Every year, thousands of investors make a financial commitment to invest a significant portion of capital into a franchised business; whether that business is a hotel, a restaurant or another type of business, maximizing the value of a franchise business investment starts before a franchise or license agreement is signed and does not conclude until the business is ultimately sold. This article will focus on some of the more traditional actions that successful franchisees utilize to best maximize their business investment.
KEY POINTS INCLUDED IN THIS ARTICLE:
—Maximizing value of a franchise business starts before any agreements are signed.
—Hiring a good CPA and attorney is critical to the process.
—The importance of adequate capital.
—Never give a “first right of refusal” on the sale of a business.
—The importance of operating software and specialized consultants.
—Managing to the bottom line is the only way to manage.
—The importance of hiring the “right” broker to sell the business.
It All Starts Before an Agreement Is Signed
All franchise investments are made with the hope of a highly profitable long-term result. In order to turn that hope into a reality, the franchisee needs to understand that maximizing the value of the business starts with a thorough understanding of exactly how the prospective business makes money, how much it costs to start and profitably operate, what are the common risks in the business and what is the likely exit strategy once the franchisee decides to sell the business.
Hiring an Accountant Is a Good Idea
Determining whether the franchise opportunity is a good one starts with a thorough review of the franchisor’s financial data. Specifically, the goal at this stage is to completely understand the business and how it makes money. The franchisor is generally the first source of that information and will almost certainly provide the franchisee with a good deal of financial information. This data is incredibly important and should be read and studied thoroughly while also understanding that such information is being offered as part of the franchisor’s effort to attract franchisees and may only be reflective of the franchisor’s best-case scenario. Concentrating on the reasonableness and expected achievability of the franchisor’s projected revenue stream is important, but understanding the necessary costs to generate those revenues is just as important. My experience is that many prospective franchisees fail to invest the necessary time into this aspect of the analysis. Any prospective franchisee without experience in reading and understanding financial statements should seek out a CPA or an otherwise experienced accountant to help with the evaluation of the franchisor’s projections and financial data. My personal recommendation is to consider producing your own projection (with the help of your accountant) and making it a point to understand what goes into every number.
Having Sufficient Capital to Operate the Business
Capital is necessary to acquire and launch most any business, and estimating how much acquisition capital is needed is often one of the easier numbers to estimate. The more difficult number is trying to estimate the amount of additional capital, sometimes referred to as working capital, that will be required to operate the business. This is an area where an experienced accountant earns his/her hourly rate. When I build my projections, I like to build in a running working capital balance that projects the balance of my cash at the end of each projection period; there is an old saying that “cash is king,” and that could not be more true when a new business is being launched. Most of the time, my projections are done on monthly periods, but I have done some that project results weekly. I also like to build in specific line-item reserves in the projection so I know exactly how much financial padding I have available to me in the event that actual revenues fail to materialize to the levels originally projected or expenses outpace those originally projected.
Now You Are Ready to Hire an Attorney
So the financial analysis is now complete and the amount of capital required to launch the business and operate it has been determined. Assuming that there is an interest in moving forward with the investment, it’s now time to identify and hire an attorney. You will be looking for an attorney with experience in reviewing and negotiating contracts. My experience is that commercial real estate lawyers often fit the description the best since they are normally well experienced with reading and negotiating contracts. Now, it is not unusual for a franchisor to push back on changes to the franchise documents, but my experience is that a good contract attorney can always improve the documents to the benefit of the franchisee. Certainly, the attorney will look to negotiate the liability exposures that may be hiding in the documents.
This is now the time that the prospective franchisee should consider going on offense regarding the terms of the franchise agreement. It’s possible that concessions may be negotiated that will add huge value to the franchise business for many years to come. One provision that I often ask for is what is termed as a favored nation’s clause. Commonly, it will stipulate that the franchisor will be entitled to the same financial terms as any future franchisee, should those terms be more favorable than those agreed to in the document. Another common provision that is often negotiated is the protected area around the business. This is often in the form of a geographic exclusion zone, giving the franchisee protection from the franchisor’s attempt to contract other franchisees within a close proximity of your location. Now, your ability to negotiate these types of concessions largely depends on how valuable the franchisor perceives the franchisee to be.
