +
                                    Initial Tax Escrow Payment
                                    ($62.50/month) = Monthly Payment
                                    Total ($3906.25/month)