The year was 1961. JFK was president. Yuri Gagarin became the first man to orbit the earth. Freedom Riders risked their lives to end segregation in the South. West Side Story won the Academy Award for Best Picture.
And an obscure Chicago salesman named Ray Kroc borrowed $100,000 from Swarthmore College to help him gain full control of the fledgling McDonalds Corporation.
How Swarthmore got in the burger business is the subject of this story-a business legend that deserves to be retold. We are indebted to John Love's fascinating book McDonalds: Behind the Arches (Bantam, 1986) for the substance of the tale.
Kroc, a once-struggling salesman of everything from Florida real estate to milk shake mixers, died a billionaire in 1984. He neither conceived the drive-in, take-out restaurant nor invented the cooking and service system that became the standard of the industry, but he had the vision to market and franchise the successes of Dick and Mac McDonald, whose San Bernadino, Calif., hamburger stand had pioneered "fast food."
Kroc was 52 when he contracted in 1954 with the McDonald brothers to become the exclusive franchiser of their name and system. The first franchises sold for $950 (you need a minimum of $75,000 today), and by 1960 the McDonalds had opened 228 stores, a modest but respectable number in a competitive business that included start-ups like Bob's Big Boy, Burger King, Burger Chef, and A&W-not to mention long-established national chains like White Tower and Howard Johnson's. Under the contract the McDonald brothers got 0.5 percent of sales, or $189,000 in 1960 on sales of $37.8 million. (The same percentage of sales in 1995 would have netted $150 million.)
For the first seven years of the agreement, Kroc didn't draw a penny of salary, but determinedly put together a new approach to franchising. McDonalds sold only single stores, not regional territories, ensuring that the company could control the opening of every new outlet. Kroc also set and enforced quality and service standards that were unknown in the industry, from speed of service to the moisture content of french fries to the famous promise of a 100-percent beef hamburger.
Most importantly Kroc decided that his company would make money only on a percentage of sales, not by forcing outlets to buy food, equipment, or supplies from a central source. His idea was that individual franchisees had to prosper for the McDonalds Corporation to make money, and he committed the corporation's resources to improving the product, training the franchisees, and promoting the idea that fast food could actually be good food.
Then there was the real estate-and that's where Swarthmore comes in. You didn't think the College would invest in Big Macs® and fries, did you?
In 1960 Kroc's corporation had turned a paltry profit of $77,000, less than half of what was paid to the brothers in California. But the company's net worth had jumped from $24,000 in 1958 to $16 million in 1960, mostly as a result of Kroc's "extremely silent partner," a financial wizard named Harry Sonneborn. Sonneborn had hit on a way of building assets that was virtually independent of the "millions sold" slogan touted by Kroc's marketing people. He proposed buying the ground under the stores and leasing it to the operators. Sonneborn, no burger evangelist like Kroc, "viewed the food service business as a vehicle for making money in real estate."
McDonalds was at the leading edge of the suburban boom of the '50s and '60s, and Sonneborn began to acquire valuable property by using franchisees' security deposits as downpayments and charging store owners "rent" that financed the company's purchase of the land. The minimum monthly fee was a 20- to 40-percent markup of McDonalds' cost, and additional fees were charged if sales went over a certain figure. Since many McDonalds franchises were instant moneymakers, Sonneborn not only covered the company's "investment," he began to generate land-office profits that were basically independent of burger sales. "His idea is what really made McDonalds rich," said Kroc some years later.
But back to 1961: While Roger Maris was smacking 61 home runs and everyone was watching Gunsmoke, Ray Kroc decided he had to buy out the McDonald brothers. Dick and Mac insisted on a cash deal of $2.7 million, and Kroc was strapped. While the company's assets were growing, it had already incurred a debt of $1.5 million from two Boston insurance companies that had exacted 22 percent of McDonalds stock. So Ray Kroc and Harry Sonneborn went looking for money-big money. Through his Boston investors (who couldn't cough up another dime), Sonneborn met the late John Bristol, a legendary investment counselor whose accounts included Princeton University's then-$100 million endowment, plus the funds of such other private schools as Howard University, Colby College, and Swarthmore.
John Love's book tells it best:
"Bristol was fascinated by Sonneborn's concept of mixing real estate with hamburgers. `Harry was very impressive to an investment man,' Bristol observes. `He got across the idea that McDonalds was building substantial value in real estate and that the franchisee was on the hook to lease property ... for a much longer period than it would take McDonalds to pay off its real estate purchases.' ... Sonneborn had been searching for old-line Eastern money for more than three years, and in John Bristol he found it in spades. Here was the type of money that had been earning interest for at least a half-century, and Bristol was about to introduce it to the world of fast food."
All that remained was for Bristol to convince his conservative clients. It wasn't easy, but he sweetened the deal by insisting on a bonus plan as part of the loan. In addition to six percent interest, the investors would get 0.5 percent of McDonalds' sales (the same amount Kroc was paying to the brothers) for an additional period equal to the time it took McDonalds to pay off the $2.7 million loan. Thus if the loan were paid off in eight years (which was Bristol's estimate), McDonalds would pay the sales bonus for another eight years.
Kroc and Sonneborn thought they had the perfect deal. They didn't have to give up any more stock, the bonus payments were no worse than they were paying to the brothers, and they would own the whole Happy Meal,® toy and all. But there was one more hurdle.
A committee of Bristol's clients balked at lending money to an upstart food service company. Sonneborn flew overnight to New York to try to salvage the loan. Bristol, it is said, bought him a shave and a new suit before introducing him to the skeptical endowment managers. "We are not basically in the food business. We are in the real estate business," argued Sonneborn.
Somehow it worked. Princeton put up $1 million and 11 other clients split the rest. Bristol predicted that McDonalds might eventually have 1,500 units nationwide, but his estimate was far below the actual performance of the company. McDonalds paid off the loan in five and a half years, and Bristol's clients eventually realized $14 million from the loan.
Four years later, Swarthmore invested in McDonalds common stock when it first went public in 1965. A $2,250 (100 share) investment in the company in that year is worth nearly $1.7 million today.
It's been said that the Quakers came to Pennsylvania to do good, and they did very well indeed. Like many old jokes, this one is based on truth. Swarthmore College's investment strategy has also done very well. According to Charles Mott of Bristol & Co., one of Swarthmore's current endowment fund advisers, the McDonalds investment is an example of the long view taken by the College's money managers. "It's a great symbol of the culture of stewardship of the endowment," he says, "a culture that's been constant through time-a recognition of the need to grow the assets to enhance the educational program. It was a risk, but though things change suddenly, sometimes wildly, Swarthmore's approach has been consistent."
Thirty-five years after Harry Sonneborn convinced John Bristol to buy into the burger business, McDonalds stock is the second largest equity, after Intel Corporation, in the College's $640 million endowment. And financially as well as academically, Swarthmore remains in the top rank of colleges and universities, not only in terms of endowment per student (sixth in the country in 1995), but in terms of total return on investment, which has averaged more than 13 percent over the past 10 years-third among 95 schools. And if a new Ray Kroc comes to call, you can bet the College just might listen.
Equity Shares Mkt.Value
Intel Corp. 101,900 $9,725,081
McDonalds Corp. 193,900 9,186,013
Fed. Nat'l Mtg. Assoc. 242,000 8,439,750
Pepsico Inc. 296,700 8,381,775
Amer. Int'l Group Inc. 82,250 8,286,688
Coca Cola Co. 106,300 8,155,263
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