Things I Have Seen and Learned
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Mike Manning
As a CFO, Adviser or Board Member for almost 20 years and a Gym Member for 35 years, I've seen a lot of good and a lot of bad in the fitness industry. What follows are a few things I have seen and learned:
Marketing as a Percent of Revenue - The most successful club chain in the industry today spends 9% of club revenue on marketing, and its EBITDA as a percentage of revenue at the club level is typically as high or higher than any other club's P&L I have ever seen. What do you spend on marketing? Good marketing more than pays for itself, but you eventually reach a point of diminishing returns. In my opinion, 4% of revenue seems like the low end of reasonable, and my friend Bill Hubner, who owned around 200 clubs over time, says 5% of revenue would be his minimum and that he used to spend 8%.
All Revenue is not Created Equal - Monthly recurring dues are the lifeblood of the industry and usually have a profit margin of over 90%. No other revenue stream matters nearly as much. Signing up as many new members as possible each month is the most important thing an operator can do followed closely by retaining existing members. Attrition can be controlled to a degree, but no matter what you do, members will pass away, move away or have financial difficulties that require them to drop out. My best guess is that maybe 1/3 of attrition can be prevented. Years ago, the CEO of a large club chain got so laser-focused on controlling attrition that the company got slack on signing up new members, and it did not end well. Selling prepaid memberships for 12 months or longer robs from the future to get you through the present and should generally be avoided unless there is a pressing need for cash. Enrollment revenue is great if you can get it, especially if you have a sales staff to pay, but it seems to have mostly gone away over the last 15 years in low- and mid-tier priced clubs with increased HVLP competition. Last year, I wrote an article for Club Insider that detailed how much I dislike annual maintenance or enhancement fees, which you can find in their Archives (www.clubinsideronline.com/archives). The more complex ancillary revenue sources become, the easier it is to lose money on them, but it should be hard to lose money selling bottled water and a small number of popular items. Selling clothing and having juice bars can involve a lot of work for no profit, but branded clothing can be a marketing expense if it is nice enough that members will wear it around town and promote your club.
Unaffiliated Personal Trainers in the Club - I see clubs that are really hard on members about not letting them be walked through a workout by someone who is not an employee of the club and wonder how much dues revenue they are costing themselves by chasing after lower margin personal training revenue because the members often get mad when confronted, cancel their membership and might take several of their friends with them. Sometimes, the person leading these workouts is just a friend or family member and no money is changing hands, which is a very different thing than having a professional non-employee personal trainer working in your club with your members. As a club owner, you probably already understand the difference in profit margin between monthly dues and personal training sessions, but do your club managers understand it? Do your personal trainers understand it? A member being walked through a workout by a friend will be just as angry at your club whether it is the general manager or a personal trainer looking for new clients who confronts them.
First Impressions Matter - Running successful clubs will always include having friendly and well-trained employees, keeping the club clean, maintaining the equipment and replacing or refurbishing the equipment on a regular cycle as it naturally wears out. Having someone friendly at the front desk who knows your members by name as they walk into your club can be one of your best member retention tools. Having dirty showers, a dusty gym floor or frequently being out of paper towels will hurt you because members talk about those things with their friends who might otherwise join your club. And, having worn out equipment when you are competing with a new club a mile away will hurt you badly.
Educating Club Managers - In the last few months, I've become aware of a club general manager in a good-sized chain who has gotten a bit out of control cancelling memberships. If you arrive a couple of times within ten minutes before the staff gets off work for the night, this manager will cancel your membership. If you are ten minutes late picking up your child from child-care even if the class you were taking started ten minutes late, this manager will cancel your membership. Bad business instincts and bad habits can sometimes be overcome with training from regional or corporate leaders, and this manager obviously does not understand the value of dues paying members and that every effort should be made to keep them and not cancel them. Sometimes, a manager needs to revoke a membership... But, the bar should be high, and the member should be doing something outrageous or putting other people in danger and not responding to interventions from management. Managers should be trained about how to have awkward conversations with members whose behavior needs to change, and many of them obviously have not been.
