For normal people, the week between Christmas and New Years is one where they see family, vacation somewhere warm, or chase their kids around. Me? Apparently, I dive back into franchising rabbit holes.

December has been a month for orange (and not, not because I’m watching the Syracuse Orange in the Holiday Bowl while I write). Orangetheory, specifically. In the spirit of baby steps toward letting go of some of the “I’m not a person who” beliefs, I went to a group fitness class solo for the first time last week. I am a middle-aged suburbanite (always have been, it’s just age and location appropriate now) so naturally I prioritized convenience and parking availability, and went to the Orangetheory in the strip mall down the street from my house. I knew there would be some running, some lifting, some heart rate monitors, but I didn’t really know what else to expect, or who to expect. That said, I figured I could probably outrun pretty much anyone who showed up, and that would prevent the worst kind of sports injury – a bruised ego.

On what was an unrelated topic until the day-of, I happened to be meeting a multi-time entrepreneur for drinks later that day; one of his prior ventures was developing and co-owning some Orangetheory studios. Naturally, the conversation turned to the class, and he mentioned that one of the large franchisees was in financial distress. So that’s where we turn today. Unlike in Orangetheory classes where splat points are good, the “bug meets windshield” splat of a bankruptcy is anything but.

My Orangetheory knowledge peaked back in 2019, when I was at Charlesbank and trying to figure out where in multi-site fitness we should play. At that point, the brand had just hit 1,000 locations; franchise gurus Roark Capital made a growth investment in 2016 when the concept had just over 350 open locations, and under their ownership, a new studio was opening basically every day. If that sounds expensive, it was – which is why the franchisor relied on Master Franchisees (who found local operators and helped them open, kind of serving as a quasi-extension of the franchisor) and Area Developers, who had responsibility for opening multiple units in a large territory.

Naturally, as the capital needs expanded (an average Orangetheory location costs roughly $700k-1.6m to open these days), individuals couldn’t finance the pace of expansion, and private equity got involved. Enter Prospect Hill Growth Partners – the firm formerly known as J.W. Childs (name changed for uh, succession planning reasons) acquired a majority stake in Honors Holdings, in early 2018. Fast forward to 2024, and Honors, through a mix of de novo studio openings and acquisitions, operated about 140 locations across 13 states, and served as Master Franchisee for 60 others.

COVID obviously was right in the middle of that period, and it’s no secret that small box fitness, particularly in blue states, suffered. But Honors went into the red zone when others were slowing down – making over 20 acquisitions between 2018 and 2022. And because of the nature of franchise agreements where franchisors typically get a Right of First Refusal to acquire a franchisee’s business, and if they don’t use that right, they still get to sign off on the acquirer and the transaction before the deal can close. In other words, Honors Holdings only got this big with the consent of the franchisor – who probably saw them as a sophisticated operator with deep pockets to ensure brand standards and a consistent consumer experience would be maintained.

As boutique fitness were slower to return to full capacity, the logical thing to do would be to open fewer new locations and focus on recovering the unit economics of existing sites. This definitely has continued to present day – over the last few years, Orangetheory has only opened about 50 new US locations a year for the last three years versus the 300+ opened per year in 2018/2019, and the total Orangetheory system has roughly 1,300 locations in the US and another 200 globally. Layering the franchisor’s slower growth and Honors’ rapid growth, that meant that Honors accounted for just over 10% of total US locations and nearly 10% of total locations – and therefore about 10% of royalties to the franchisor. Those royalties, and Honors’ existence was cast into doubt in recent weeks, as an involuntary bankruptcy petition was filed against Honors by a former franchisee who sold studios to Honors but wasn’t paid the seller notes / installment payments they were owed. Involuntary bankruptcy petitions are rare and happen when someone else (probably someone you owe a lot of $$ to) decides you’re bankrupt, versus the more orderly and common situations where the company is effectively coming to terms with reality and filing themselves. Chapter 7 petitions, where the business is wound down are also quite rare in larger companies, relative to Chapter 11 where the business is typically restructured but remains operational.

Here’s where it gets a little complicated. Honors’ lender group includes WhiteHorse Finance, a Business Development Company (“BDC”, basically, publicly traded version of a mid-market private credit fund) affiliated with PE firm H.I.G. Capital. I am by no means an expert in BDCs but one thing that’s fun about them is that by reading their quarterly reports, you can figure out whether some PE-backed companies are headed into financial distress. In their November 7 earnings call, WhiteHorse mentioned putting the company on non-accrual (aka they stopped paying interest), and that they were working with the franchisor to restructure the credit (aka they probably needed Roark’s / Orangetheory corporate approval to take over the company). My take on the 7 vs. the 11 was that there was either something funky in the credit agreement or franchise agreement that led Whitehorse to think foreclosing on the franchise agreements and transferring them to an entity that they controlled was the most efficient path to taking control of Honors. This let some pretty spooky headlines around Honors going out of business get written, but if the Orangetheory subreddit is any judge, people were a little confused but mostly excited that this could lead to better customer service and studio maintenance.

Seeing very large franchisees in well-known brands teeter on the brink isn’t without precedent – NPC operated about one of every six Pizza Hut’s in the US before it went under, and a few large Burger King operators went under in 2023, due to a mix of labor inflation and slowing foot traffic. These size bankruptcies can be pretty impactful to the franchisor, who could stand to lose these royalties if they don’t either (i) step in to temporarily or permanently operate the sites or (ii) find someone else who will. But Burger King and Pizza Hut weren’t growth brands a few short years ago – which speaks to the more fickle nature of consumers of fitness and wellness, relative to consumers of pizza and burgers.

I come back to my class experience earlier this week – to my untrained eye, the Orangetheory experience is Barry’s but for the masses. Hence me feeling like I kicked ass in my first Orangetheory class, whereas Barry’s left me feeling a little more sore and a little less adequate (chalk that up to performance, vibes, clientele, whatever). And while Orangetheory’s addressable market is no doubt larger (hence the 1,500 units versus Barry’s 85), staying power at a premium price point might require a little more sex appeal than what Orangetheory is currently selling today. The “hardcore” concepts like Barry’s and Solidcore might never get to 1,000 units, but measured growth and catering to a relatively elite, loyal core seems like a great formula.  

Roark Capital seems to own half of the “A” tier franchisors in the US – and recently merged Orangetheory into their multi-site wellness platform that also owns Anytime Fitness, The Bar Method, and other concepts. To me – that signals some realization that Orangetheory isn’t a growth concept anymore, and instead needs to leverage the benefit of a broader shared services platform for cost-cutting and efficiency purposes. That certainly doesn’t mean the best days of the brand are behind it, but it does mean that I’d be hesitant to pay a high multiple for existing locations or sign up for a large commitment to open a bunch of new locations in existing territory.   

Thinking about this ordeal brought me back to my personal risk tolerance. I’d probably still consider an investment in an Orangetheory franchisee as part of an institutional private equity portfolio, and I’d still become the CFO of a franchisee. In those scenarios, the “worst case” scenario is that you get fired, either from your private equity firm when the investment goes south, or by the owner of the franchisee when the business doesn’t perform. But good-sized franchisees are still available for sale – and I’m no longer sure I’d wade in here with an SBA loan and a personal guarantee, when the downside there might be personal bankruptcy. But – who knows, I’ve got another week off work, so it might be time to keep digging in. And I bought a dozen classes, so I’ll be back at Orangetheory either way.