Earnings Claims of Top Franchises Revealed

Earnings Claims of Top Franchises Revealed

  • Anytime Fitness
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No, thanks. I'm not interested in uncovering the actual earnings of hundreds of franchises at this time.

Franchise Chatter Guide: Factors to Consider When Selling Your Franchise

by Daniel Slone on April 22, 2014

in Franchise Chatter Guides, Selling a Franchise



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This Franchise Chatter Guide on selling a franchise was written by Daniel Slone.

I have previously discussed the mechanics of buying an existing franchised business as an alternative to establishing a new franchise, especially in systems that are mature and have few open markets remaining. I have also discussed business valuation, mostly from the point of view of the buyer. Now it’s time to look down the road and contemplate selling a franchised business that you’ve built.

It’s an old saw with a lot of truth: Sellers tend to think something is worth more than it actually is, and buyers tend to think it is worth less (or at least are willing to pay only so much). Bringing the two sides together is the art of the deal, but naturally no one wants to end up on the short side of any such deal. Here we’ll consider aspects of the buyer’s perspective to keep in mind while helping you position your business to command the best price.

Risk Premium: It’s Not Just for Investors and Lenders

If you happen not to have encountered the term risk premium before, you probably have and just don’t realize it. The fact is that if you’ve ever taken out a loan or invested in a bond, you’ve experienced risk premium. If you’ve done both, you’ve experienced risk premium from both perspectives.

The basic premise of risk premium is that someone who has money they would like to use to make more money has many options available to them. This is true whether that “someone” is an individual, a bank, a business, a hedge fund, or even a government.

But any possible use of that money to make more money carries some degree of risk, even if that risk is miniscule. A bank that makes a loan might not be repaid. An investor or hedge fund might pick the wrong investment and lose some or all of what they invested. A business might put money into launching a new product line or building a new factory or opening ten new stores only to have the marketplace, economy, or business environment change to its detriment.

So the very first question is: where might one put money that carries no risk of loss? What about a bank savings account or money market? Well, those are pretty close to risk-free, at least assuming you don’t exceed the FDIC-insured limits at any one bank. But to describe current rates of return as “anemic” would be charitable—the sort of charitable that would have made Mother Teresa envious if envy weren’t a deadly sin.

A better alternative—and, as it happens, the generally-accepted benchmark for risk-free return—is U.S. Treasury bonds: the sovereign debt of the United States, backed by the full faith and credit of the U.S. government. Now, while statements like that might elicit sniggers or cynical rejoinders, or even reminders of past debt rating downgrades, the fact is that while America’s fiscal house may be in some degree of disorder, compared to the rest of the world it’s still the best bet.

As I write this, the interest rate on the 10-year Treasury note is 2.628%, and on the 30-year bond it’s 3.460%. (That simple fact is itself informative; the 30-year bond yields almost a third more than the 10-year note because it’s harder to predict conditions 30 years out than 10 years out—that is, the risk is greater.) So it’s possible to do nothing more complicated than invest in Treasury bonds and earn in round numbers 3% with as close to no risk as you’ll find in our imperfect world.

With that in mind, let’s go back to that hypothetical business that’s considering some form of expansion. What if building that factory will cut production costs and improve net profits, returning 5% on the amount spent? That’s reasonable—the company knows very well and in great detail what its production costs entail, the cost of the factory and the equipment is pretty predictable, and not many of those factors are likely to change significantly, making the overall risk of the endeavor low—so a mere 2% above the risk-free rate of return is probably acceptable.

At the other end of the spectrum, what about launching a new product line? Depending on just what that product is, how similar it is to other products already in the market, and overall market conditions—including how easily a competitor could roll out a similar product—a new product could be very risky indeed. The company might require an 8%, 10%, or even greater return on investment in order to make that move.

