How To Determine The Current Value Of An Existing Franchise
Owning a franchise is often an attractive option for entrepreneurs. Factors such as brand awareness, corporate training, and franchise purchasing power are a few of the benefits that seemingly give franchisees a leg up over individual business owners. With that said, not every franchise location is a clone of its peers, with myriad factors capable of influencing the value of a specific location. Therefore, whether you are an owner looking for advice on how to sell a franchise or an entrepreneur looking to explore the benefits of becoming a franchisee, the following 5 methods can provide helpful insights into the valuation of an existing franchise.
Start with the Balance Sheet
When looking into how to value a business, any preliminary efforts will likely start with the balance sheet. The balance sheet is a breakdown of the business’ assets and liabilities.
Often referred to as the “book value” of the business, the assets of a business will include items such as real estate, buildings, vehicles, equipment, and anything else that could be sold to obtain cash. Liabilities will include items such as loans, accounts payable, mortgages, and any other outstanding debts that the business may owe.
With the exception of land, assets can be depreciated and written off for tax purposes, making the net assets of a business look quite small. In addition, the balance sheet does not concern itself with the ongoing revenue potential of a business, so it is far from a complete picture of what the business is worth.
However, for franchises that have a lot of specialized equipment–such as restaurants–with most of its assets paid off, the balance sheet is an important document to dissect when preliminary valuations are conducted.
Revenue is one of the most controversial statistics for assessing business valuation. Some entrepreneurs find it completely irrelevant, while others feel like it is the single most important metric for determining a business’ growth potential.
Revenue is simple to analyze: it is the total value of all goods and services sold by a business. It is the amount of money brought into the business before factors such as cost of goods sold, wages, warehouse expenses, etc. are taken into consideration.
A business may have enormous revenue but very little profit. The grocery industry is a good example. Grocery stores sell a lot of stuff and accumulate enormous revenue each month, but the cost to generate this revenue is extremely high, with final profit margins usually hovering around 1%.
For this reason, revenue is more applicable as a valuation metric for smaller franchises looking to increase market share. If there is a pattern of increasing revenue each year, the buyer can feel confident that more customers are turning to the business, with profit margins to be optimized with improved management.
Use an EBITDA Multiple
An EBITDA multiple is a widely used technique for quickly assessing a business’ value. EBITDA is earnings before interest, taxes, depreciation, and amortization.
These items are excluded from earnings because they will differ between the buyer and seller, so EBITDA is a more fair starting point for the buyer and seller to assess the franchise from their unique perspectives. For example, if the seller has most of his or her debts paid off, interest expenses will be very low. However, the buyer may have to utilize significant leverage to make the purchase, causing his or her interest to be sky-high.
Common EBITDA multiples are three or four. However, they can be as low as two or as high as five, depending on what type of business valuation calculator is used.
Analyze the Cash Flow Generated
The cash flow multiple is arguably the king of business valuation techniques. Many of the other metrics for assessing a franchise’s health can be manipulated for tax purposes. However, at the end of the day, any business owner is primarily concerned with the amount of free-and-clear cash that the business generates.
Revenue may look enormous, but if most of the revenue is created via credit or installment purchases, that revenue can be difficult to convert into ready cash. On the flip side, income may look small, but if an owner is writing off depreciation and business expenses, such as company cars or owner wages, the actual cash potential of the business is much higher.
The cash flow statement factors in these circumstances, with many buyers valuing the business at five times its yearly cash flow.
Study the Sale of Comparable Businesses
Finally, after all of the metrics of the specific franchise have been picked apart, it is often helpful to take a look at the sale of comparable businesses before arriving at a final figure. This is usually much more helpful for franchises than private enterprises, as there are often many apples-to-apples comparisons on which to draw.
The franchise itself usually can help the franchisee through the sale process by providing a robust list of comparables. After analyzing these figures, a valuation can be made for a specific store based on factors such as location and management.
5 Methods for Helping Determine the Value of an Existing Franchise
There are many benefits of becoming a franchisee of an established brand. However, despite the established presence, not every franchise location is as valuable as the next. Therefore, careful assessment of the balance sheet, revenue, EBITDA, cash flows, and comparable sales are all critical factors for determining the current value of an existing franchise.
Sam Willis is a business and finance writer that focuses on helping small business owners increase the value of their business. He specializes in topics related to business valuation, business management and business acquisitions.