17 Apr Franchise Valuations: Critical Insights to Consider
Written by: JoAnna DiCicco, CVA
(5 – 6 minute read)
Analysis Required in Valuing a Franchised Business
While valuing a franchise business may seem similar to any other small business, additional analysis is required. Typically, additional information is readily available for an Appraiser and should be utilized to better assess the company. Furthermore, it is important for the appraiser to understand the unique differences of each individual franchise.
Franchise Disclosure Document Analysis
The Appraiser should always attempt to obtain a Franchise Disclosure Document. This document will provide expansive information about the franchisor, required fees, franchisee performance, and much more. The Franchise Disclosure Document should be analyzed in its entirety as each individual franchise may have certain guidelines, processes, or requirements that are unique to its operations (i.e. certain franchises require a manager to be present in addition to the current owner).
For purposes of valuing a business, the below sections of the Franchise Disclosure Document are closely analyzed and considered within the report.
Item 6 – Required Franchise Fees (Royalty, Marketing, etc.)
The following table has been extracted from Item 6 of a Sample Franchise Disclosure Document and details required fees for franchisees:
As can be seen in the table above, a franchisee is required to pay ongoing royalty fees of 8% of gross sales, and ongoing advertising / marketing fees of 3% – 4% of gross sales. If the Appraiser’s analysis of the subject company’s financials reflects royalty or advertising/marketing fees that are higher or lower than what is required based on the Franchise Disclosure Document, this should be questioned further. The Appraiser should confirm whether a hypothetical buyer would continue to incur royalty and marketing fees at a similar rate to the subject company (with supported reasoning) or if a hypothetical buyer would incur fees as stated in the Franchise Disclosure Document. Adjustments to cash flow should be made accordingly based on the response and the expectation of the expense for the hypothetical buyer.
Certain franchises or franchisees may report sales net of royalty expenses. As such, it is important for the Appraiser to obtain understanding of the accounting practices for each individual business. This is a more common practice across franchises rather than individual franchisees and should be paid close attention to when adjusting for royalty expenses.
Item 19 – Financial Performance
The following tables have been extracted from two Sample Franchise Disclosure Documents:
Item 19 data usually includes revenue data, including but not limited to, the high, low, average, and median revenues of mature franchisees that were open for at least a full calendar year. In certain cases, it will also include data for COGS, gross profit, certain expenses, EBITDA, or operating profit. The Appraiser should analyze the subject company’s metrics in comparison to all available franchise data to determine whether the company is performing better, worse, or in line with other franchisees.
This information is not always available for all franchises; however, it is very helpful in analysis when the information is available to the Appraiser. This information can impact whether the subject company should receive a higher or lower multiple based on its comparison to other businesses within the same franchise.
Item 20 – Outlets and Franchisee Information
The following portion of a table has been extracted from Item 20 of a Sample Franchise Disclosure Document
This table details the businesses open at the start of the year along with how many have been opened and terminated during this year. This assists the Appraiser in analyzing the growth of the franchise and what impact this may have on brand recognition and demand.
Franchise-Required Renovations and Responsible Party
Certain types of franchises (specifically restaurants or businesses with a retail storefront) may often have franchise-required renovations. Renovations may include minimal items such as signage updates and painting a new color scheme or can be more extensive to the point of an entire re-theming or re-branding. Sometimes renovations and/ or remodels may be mentioned in the Franchise Disclosure Document (similar to the below blurb extracted from the Sample Franchise Disclosure Document):
However, most often, this information must be directly requested from the current owner. It is important that the Appraiser obtains information on the date and cost of the last franchise-required renovations in order to anticipate any potential upcoming renovations. The Appraiser must also obtain information on any known franchise-required renovations in the future.
If there are renovations required, the Appraiser must determine who is responsible for the costs of the renovations, what the costs will be, and the date by which the renovations must be completed. If the cost of the renovations will be incurred by the Buyer, these costs must be factored into the business valuation.
Conclusion
The overall value and earnings multiple of franchised businesses tend to be higher than those of independent or “mom-and-pop” type businesses (all else considered equal). This can be attributed to the brand recognition advantage that franchised businesses hold, which helps increase popularity and, in turn, drive demand. Additionally, franchises have processes to be followed that have already proven to be successful. They offer training for franchisees, which allows for a smooth transition to a Buyer, along with assistance in administrative tasks that may not be available to an independent business. Due to the continued involvement and oversight of the franchisor, these types of businesses generally receive higher multiples than non-franchised businesses within the industry.