How to do franchise resales right
Jumping into discussions about resales before the ink is dry on a franchise agreement is a little like discussing divorce before the wedding. However, exit strategies are a natural part of the life cycle for any business, and franchisors are recognizing that addressing resales early on can help to pave the way for a smoother transition in the future.
The maturing of the franchise industry, along with an uptick in resale activity, is bringing resale conversations to the forefront for many companies. According to FRANdata, the average transfer rate across all active brands franchising rose from 3.5 percent in 2013 to 4.1 percent in 2016.
A variety of reasons can trigger a franchisee resale such as retirement, personal reasons, entrepreneurial burnout, undercapitalization or the fact that the business simply isn’t a good fit for the franchisee. And resales can occur after a year or two or after an owner has held that business for 20 or 30 years.
The Dwyer Group typically sees 2.5 to 3 percent in resales each year for a variety of reasons and the company has an internal resale department to help franchisees sell their businesses. For example, the company tracked 128 franchise resales last year out of about 2,700 total franchisee-run businesses in North America across its 11 brands such as Glass Doctor, Molly Maid and Mr. Rooter.
“We want to see resales, because it brings someone fresh and new into the system,” says Mary Thompson, chief operating officer of franchise brands at the Dwyer Group.
A change in ownership also can help to revitalize a particular location, she adds.
Savvy franchisors have created formal processes for franchisees gracefully wanting to exit the business, says David Omholt, CEO of The Entrepreneur Authority, a leading franchise brokerage firm based in Dallas. Some of the more mature franchisors even have dedicated resale experts internally on staff to assist with those transactions. “If a franchisor knows a franchisee has mentally checked out and perhaps is no longer bringing their A-game, they likely aren’t generating the kinds of royalties that hungrier, more engaged franchisees would,” he says.
The resale or exit plan is an important element in the franchise relationship. However, many franchisors make the mistake of not addressing the resale subject from the outset, notes Edward Kushell, president and founder of the Franchise Consulting Group in Los Angeles. Does the franchisee want to run that business for five or 10 years?
Do they want to build a business they can sell when they retire, or perhaps pass the business on to their children or grandchildren?
The Dwyer Group starts from day one asking franchisees to think about what their exit strategy is. Most tend to look a little like “deer in the headlights,” because they have just signed up, says Thompson. But everyone has a different goal or plan, whether that is to work the business for 10 years or until retirement, or to sell the business or pass it on to the next generation. Understanding those goals helps to build a stronger business plan. People who don’t plan for an exit often end up selling a business in reactionary mode, which is not always going to yield the best result. So, it is important to take a holistic view and start laying the groundwork all throughout the life of a business.
Some franchisors are proactive in addressing resales early on with incoming franchisees. “You want to be able to trumpet the successes that franchisees have had in selling their businesses, because at some point, everyone is going to want to be able to sell the business for a reasonable price,” says Omholt.
It also is beneficial to embed resale discussions into the franchise system through educational sessions and webinars. For example, franchisors can address that topic at annual conventions by organizing break-out sessions led by tax advisers or certified valuation experts.
Play a supporting role
Franchisors can support their franchisees by helping them to think about an exit strategy, as well as walking through some of the processes for business valuation.
Ultimately, it is up to the franchisee to decide on sale price. However, the franchisor can help walk the franchisee through the process of determining a realistic valuation.
“We can hold up the mirror and tell them what the buyer is going to look for,” says Thompson.
What does the multiplier of EBITDA (earnings before interest, taxes, depreciation and amortization) look like? How do they do an add-back for things the seller is taking out of the business that doesn’t add value to the business?
In some cases, the franchisor can connect the franchisee with interested buyers. Some potential franchisees only want to buy an existing business rather than starting from scratch, while others might want a franchisee in a particular location or territory that is already sold. Resales create an opportunity to bring those interested franchisees into the system, and most franchisors keep records of those inquiries.
Buyers could be a trusted employee or someone in the industry who is ready to go to the next level and become a franchisee, or a neighboring franchisee who wants to expand their territory.
Some franchisors will bet on the horse they know—an existing franchisee—rather than take the risk of bringing in a new operator. “Sometimes that’s a great thing, but as an across-the-board practice, we don’t see that as particularly healthy,” says Alan Gallup, a principal at National Franchise Sales. In any industry, it is important to have a certain portion of new development or resales coming from fresh blood coming into any organization.
“That helps to stimulate new thought, new ideas and it creates a little competitive environment, which if properly managed, is a very healthy thing,” says Gallup. In addition, for a franchisee who is looking to maximize the value of their property, restricting the resale to a handful of chosen favorites is going to limit the value.
Franchisors do need to be proactive in introducing a potential buyer to the brand. Prior to closing a resale, it is important for that buyer to fully understand what that brand is all about, what the franchisor does to help support its franchisees, and what is expected of the franchisee. For example, the Dwyer Group brings potential buyers into its brand “discovery day” orientation. Buyers also undergo full franchisee training to help them hit the ground running when that sale closes.
At the end of the day, the franchisor does have approval rights on a resale. Franchisors want to make sure that buyer has the necessary financial resources and is qualified to run the business. “One of the factors that franchisors have to deal with is that selling franchisees naturally want to get as much as they can for that business. If the franchisee sells it for more than it is worth, it puts a great burden on the incoming franchisee,” says Kushell. So, franchisors want to approve what is a fair price that will benefit the seller and also help to position the incoming franchisee for success, he adds.
12 tips to maximize resale values
Resales are on the rise in a maturing franchise marketplace. One of the added side benefits of maturity is a bigger pool of potential buyers, and more capital available to help finance those transactions. Franchisees need to set a fair and realistic price for that incoming operator, but at the same time there are steps they can take to put their best foot forward and maximize valuation. Some top tips from industry experts include:
1. Maintain good, clean financial records. The standard is to have three years of tax returns and three years of profit and loss statements.
2. Clean up the balance sheet and make sure there are no under-productive assets or unnecessary expenses that are draining profit margins.
3. Closely manage gross margins to show the franchise business is within the benchmarks of the brand.
4. Pay yourself appropriately. If a franchisee is taking a low or no salary, the buyer will add that expense in, which will reduce the value of the business.
5. Positive sales trends have a big impact on value. Anytime a seller can show a positive sales trend without a reduction in the percentage margins, it’s going to improve the multiple of EBITDA (earnings before interest, taxes, depreciation and amortization) that is obtained.
6. Keep a well-documented paper trail, including clear memos explaining why the franchisee has made key business decisions, such as made a capital expenditure or hired—or fired—a particular employee.
7. Prepare your business for sale just as you would prepare your home for sale. Make sure repairs are made, equipment is in good working order, employees are well trained and the property is clean and well maintained.
8. Clean up problems that could negatively impact the value of the business, such as personnel issues. In addition, be mindful of high employee turnover rates, which often creates a red flag for buyers.
9. Stabilize the customer base. The more repeat business that an operation generates from a stable customer base, the higher the multiple is going to be because of that more predictable income stream.
10. Cast a wider net by marketing the business broadly to potential buyers and not just focus on a few candidates within the base of existing franchisees.
11. Separate ties. Make sure the success of the business is not too closely tied to the personal dynamics or goodwill of the individual seller.
12. Don’t act like a “lame duck” owner. Don’t make short-sighted decisions to cut costs, such as avoiding repairs that are long overdue.