Fixing Messes - A business turnaround specialist I've met a couple of times at corporate governance conferences likes to say that, with enough time and enough money, any struggling business can be turned around, and I completely agree. But, time, money or both are often limited. Every situation that involves fixing a mess is a bit different, but history in the fitness industry tends to rhyme, and the same types of problems tend to pop up at different club chains over time.
Good vs. Okay Club Locations - When growing, signing a lease for an "A location" where the landlord will not negotiate on the rental rate or TI money is usually better than signing a lease on a "C location" where the landlord will drop rent significantly or offer a lot of TI money to get you in the space. This is because the landlord will usually drop the rent significantly or offer a lot of TI money to get you in the C Space, knowing the location is poor.
Site Selection Mistakes - A common way to get good at site selection is to make several mistakes that you learn from. It is much better to learn from someone else's mistakes and avoid making them yourself. A bad location caused by poor site selection is hard to turn around no matter how much money, marketing and talent you throw at it. The best thing about opening a bad location is that the lease eventually ends. Doing a few bad locations in a short time will badly hurt your ability to grow. I once did due diligence on an acquisition where the club chain had done 61 good clubs in a row before making its first site-selection mistake, which remains the best streak I have personally seen. Most chains I've looked at have had at least one site selection mistake in the first 15 clubs, and it is not uncommon to see several mistakes in the first 15 clubs.
Site Selection and Fast Growth - Founders of growing chains sometimes get cocky about site selection and will sign a lease for a challenging location because they are confident that they could make the location work if they were the general manager. They might be correct about that, but often, the talent level of newer general managers in a growing club chain is not comparable to having the founder in that new club, so it struggles. Growing and maintaining the manager pipeline is one of the biggest challenges growing club chains face. Holding out for A locations only almost always works better than taking chances on marginal locations.
Negotiate a Favorable Lease - A 10-year base lease with several extensions is better than a 15-year base lease with extensions because the surrounding demographics can change quite a bit in ten years, and you might want to end the lease after the base term. You can probably lock up the location for 25 or 30 years either way after the lease extensions are considered. I once talked a landlord into reducing the rental rate during the extension periods since the TI they paid us on the front was paid back in the base lease term, but landlords will fight not to do that since it impacts their ability to borrow additional money on the building as time passes. Ask anyway. What landlord would not want 30 years of payments on a loan that was paid back in ten years? Annual rent adjustments linked to CPI increases are something I always tried to negotiate out of leases. As we've seen the last few years, inflation can ramp up and stay high for a while. If a landlord insisted on annual rent increases, I always tried to stick to fixed dollar increases of 2% or less to protect against rapid inflation, especially since I've never been a fan of increasing monthly dues pricing for existing members.
Personal Guarantees - Personal guarantees should be avoided, but they can be hard to get out of if you need your landlord to give you a lot of TI money to get the club built. After you have half a dozen clubs up and running, the business should stand on its own with no personal guarantees from you to landlords. Hold firm, and many landlords will back off the guarantee. And, it will not kill you to walk away if they do not back off. Any personal guarantees on leases should end when the base lease ends and not carry forward to any negotiated lease extensions, but you cannot blame landlords for asking. Unless you have a good lawyer when negotiating your leases, any personal guarantees you give landlords on leases will not necessarily go away if you sell your company before the lease ends, and that needs to be negotiated before the lease is signed. A buyer of your clubs assuming your personal guarantees on leases in a purchase agreement does not mean your former landlords cannot come after you if the buyer later defaults on the leases or bankrupts. Avoid personal guarantees to lenders and business partners, too. After 10 or 12 clubs, the bank should not need your personal guarantee, but they will keep asking for it. Get good at saying "no" when someone asks you for your personal guarantee.
Get a Good Attorney - Paying a higher rate to get a good attorney will save you money in the long run because a mediocre attorney who charges less will eventually get you in trouble that will cost you a lot of time and money to get out of.
Surround Yourself with Smart People - Try to figure out what you do not know and find people to work for you who are good at those things. No one is good at everything.
