Andy Bell was tired of the corporate world after 17 years in the food and beverage industry. In 1998, he founded his own franchise Handyman Matters in Lakewood, Colorado. Over the next 21 years, Bell would build the system to 57 franchisees collectively employing approximately 250 handymen and women in 121 territories across 23 states.
In 2019, Ace Hardware came calling to purchase Handyman Matters. As part of the home improvement industries’ general strategy shift to home maintenance, Ace thought Handyman Matters would be a natural fit to incorporate into their Ace Handyman Services subsidiary. Similar to most transactions in the franchising industry, it was completed between two private companies. As with most private sales, the value of the deal was never reported.
Business valuation has always been equal parts science and art. It can be hard to gauge how franchise value is determined with relatively little publicly reported on valuations.
In some instances, a key index of valuations can be the public markets. However, one key drawback is these are often not indicative of an arm’s length valuation price for most private companies. Public franchise companies are usually much larger than the typical private franchisors. For instance, McDonald’s has over 33,000 outlets worldwide. It’s hard to draw too many comparisons to Andy Bell’s Handyman Matter’s franchise with its’ 57 units in 121 territories.
Regardless of the issues mentioned, there are some basics in which a franchisor can start to evaluate how much their concept may be worth.
Basic Valuation
Fundamental valuations for smaller private companies are generally determined as a multiplier of EBITDA (earnings before interest, taxes, depreciation, and amortization). The purpose of EBITDA is to approximate cash flow. As such, there may be additional “add-backs” or “deductions” from EBITDA to estimate better what cash flow will be for the new owners.
Once this number is determined, it is multiplied by an earnings multiplier to come up with approximate value. The earnings multiplier is where the magic is. Multipliers can be based on many things, some of which we will talk about below. However, to illustrate the power of this, let’s walk through a quick example below.
If your franchise has an EBITDA of $250,000 and the earnings multiplier is 3x, the total valuation would be $750,000 (3 x $250,000). However, if it is determined that the business should have a multiplier of 5x, the valuation increases to $1,250,000. Quite a difference!
Emerging Concepts
An emerging concept is generally defined as a brand that has started to gain some critical mass. That would typically be between 30 to 100 units. Maybe the system has not had incredible growth, but it is relatively stable. This is where 80% of franchisors fall today.
Emerging concepts are the hardest to value for several reasons. First, there is little public data available to base valuations on. Even in there is some data, historic multiples also may not be relevant. The way each franchise brand is the setup is so unique…royalty rates or supply chain lines can wildly affect revenues. And lastly, these companies usually have entrepreneurial management with a focused vision. If a company is looking at incorporating that brand into their existing management structure, they have a vast amount of considerations that may affect how they look at the value.
Considerations for Franchisors
How are earnings multiple determined? Remember at the beginning, when we mentioned franchise valuation was both part art and science. Let’s dive into that a little more.
- Growth Rate – Franchise brands with higher unit growth rates will drive higher multiples. Early growth with later stagnation will often lead to questions.
- Unit Level Revenue and Profitability – Franchise brands are only as strong as their franchisees. If a brand can show that it can help owners increase revenues and overall profitability, they will realize a higher multiple.
- Organization – When a buyer comes in and sees an organization that doesn’t have defined roles, hasn’t been diligent in their document retention policy and has little in the way of established systems, they see dollar signs. These are not good dollar signs, either. They see expense and risk. When investors see costs and risks, they immediately lower their valuations.
- The Moat – The moat is my phrase for how much unique space has the business been able to create? Do they have a unique concept? Is the secret sauce that secret? When I ask franchisors what makes their concept unique, this is the answer. The more they have been able to stand out in their industry, the higher the valuation they will see.
- Multiple Revenue Streams – The more a brand can create multiple revenue streams at both a corporate and franchisee level, the higher their valuation will be.
The Best Type of Revenue
Not all revenue is created equal. That is good news for franchise brands as the revenue that comes along with the highest values is recurring revenue. Just their luck that royalty revenue is very similar to recurring revenue, so potential investors get excited about it.
In my experience, I have seen multiples as low as 2x and as high as 10x. Typically, revenue multiples for franchise brands are between 3x and 6x. As we noted above, that difference can represent hundreds of thousands of dollars in a franchise valuation.
Do Not Go It Alone
Franchise brands must keep an eye on their exit. Even if it is years in the future, setting things up today with an exit in mind drives future valuation. Large brands have the advantage of having a financial executive in place to help make sure best valuation practices are being adhered to. Smaller brands have the option of using contract or part-time CFOs.
When it gets time to sell, talk to people who have experience selling brands similar to yours. There is a dizzying array of factors that go into a realistic valuation. Having a consultant that has a background in franchise deals can significantly aid in the overall valuation.
The critical point to take away from this article if valuations are in flux. Sometimes the issue may not be multiples as much as the amount of time to complete a transaction, availability of buyer financing, and the necessity of the seller to carry any of the purchase price. Regardless, there are steps you can take today to put yourself in the best situation possible.
About Krieger Analytics
My name is Matt Krieger, and I am the founder of Krieger Analytics. We are a virtual CFO and bookkeeping services partner for small businesses and franchisors. Our goal is to completely outsource your accounting department from bookkeeping to victual CFO services. I am also the owner and franchisor of a concept called Monkey Bizness, in Denver, Colorado. I know what running a business entails.
As a small business owner with a background in finance and strategy, I realized the benefits that a virtual CFO could bring to smaller organizations. Most franchisors and small business owners don’t have a need (or budget) for a full-time CFO or bookkeeper. To better fit my clients, Krieger Analytics is a part-time resource. While most think of CFO’s being involved in finance and accounting (we are), we are also involved in much more. We partner with clients by coaching, giving them clarity into their business, and creating growth strategies. Conversations are free, so don’t hesitate to reach out to me at [email protected].