It’s no different for a bank making a loan. The greater the credit risk the borrower represents, the higher the interest rate will be. The presence and nature of any collateral also plays a part, which is why the rate on credit cards (entirely unsecured) is higher than the rate on car loans (there’s collateral, but it’s highly mobile and depreciates relatively quickly) is higher than the rate on a mortgage (it being rather difficult to relocate a house).

So why have I beaten you up for seven paragraphs about risk premium? Well, selling a business means asking someone to invest money. The degree of risk your business represents will directly impact the selling price—and you need to understand the buyer’s perception of risk.

Who Says My Business Is Risky?

The financial marketplace sets bond and interest rates and stock prices through the actions of millions of individual participants each assessing risk. Businesses are rather less straightforward, unfortunately. So what are some risk factors a buyer might consider?

Track record: How long has your business been established? If you start your very first company and walk into the bank to apply for a loan without having sold the first widget or signed the first client, the response may be less than welcoming. If you walk in with ten years of solid financial statements, you’ll probably come out much better. The buyer wants to know the same thing. You can talk about how great the company or the concept is, but what can you prove?

The organization that employs me frequently buys distressed multi-restaurant operations and rehabilitates them. It takes time to turn things around, and having two years of losses followed by six months of profit won’t inspire confidence in most buyers. Sometimes it is necessary to keep a business longer than you might like in order to improve the numbers and sell for more at a later time.

Results: Yes, buyers certainly want to see profitability (or at least the potential for profitability, but hopefully you’re not selling a distressed operation!), but there’s more to it than that. First, how volatile have your financial results been? If you swing from profits to losses month to month, quarter to quarter, or year to year (aside from normal seasonality if that applies), those profitable periods probably won’t inspire much confidence.

Second, if your profit margins have been tissue paper-thin, any disruption could quickly drive the business into negative territory.

And finally, have your bottom-line numbers been affected by any extraordinary factors? For example, one of my organization’s companies sold and leased back several restaurants over the course of several months, producing gains on the sales close to two million dollars. But no buyer should care about that—those restaurants can only be sold once, after all. On the other hand, if extraordinary items have negatively affected your financials—say for example that you caught up a bunch of deferred maintenance, retired a significant amount of debt, or sank money into renovations—you should make sure the buyer understands that as well.

Strength of the brand: This is where the double-edged sword of franchising comes whistling through the air, maybe aimed at your neck, maybe aimed at your opponent’s neck. (Sorry—too much Game of Thrones, I suppose.) Being part of a franchised brand can be a great thing when that brand is strong, growing, well-established, successful, and so forth. Being part of a franchised brand can be a burden when that brand is dated, shrinking, failing to innovate, being out-competed, or small. The problem is that you don’t control any of those factors. Regardless of how well you run your own operations, the brand can be an albatross around your neck.

If the brand is in decline, sometimes the decay is visible from the outside, and sometimes the signs are more subtle. Systems owned by publicly-traded companies must by law make much information available to the public, and the franchise disclosure document also contains important data. If the decline is mostly inside knowledge, you’ll probably want to shy away from buyers who are existing franchisees of the system—they’re going to want a bargain price on your business, if they’re willing to buy at all.

Franchise-related costs and requirements: Your franchisor has the say in several important areas. What are your royalty and advertising fund contribution rates like? What is the transfer fee? What is the renewal fee, how long is the franchise term, and how long is left on your current agreements? Are you required to buy certain product categories from certain suppliers? These are all considerations the buyer will have to face if he or she buys the business, and they all carry a cost.

Common business factors: A savvy buyer is going to consider basic characteristics of your business that are not specific to franchises. Is the business highly seasonal? How hard is it to find (and keep) key employees? Are insurance costs high? Is a large amount of inventory required? How many competitors are there, and how crowded is the marketplace? Are there significant barriers to entry for new competitors? Does the business use or rely on technology that is rapidly changing? You can probably think of twenty more without much effort.

