With resales on uptick, buyers try, try again
Ibrahim Choudhry was able to turn around three struggling Edible Arrangements units, and now operates four with his brother.
Franchisees who held onto their units during the recession are beginning to put them on the market, either because they are ready to take a profit, or because they’ve run out of funds to keep them going. Good units are available, but so are unprofitable ones that need to be turned around.
Transfers of existing units to new or different franchisees dropped by more than 40 percent from 2008 to 2010, then picked up again in 2011, says a new report called Franchise Unit Turnover by research firm FRANdata in Arlington, Virginia. Business brokers around the country report their franchise listings began rebounding about 18 months ago and have been strong ever since.
Nancy Estep-Critchett, founder and president of Franchise Resales in Sarasota, Florida, said her company has between 50 and 200 franchise listings at any one time. Jerome Thissen of National Franchise Sales in Newport Beach, California, said he usually has between 80 and 120 listings. General business brokers such as Sunbelt and BizBuySell list hundreds of franchises on their national websites.
The majority of resales, however, are handled by franchisors themselves. Gary Findley, COO of Snap Fitness in Minneapolis, said, “Franchisees who want to sell their clubs generally come to us first. We turn their requests over to our outside sales contractors, who hook up the sellers with interested buyers in their territories.” Unlike a franchisee who has to build a new gym, the buyer of an existing fitness club starts out with a going business and a list of customers, Findley said.
While some Snap franchisees sell because of life changes or because they are ready to realize a profit, others are “burned out,” Findley said, “or opened a club because they thought it would be a neat place to hang out and never ran it as a business.” Like many franchisors, Findley said Snap “will approve a marginal buyer if we think he or she is in a better position to run a low-performing center than the seller is.” The Snap Fitness clubs that are really struggling, Findley said, are the ones owners list with brokers.
But not all broker listings are for failing franchises. “It’s shocking how many brands don’t have an internal mechanism to address resales,” Estep-Critchett said. Many franchise resale listings are for franchises that depend on discretionary spending, she said, like frame shops, gyms, spas and tanning salons that became unprofitable during the recession and the current owners do not have the money to take them back to a profitable level. “A buyer with capital can jump in and take advantage of a turnaround,” she said.
Bidding wars break out
Brokers agree that a tired single-unit restaurant franchise is the toughest to sell, but multi-unit packages of the same restaurant concepts are in such demand they even generate bidding wars. While other investments have dropped in value, “restaurant companies have become the new bonds, where you can put your money to work for consistent cash-on-cash returns,” said Patrick Silvia, president of Advanced Restaurant Sales in Marietta, Georgia. While restaurant franchises today should sell for reasonable multiples, of 4 to 6 times EBITDA or gross earnings, actual sales “are all over the board,” said Thissen. “I recently sold eight El Pollo Loco’s out of bankruptcy for over 10 times EBITDA.”
Dejan Vojnovic, of Highland, North Carolina, president of National Restaurant Brokers, said current sellers of multi-unit restaurant companies want to complete their transactions before January 1, 2013, when capital gains taxes go up and some provisions of the Affordable Care Act go into effect. “Many of them are old-timers who don’t have the money to reimage their restaurants,” Vojnovic said. “They list with us because they think they will get a better price than selling off their units to neighboring franchisees.” Buyers of multi-unit packages tend to be private equity companies that have funds to invest or large multi-unit owners who want to get even bigger, Vojnovic said.
Detective work required
If you are looking for a single unit, beginning a franchise resale search on broker websites requires some detective work, because most list the type of store but not the brand. They’ll say “a profitable ice cream franchise,” for example, instead of a Carvel or Cold Stone. Ray Boreham, a broker with Sunbelt in Atlanta, said franchisees place blind ads “because they don’t want their employees, vendors or competitors to know they’re for sale.” You’ll have to sign a confidentiality agreement with the broker before he or she will reveal the franchise concept.
Once you find a franchise you like that’s for sale, “it’s always best to contact the franchisor and tell them you’re looking at a unit,” said Michael Gray, a principal at Gray Plant Mooty law firm in Minneapolis. They’ll vet you, to be sure you have the financial and personal ability to be a franchisee, provide you with disclosure documents and may even point you to other franchise resales in their system that could be a better fit.
Making resales work
At this point, Roger Schmidt, an attorney with Schmidt Ayers in Woodway, Texas, and the former general counsel for Curves, said you should begin serious due diligence. Study the franchisor, looking at the health of their system. Figure out why the unit is for sale. Many franchisors, Schmidt warned, bought up failing units during the recession rather than let them go dark and are refranchising them now.
Buying a highly successful franchise can also be a problem, he said, because it may be difficult to replicate that same level of service or products. “Hire an attorney and an accountant,” Schmidt said, “to go over the unit’s profit-and-loss statements. Look at the seller’s bank statements and tax returns. If you find something wrong, don’t be afraid to say no and move on.”
Turnarounds of resale units are tough, many sources said, but two brothers are making it work. In 2009 and 2010, Ibrahim Choudhry turned around three shuttered Edible Arrangements franchises in California. Ibrahim, now 26, started working as a trainer for Edible when he was 19 and lived near corporate headquarters in Connecticut.
When his family planned a move to California in 2009, “they offered to sell me a failed unit in Claremont at a really low price,” he said. “As soon as I reopened, former customers called to say they had paid for orders that were never delivered. It wasn’t my problem, but I offered replacement arrangements to show our commitment to customer service.”
Choudhry walked through nearby neighborhoods each night, distributing marketing door hangers. Within a few months, he and hisolder brother, Hashim, took over two more failed locations.
Today, Ibrahim and Hashim operate four profitable stores and hope to acquire more. “I had no choice but to make it work,” he said.