How to avoid business valuation traps

Paul Dodgshon, sales director of Business Partnership, advises on how to find the value of your franchise business, no matter your situation

Selling a franchise business can be a big step in someone’s life and one that needs careful consideration. The prospect of valuing your franchise can be daunting, especially if it is not making a profit, but there are plenty of resources to help you.

The main difference between valuing a franchise and an independent business is the franchise brand itself. The value of a global brand franchise like Burger King will be different to one like Camile Thai which currently operates fewer than 50 locations. Franchising by definition means your value is intrinsically linked with the master franchise brand and every other franchisor operating under the same brand. Put simply, a brand that is seen ‘on every street corner’ adds value.

When valuing a business or a franchise for the open sale market a multiple of net profit is often the most important guide. That multiple can very much depend upon the strength of the brand. The other matter franchisees have to consider is how much of that sale price ends up in your pocket as the owner.

A franchise sale will often incur other fees from the master franchisor to cover for vetting, approving and then training the new franchisee you are selling to. There will also be fees to any professionals you use – broker, solicitor, accountant – and maybe costs for a refurbishment to bring a retail site up to the latest brand standards. All these costs should be detailed in the franchise agreement you signed with the franchisor along with who pays for them.

So, here are my top tips for valuing your franchise and what traps to avoid.

Valuing a successful franchise

When it comes to valuing your franchise, the first thing to consider is whether the business is performing well or not. Determine the true net profit of your business by bringing your accounts up to date. Get both annual accounts and year-to-date management accounts to show a buyer what the profit is. It is hard to sell a business without these figures. ‘Trust me we are making money’ will not work for most buyers and certainly not their funders.

A broker would then apply a multiple to this profit. The multiple depends on several factors, including the brand strength, stability of the business’s cash flow and the forecasted business growth. A profitable business is usually valued at between one and five times the net profit.

If your master franchisor is selling new locations for a fraction of the price of your resale, you have to be able to demonstrate why. Such factors include how long you have operated, how good your location is, and how long it took you to get from a standing start of a new franchise to a break-even point. A new franchise may look cheap on paper, but there’s no immediate incoming cash flow and lots of set-up costs.

An existing and already profitable franchise has that income, so remind your potential buyers. Remember, franchise resale valuations are never exact, and your franchisor may have different expectations for the business, so the next step in the process is negotiation.

Valuing a failing franchise

Unfortunately, not all businesses succeed so how do you value a failing franchise? A good place to start is to find out the total cost of a new franchise, including the price of the business and any required investment in equipment or refurbishment of the building. This is an entry point for anyone interested in that franchise. And if you have a retail franchise, the good news is your unit may be more valuable than you realise. For example, good contracts and well-maintained equipment or other similar assets can help the price of a business.

If, however, your franchise is growing and the turnover is increasing but is currently unprofitable, you will need to provide some forecasts to show that the future is looking better. And if your business has faced temporary issues, such as roadworks which reduced footfall to the business, but is expected to recover to previous profit levels, you might take a 15 per cent discount from your valuation. You will then be expected to provide historical accounts and fully explain the situation to give the buyer a full understanding of the circumstances.

I recommend researching your industry and finding out what other struggling businesses have sold for. Whatever value you arrive at, don’t forget those additional franchisor administration costs. If that tips the balance of funds into a negative, you could also estimate the business’s liquidation value. Speak to a professional insolvency practitioner who can advise on this.

The valuation traps in franchising

Whether it is because someone is planning to take a step back, or ready to let go and try something new, almost everyone in franchising reaches the stage where they want to sell their franchise. It is crucial to carefully design your business sale so that you do not set unintended valuation ‘traps’, which could hinder the effectiveness and increase the costs of your transition.

1. Look at your franchise from a buyer’s perspective
When you have spent years of hard work and finances building your franchise, it is often difficult not to see your business through rose-tinted glasses. However, look at it from a buyer’s perspective. Forget that you know everything. Assume your buyer knows nothing. Ask yourself, if you were buying the business, would you be offering a top price or discounting it?

2. Profit is key
Another pitfall in the sales process is thinking your business is more valuable than it really is because it has a high turnover. Unfortunately, this is not the case. A franchise’s value comes from profits, not turnover. So, when setting an asking price, make sure you factor this in; otherwise, the likelihood of selling your business is massively reduced.

3. Do not be flattered
Try not to be overhasty when accepting a higher-than-expected valuation. If a great valuation is provided by a broker, question how it was arrived at. If you are offered a price which seems too good to be true, it often can be unachievable.

4. Free versus fee?
When it comes to having your business valued, you often have the chance to get either a free valuation or a paid-for valuation. Both have their place in the business world, but a paid valuation will go into much more detail, which is far more beneficial when it comes to something important, like selling your business.

5. Don’t pass on administration fees
Be clear if the administration sale costs from the master franchisor are to be paid by you. There may be some room for negotiating to split these fees, such as refurbishment to improve the business is for their benefit. If you can, that’s a bonus, but at the end of the day the profits of the business must provide the opportunity to repay a buyer’s total investment. Inflating the asking price will simply put people off enquiring in the first place.

Finding the value of your franchise is an intimidating process if you do not know what you are doing. So, I recommend consulting an independent business broker for advice when it comes to selling your franchise. It is also worth discussing the resale with an accountant or lawyer with experience in the franchise industry. They will be impartial and able to offer support during the negotiation discussions. By following these steps, you will be able to find the value of your franchise business, no matter your situation.

The author
Paul Dodgshon is sales director of Business Partnership. With over 17 years’ experience helping businesses sell quickly at maximum value, Paul understands the practical and personal issues involved in selling a business.