All of these things taken together produce a composite level of risk associated with your business. The relative level of risk will determine what degree of discount off the fundamental business valuation the buyer will expect.

Finding the Right Buyer

Others have said it many times before, I’ve said it before, and I’ll say it again: Being a franchisee is not for everyone. What’s ideally required is sort of an odd hybrid between an entrepreneur who can think creatively, innovate, market aggressively, assess risks and make decisions, and be proactive, and a businessperson who can do all of those things within the constraints of an existing business model, product or service line, and marketing plan.

The classic iconoclast entrepreneur who is out to break all the rules and remake the marketplace—and who is actually quite rare—will not be happy as a franchisee, nor for that matter particularly successful. There’s a reason the International Franchise Association has a special program for veterans, after all: military personnel have to work within the confines of a system, mission, and command structure, yet must also take ownership of the missions and units entrusted to them, innovate quickly in the face of complications ranging from enemy action to logistical snarls to natural challenges such as weather and terrain, and above all be decisive.

Make certain your buyer understands this. In all likelihood he or she does, but for some the evaluation of a business purchase doesn’t fully take into account the nature of franchising.

There are significant advantages to selling to existing franchisees of your system. One is that the franchisor’s approval process (remember, they have the right to approve or reject your buyer) is typically expedited. Another is that the buyer already understands in detail the nature of the operations, which is particularly helpful if you’re in a niche market and saves you the process of educating potential buyers about the business. Existing franchisees are also very accessible through franchisee associations and conventions.

Your other options are to hire a business broker or try a “For Sale by Owner” approach. The pros and cons are very similar to hiring a realtor to sell your house or doing it yourself. You’ll spend a lot of time pursuing leads, dealing with potential buyers, and answering due diligence, and you’ll have to filter out the “tire kickers” yourself, but you’ll save the commission. Only you can decide whether eliminating that cost is worth your time and effort.

Focusing on the Numbers

Any buyer will base much of the buying decision on your financial statements. Several requirements are implicit in that.

Ensure that your financial statements are clean, easy to read, logical, and generally adhere to accepted accounting principles. You’re not filing a 10-K with the SEC here (and be glad you’re not), so you needn’t worry about every minor accounting rule (in any event, your accountant should have fixed whatever needed to be fixed at tax-filing time). But easily understood financials increase everyone’s comfort level and portray you in a positive and professional light. The more questions the buyer (or more likely, the buyer’s CPA) has to ask about your financial statements, the more they might start to wonder just what it is you’re hiding, or at best whether the numbers are even reliable.

It may be helpful to recast your financial statements in a format that makes it easy to determine EBITDA (refer to the article on business valuation if needed) and also to remove any extraordinary items that won’t apply to the buyer. If you pay yourself a hefty salary, isolate that so that it can be backed out—that’s money that will fall to the bottom line for the buyer, or at least needs to be evaluated in terms of the buyer’s specific circumstances. As another example, we have a holding company that pays all above-store-level management for our restaurant companies and employs the corporate staff that provides accounting and other administrative support. In return, the restaurant companies each pay a management fee to the holding company. That is an expense that would not apply to a buyer.

Finally—and I shouldn’t have to say this, but it bears saying—be honest. Attempting to mislead a buyer through creative accounting or outright deception is likely to be discovered at some point, probably during the due diligence prior to the purchase, and needless to say it won’t endear you to the buyer or do much for your reputation. If the purchase goes through, material misrepresentation in violation of the purchase agreement will probably bring you some very ugly and very costly litigation that you are unlikely to win.

Building a successful business really has one of two ultimate goals: handing the business down to your children or selling it. If you choose the selling route, be smart (and patient) in positioning your business to command the best price. Understand what makes your business especially valuable, and understand equally well what its limitations are. Identify the right buyer, and make that person understand why and how the business can benefit him or her. There’s more to it than just hanging out a “For Sale” sign and slapping a price tag on the company—this should be selling as a process, not an act.




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