Private Equity: Is it right for you? - Once you reach a certain number of clubs, if you are doing well and creating wealth, you will attract interest from Private Equity ("PE") groups. Like CFOs, salespeople and any other profession, some PE professionals are much better than others, and it is not always easy to tell the difference before the money moves. The best PE professionals will understand what they know and do not know about your business and seek to help you in the areas you probably are not as good at, like continually raising significant money to grow while minimizing equity dilution for the shareholders. If they have good business instincts, they might even have a few ideas that are beneficial to the operation of your business, and they will keep a cool head in a crisis. The worst PE professionals might be described as "educated idiots" who do not understand what they do not know, will fight with you about things that do not matter or things they do not understand, and might not handle a crisis well. Many PE groups will insist on taking a majority equity interest in your company, but some will take a minority equity stake in your business that comes with a veto of significant actions you might want to take and might include a put option they can exercise to be bought out at a future date with a certain guaranteed rate of return. There are advantages and disadvantages to doing a minority equity deal, but if you do one, you need to achieve the agreed growth plan or the value of PE group's equity can grow while yours shrinks. If you give up voting control, the PE group generally needs to have the same class of stock that you do when the deal closes. If you give up voting control and the business experiences some turbulence, your PE partner can terminate you, which more than a few fitness industry CEOs have learned the hard way. There are a few PE investors who have invested in the fitness industry, made a lot of money and still do not understand how the industry works, but they were smart enough to stay in their lane and enjoy the ride.
Learning About PE - I have a hard time thinking of a large successful company in our industry today that has not had PE backing, so if you want to grow to have 100 or 1,000 clubs, you probably need to start educating yourself on how PE works. Hopefully, the HFA will find someone strong to continue to do the financial panels at the trade show that Rick Caro did so well for so long because they were a great way to meet PE groups who invest in fitness and learn about what they look for and how they see the industry. Talking to operators whose PE deals went bad can be just as if not more educational than talking to operators whose deals went well. If you are considering bringing on a PE partner, ask them about deals they've done that went sour, and try to track down and talk to the operators of those deals to understand what they think went wrong. If they've been investing for 20 years and tell you they've never had a deal go bad, chances are they are conveniently forgetting at least a couple. I would not rule out hiring a psychologist to do some personality profiling of both the PE professionals who will be involved in your company after the deal closes and yourself to estimate how well you will work together because bringing in the wrong partner can be disastrously wealth destroying for you.
Doing a PE Deal - If you are doing a PE deal, you want an attorney who spends most of their time representing clients in securities transactions. Your local attorney who has helped with three PE deals in the last 15 years is probably not who you want representing you because the PE group will have a big city lawyer who sees securities transactions every month and knows exactly what they are doing and asking for when they draft the agreements. Your attorney needs to be as good and as experienced as their attorney. You also want a good investment banker to shop the deal to multiple equity groups whose investment criteria match where your business is at the time, and Rick's financial panels were great for meeting investment bankers, too. Do not necessarily jump at the first PE group that approaches you because they were introduced to you by someone you admire who made money with the same group several years ago. I've seen that blow up, too.
Attend the Trade Show - Go to the HFA Trade Show every year if you can. Meeting people who can give you independent references if you are thinking about switching operating systems or can help you think through other big changes you might want to make is worth paying for the flight, hotel, transportation and food to attend. A PE professional who invested in a couple of different club chains once told me that he thought most fitness industry CEOs were pathological liars (which we'll assume does not apply to subscribers of Club Insider), so while participating in peer roundtables can be incredibly useful, those buddies you see a few times a year might be less honest about something they've gone through than the CEO of a larger chain you meet at the show. More potential references are better. I usually learn something, see something new or meet someone interesting walking the show floor each year. Attending Rick Caro's Financial Panel was always time well spent. You can learn a lot at the trade show by meeting and listening to people who have owned clubs for 30 or more years. They've seen the industry evolve in ways that would have been hard to predict in 1990, have survived several recessions and are often happy to talk.
