Starting early and gathering the right documentation will help you determine the value of your brand.
Franchisors exploring the idea of selling their franchise system have their work cut out for them when determining how much their business is worth. With the right amount of preparation, though, the valuation process can run smoothly.
1851 Franchise spoke with two experts who frequently work with franchisors looking to sell their franchise systems: Christian Thompson, a managing partner with the Franchise & Business Law Group, and Saul Komisar, a consultant with Transworld Business Advisors. Here are their best tips for brands beginning the valuation process.
Komisar noted that while his company works with franchisors any time they want to sell, the earlier they can help, the better. Whether a sale is happening in one month or in ten years, “the earlier they start preparing for that day, the better off they’ll be.”
Thompson recommends starting the valuation process three to five years in advance.
“Before getting to the exact value, it’s a good idea for a franchisor to start the process a few years in advance,” he said. “The amount of money that the franchise system brings in is only one determining factor, and a lot of things can affect whether that stays in place or goes away. A savvy buyer will look at factors other than just the royalty stream and the profit and loss statement. Franchises are unique because there’s so many variables that affect a franchise system.”
Starting years in advance also gives franchisors who are looking to rid their system of bad franchisees a huge advantage.
“If you’ve got any bad franchisees that are coming up for renewal in the next three to five years and you can shed some dead weight, that helps a lot,” Thompson said. “You don’t want to make your problem somebody else’s problem. The buyer is going to be inheriting those franchise agreements, so you want to make it so there’s not going to be any red flags that pop up.”
Talk to a lawyer - and a broker
“Because I’m a franchise attorney, I would say talk to your attorney,” he said, adding that “the attorney is usually connected with some different resources.”
Together, Thompson noted, the franchisor and attorney can outline the steps the franchisor needs to take, and the attorney can also put the franchisor in touch with a broker who can give them a quick and easy assessment to determine the value of the franchise system at that point.
“They’re really going to be looking at the numbers only at that point, which gives the franchisor an idea of if they even want to go down the road of trying to sell,” he said.
Thompson noted that the same way a homeowner may consider carefully investing money into their home before a sale, a franchisor may have similar considerations about whether to invest in a certain area of the business before they sell. In such situations, franchisors can benefit greatly from working with a consultant to determine where to remedy their system, Thompson said.
“I would definitely recommend someone work with a consultant the year before they sell, a few years in advance if possible,” Thompson said. “Consultants are very valuable, but the more time that you give yourself to recoup your own investment in that, the better.”
Iron out any franchisee issues
“It’s going to be really hard to sell while in litigation,” Thompson said. A franchisee lawsuit, he noted, can hurt the sales momentum of any franchise system, so franchisors should let their attorneys know whether they have any franchisees in their system that might potentially sue in the near future.
Thompson suggested franchisors take immediate action in regard to franchisee issues and consider coming to some sort of buyout agreement or remedy so it doesn’t impede a potential sale.
Review the FDD
Reviewing the FDD is crucial, and “not just the latest FDD, but the FDDs that are in the hands of long-standing franchisees,” Komisar said.
If there are problems within the FDD that the franchisor knows will be an issue for a new buyer, they will want to be “addressing those early,” he said.
Make sure rules are enforced
Thompson noted that a new buyer might want to come in and make everybody redecorate or update their franchise, but does the franchise agreement allow for that?
“If you’ve got side deals in place - maybe you’re giving special treatment to certain franchisees that may be your favorites - and a new sheriff came to town and took over, is that going to affect your system’s morale?” Thompson asked. “The more franchisees are following the system and the more uniform things are enforced ahead of time, the better.”
Gather the right documentation
Franchisee financials, tax returns and profit and loss statements are just some of the documents franchisors should start gathering as soon as possible if they want to sell their franchise system, Thompson said.
“This sounds obvious, but in practice, it’s not,” he said. “[Franchisors] want to have copies of all signed franchise agreements, any addendums that have been signed and the Item 23 receipt pages for everyone that they’ve sold to on hand.”
Franchisors should also collect any documentation of registration in different states, Thompson said, adding that it’s important for the franchisor to know the dates of the franchise documents on file in registration states.
Some sort of organized memorandum should be put together that “addresses anticipated questions or concerns,” Komisar said. “That document can run from 100 to 250 pages, depending on the depth of what’s being put together.