Financial Matters

by Craig Weston

last updated 18/05/2012

Craig Weston is a director of Inspired Business Solutions, chartered accountants of Auckland, who specialise in franchise work.

could I sell my franchise for?

by Craig Weston

last updated 18/05/2012

Craig Weston is a director of Inspired Business Solutions, chartered accountants of Auckland, who specialise in franchise work.
May 2012 - I own a franchise and am thinking about selling it. Can you give me any direction on who I could talk to regarding valuing an existing franchise?

A. The first thing I would ask if you came to me for advice is whether now is the best time to sell? We are currently at the bottom of the economic cycle (I hope!) and unless your business has been performing exceptionally well during the last few years, you are unlikely to achieve the level of return you might if you are able to hold on for a bit. There are business buyers out there, but at the moment many are looking for a bargain. If you have decided the time has come to sell, though, the better prepared you are with facts and figures, the more chance you have of getting a fair price for the business.

Every owner is always interested in what their business is worth. However, no one really knows the value until a purchaser has signed an unconditional agreement to purchase. This is a clear, unequivocal statement of the worth of the business to a willing buyer (assuming the vendor is not over-anxious or pressured).

Up until the time of that agreement, business valuations are somewhat subjective. However that subjectivity factor can be reduced by applying accepted business valuation practice. Just as one can find out the estimated value of a house before listing on the market, you can find out the estimated value of your franchise business prior to listing it.

People who can assist you include:

A chartered accountant who specialises in franchise work. Valuing franchises can be different from valuing non-franchise businesses. A known brand could add significantly to the value; for example, a franchised café may be worth considerably more to a buyer than an independent coffee shop. In many cases, the risk of failure in a franchise is lessened and therefore the sale price may reasonably be higher than a non-franchised business. These are factors that accountants inexperienced in franchising may not take into account.

A business broker who specialises in selling franchises. These people know how much franchises are selling for and may have sold the same kinds of franchise businesses in the recent past. They will give you their view on what your franchise is worth on the market.

Other franchisees who have sold their businesses recently. They may be willing to share their experience with you and how much they realised on sale. Remember that, even within the same franchise, each franchisee’s business will vary according to position, market, turnover, age of fittings and equipment and so on.

Your franchisor. At some point, you will need to tell your franchisor of your intention to sell, as there may be clauses governing the sale in your franchise agreement. For example, the franchisor will probably have to approve the incoming purchaser. By involving the franchisor early, they may be able to help you value the business through comparison with other re-sales and may even know of a possible buyer from among their list of potential franchisees.

In the case of the accountant and broker, they will be better able to assist you with your valuation if you make some basic information available to them. This information would include:

- Financial statements prepared by your chartered accountant for the past 2 years.

- Recent management reports prepared on your own accounting system.

- Copies of GST returns for the past two years.

- Franchise agreement.

- Lease agreement.

- Your understanding of how the wider franchise system is doing generally.

Speaking as a chartered accountant, here’s a word about your financial statements on which a valuation is often based. Frequently, these statements include (legitimate) costs which need to be removed for the purposes of a valuation. Examples include interest, tax, home office expenses, excessive motor vehicle expenses and perhaps a portion of shareholder salaries.

These kinds of expenses need to be added back to the net profit to show an adjusted ‘earnings before interest and tax’ (EBIT). Normally, as a rule of thumb, a valuation is then calculated by applying a multiple to this adjusted EBIT figure. In my experience, the multiple is usually in the range of two to four times EBIT; however I have seen higher and lower depending on the market, the industry and a host of other factors.

The business will also include hard assets such as plant, fixtures and fittings and stock. These comprise part of the sale price. The difference between the total sale price and the value of the hard assets is called ‘Goodwill’. Goodwill is intangible – you can’t physically see it like you can with hard assets, but it is often a big part of the price you pay for the ability to create future profits and give you a return on your investment.

A word of caution - often the historical information provided by a vendor shows a profit position that bears no relation to the price. In other words, the profit is poor but the asking price is huge! The vendor may explain that the potential of the business is massive and you need to pay for that. Well, if that’s the case why isn’t the vendor staying in to reap the rewards of all this potential? If you try to include such an element in the asking price, any well-advised purchaser will immediately discount it.

Determining the value of a franchise before a sale is an art, not a science. It is subjective and in the end the value is what a purchaser will pay. However, using the right advisors will assist you to come up with a realistic figure that will enable you to make an informed decision about selling. I wish you well with your sale.

Craig Weston is a director of Inspired Business Solutions, chartered accountants of Auckland, who specialise in franchise work.
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