Financial advice on estimating the value of a franchise before selling from Inspired Business Solutions

Inspired Business Solutions  provide advice on establishing a fair market estimate of the value of a franchise before considering putting the business up for sale.

Every owner is interested in what their business is worth, however no one really knows the value until a purchaser has unconditionally signed an agreement to purchase. This is a clear unequivocal statement of the worth of the business to a willing buyer, not an over anxious vendor.

Up until the time of agreement, business valuations are ultimately somewhat subjective. That subjectivity factor can, however, be reduced by applying accepted business valuation practice.

Just as one can find out the estimated value of a house before listing on the market, you can find out the estimated value of your franchise business prior to listing it. People who can assist you include: 

A business broker who specialises in selling franchises – these people know how much franchises are selling for and may have sold the same kinds of franchise businesses in the recent past. Business consultants will give you their view on what your franchise is worth on the market.

A chartered accountant who specialises in franchise work – valuing franchises can be different to valuing non franchise businesses. In some cases the risk of failure in a franchise operation is lessened and therefore the sale price may be higher than a non franchise operation.

Other franchisees who have sold their businesses recently – they may be willing to share their experience with you and how much they realised on sale.

These first two people will better be able to assist you with your valuation if you make some basic information available to them. This information would include:

• financial statements prepared by your chartered accountant for the past 2 years
• recent management reports prepared on your own accounting system 
• copies of GST returns for the past 2 years 
• franchise agreement 
• lease agreement; and
• your understanding of how the wider franchise system is doing generally.

Now, a word from a chartered accountant about your financial statements (on which a valuation is often based). Frequently, these statements would include (legitimate) costs which need to be removed for the purposes of a valuation. Examples include interest, tax, home office expenses, excessive motor vehicle expenses, and perhaps a portion of shareholder salaries.

These kinds of expenses need to be added back to the net profit to show an adjusted ‘earnings before interest and tax’ (EBIT). Normally as a rule of thumb, a valuation is calculated by applying a multiple to this adjusted EBIT figure. In my experience, the multiple is usually in the range of 2 to 4 times however I have seen higher and lower.

The business will also include hard assets such as plant, fixtures and fittings and stock. These comprise part of the sale price. The difference between the total sale price and the value of the hard assets is goodwill.

Goodwill is intangible; you can’t physically see it like you can with hard assets, but it is often a big part of the price you pay for the ability to create future profits and give you a return on your investment.

A word of caution - often the historical information provided by a vendor shows a profit position that bears no relation to the price. In other words, the profit is poor but the asking price is huge. The vendor may explain that the potential of the business is massive and you need to pay for that. Well if that’s the case, why isn’t the vendor staying in to reap the rewards of all this potential?

Determining the value of a Franchise before a sale is an art, not a science. It is subjective but finding the right advisors will assist you to come up with a figure that you can work with.

Craig Weston is a director of Inspired Business Solutions, chartered accountants of Auckland. Inspired specialise in franchise advisory services, and are members of and act as external accountants to the Franchise Association of New Zealand.