Never Agree to a Buy-back Provision or a First Right of Refusal
In a huge document, it is not unusual for the franchisor to hide seemingly innocent provisions that, if agreed to, could have a material negative impact on the future sale value of the business. One such provision is commonly referred to as a buy back or a first right of refusal provision. Why is that such a deadly provision? Well, any prospective buyer, other than the franchisor, will be extremely reluctant to enter into negotiations with the understanding that the franchisor can always meet the terms of the offer and acquire the business. Essentially, such a provision eliminates competition for the franchisor at the time when getting the most for your franchise on a sale requires a competitive environment.
Utilize Outside Professionals to Set Up the Proper Operating Systems
Now that you have negotiated and signed the franchise documents, it’s time to manage the business with the goal of maximizing your bottom-line results. Most businesses utilize outside professionals to help in achieving their operating goals. Outside help comes in many forms. I would start with finding a systems person who can help install and launch the necessary financial and operating software that is required to operate the business. Do not make the mistake of not recognizing the true value of the software and the consultant. A successful franchisee will understand and utilize the data that the support software generates to make important business decisions.
Micromanaging Operating Costs
I cannot overstate the importance of managing operating costs. How do you do that? Start with soliciting multiple bids for services or goods. Once you have contracted for services or ordered goods, look at the individual invoices with a critical eye. You would be surprised at how much scrutiny the details of purchases get at highly profitable large businesses. The biggest of those businesses have systems to catch overbillings, but if you are not big enough to have such systems, you need to find a controller or accounting manager who possesses an eye for detail.
Generating Timely Financial Statements
Virtually every successful business owner figures out how to generate timely and accurate monthly financial reports, with profit and loss statements and balance sheets being the basics. Hiring the controller or accounting manager previously mentioned, or in some cases, contracting for such services, is a critical and must-do step. Allowing your accounting person to focus on the accounting side of the business and letting you, as the franchise business owner, focus on strategically operating the business is the key to optimizing your bottom line. The minimum skillset that any such accounting person must have is a complete understanding of double entry accounting; if you don’t know what I’m talking about here, ask your CPA for a quick explanation. Last but certainly not least, your accounting person can take over the outside financial reporting that your lender and/or outside investors will require.
Selling the Business
You’ve done most everything right and are now at the point that it’s time to sell the business. Just how do you do that? I have sold a number of franchised businesses in my career, and I can attest that utilizing the RIGHT business broker is likely the right course of action. However, finding the right one is the key. The right one can access a much larger population of potential buyers than you could ever hope to access on your own. To find the right broker, I would start by asking your banker, lawyer and CPA for recommendations and then thoroughly interview their candidates. In the hotel business, there are a number of commercial real estate brokers who do virtually nothing but hotel properties. My experience is the best of those brokers have a large and active database of prospective buyers and have the ability to effectively put your property details out to buyers on a national basis. There are a few big boys who broker the big flag hotel properties, but there are also many small and exceptional firms that broker the small properties. If your business is not a hotel, you should utilize the same group of trusted professionals to help you find the right business broker.
I will end this article with a personal story. I was once part of a senior management team that developed and ultimately sold a multicity Blockbuster Video business. The business was started in 1987 and sold in 1999. Yes, we sold before video on demand became a reality. We were big enough to be lucky to get one of the big investment banking firms to represent us when we decided to sell the business. The investment banking firm’s terms included a stipulation that their fee would be a minimum of $2 million. Our team debated whether this was just too much to pay but, to the credit of our visionary CEO, we signed on. Ultimately, the sale closed and a business that was originally capitalized for $7 million was ultimately monetized for more than $100 million, and it was clear to our team that the investment banking firm hired brought the last $15 million to the final price. To make that result possible, we utilized virtually every one of the lessons spelled out in this article, so doing the right things from the very beginning can mean millions more when the business is ultimately sold.
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About the author: Mr. Eckerman is a certified public accountant and is affiliated as a joint venture partner with Patton Asset Management LLC. In addition to working for an international accounting firm for more than 12 years, Mr. Eckerman spent 23 years, first as chief financial officer and then as president, of a very successful Houston-based private investment firm. The private investment firm operated and sold internationally flagged hotel properties as well as a national retail franchise business. Mr. Eckerman now consults with businesses on all kinds of financial and managerial matters and can be reached at 713-598-0040.