Any brand trading above 5.5X will likely have high-growth appeal or attractive EBITDA and development opportunities. EV to seller’s discretionary cash flow(SDCF or SDE). Finally, multiply net sales by the implied rent to cap rate ratio. Big or small, most restaurant owners I know do not apply these drivers correctly and thus are poorly informed about the value of their companies. What is the impact on remodeling a restaurant and then selling it vs. selling before a remodel is due? It is typical to assume a percentage of sales ranging from 3.0% – 5.0% or higher, based on the size, brand, geography, and actual expenses associated with existing operations. Once actual G&A is added back and other adjustments are made to the store-level P&Ls, an assumed G&A is deducted from EBITDA before the multiple is applied. Yet even if the land and building are now worth $800,000, that’s not what the balance sheet will say. The income approach, via the discounted cash flow method, where the value is estimated based on the cash flows a business can expect to generate over its remaining useful life. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. Your email address will not be published. Recently a young analyst approached me surprised at the perceived simplicity of valuing franchise restaurants. The selection of appropriate valuation multiples is a function of the specific facts and circumstances extant at the valuation date. We find that market multiples and the cost of capital are normally more generous to franchisees than similar unaffiliated operations. Now, are they realistic? 3. A sound valuation relies on multiple factors, all vetted to the extent … The implied rent then must be subtracted from EBITDA so that business and real estate values are not double counted. To prove out the extent of the price premium in any particular case, one only needs to compare the market multiples from Pratt’s Stats and BizComps for sales of franchise operations versus unaffiliated operations. If you have found this overview insightful or if it has peaked your curiosity, please feel free to reach out to me for a deeper discussion. Yet until those credit sales are collected, there is no cash to pay employees or vendors or buy new inventory. Why? If you stopped here, you would think that Joe’s is worth more than Subway. Even using the mean (average) multiple makes a lot of assumptions about how comparable some very different companies might be. So if we buy a hypothetical restaurant and pay $750,000 in cash, our hypothetical accountant must enter the transaction into our books and assign values to each component. While the owner’s debt does not affect what the business will be worth to you as a buyer, it can provide a clue as to why the seller is willing to accept what seems to be an unusually low price—something that should always be cause for suspicion. (For simplicity, we’ll assume for now that we bought only the restaurant and not any operations. Assets have hard values, so this should be an excellent starting point for valuing a company. Such appraisals are used for buyers and sellers, lenders, estate planners and to provide expert testimony in franchise, … If you want to invest in a franchise company and feel confident you won’t have buyer’s remorse, it helps if there are high multiples. EV to total business assets. For example, cities such as Dallas, Los Angeles, and Atlanta may have heavy QSR penetration. There’s more work to be done, however. Subway franchise: ($76,272 x 1.98) = $151,018. • High multiples and speculation are gone. Yet that $20,000 (and more) could evaporate five minutes after the opening bell tomorrow. We did about $1 billion a year in revenue—people have to eat, after all. The Franchise Valuations Reporter Special Edition July 2013 Publisher's Note Welcome to a special edition of The Franchise Valuations Reporter devoted to just one topic: EBIDTA. Assets (accurately valued) plus a multiple of cash flow represent a good starting point for a total value. Enterprise value(EV) to gross revenues or net sales. This Franchise Chatter Guide on how to value a business was written by Daniel Slone. 2. We can open that can of worms later.). Businesses sell things, so it would seem that revenue (meaning sales, not net income) should be a fair guide to valuation. The seller might have almost no debt (and therefore almost no interest expense) while the buyer is about to be mortgaged to the hilt to swing the purchase and therefore will carry a much higher interest cost. As such, you have likely heard of cap rates and their application in ascertaining value for fee-owned restaurant real estate. Your email address will not be published. Each is discussed below, though expounding upon their dynamic relationship with one another is beyond the scope of this discussion. This is where the statement of cash flows comes into play. The cash flow statement can also be distorted, after all. Yet the fact of the matter is that an accurate valuation is rather more complicated for any but the simplest business. You can calculate the estimate of business market value using a number of valuation multiples– each establishing business value in relation to some measure of its financial performance. Price to revenue: 50% to 80%. Required fields are marked *, Previous post: Franchise Costs: Detailed Estimates of Planet Beach Contempo Spa Franchise Costs (2013 FDD), Next post: Franchise Chatter Guide: How Dunkin’ Donuts and Krispy Kreme Are Faring in the Fast-Food Breakfast Wars, Need help? March 24, 2014 by Daniel Slone Leave a Comment in Buying a Franchise, Franchise Chatter Guides, Selling a Franchise. The final aspect involves some prognostication and your best estimate of future conditions. From our experience, buyers treat these future remodeling expenses differently by brand depending largely on the expected increase in sales and profits thereafter (or lack thereof). Revenue is important as an indicator of performance, and revenue trends (is it growing, by how much, and how have growth rates held up over time, for example) are even more important. For any franchised restaurant, this figure can be simply calculated from the most recent P&L (on a by-store basis). How established is the franchise system, and how quickly is it growing? Public companies have it easy. a. M&A Activity The most obvious reason to value a franchise … If you buy 1,000 shares of a stock at $50 and the share price rises to $70, its value is now $70,000 versus the $50,000 you paid. Second, what significant difference can you make in the acquired business? In the absence of an appraisal or other objective source that assigns separate values, we must somehow distinguish between the value of the land and the value of the building. For example, a business that sells extensively on credit will generate all kinds of revenue and may even have a great net income number. G&A% is also typically less for a high Average Unit Volume (AUV) business than for a low AUV business with the same number of units. This might not be the case for smaller cities or in different regional areas of the US. They may also pay themselves (and often family members as well) generous salaries and bonuses. As you probably already know, "high multiples" describes … Fast food franchises… Here is some helpful information to get you to a successful valuation and faster sale of your business. I have previously discussed the mechanics of buying an existing franchised business as an alternative to establishing a new franchise, especially in systems that are mature and have few open markets remaining. One final word on net income, EBITDA, and cash flow: Examine the financial statements closely for factors unique to the current ownership, especially for businesses that are making little to nothing or even losing money on paper. EV to owners’ equity. Using revenue for valuation, however, in my opinion leaves much to be desired. So the balance sheet can mislead in two different ways. (This is an oversimplification, because capital improvements like the aforementioned renovation would have been booked to improvements and would also appear on the balance sheet, but bear with me.) If not allocated at the store-level, beverage rebates should be added back, while credit card fees and bank charges need be subtracted. As for the land and building, it depends on the condition of the building, the location of the lot, economic and real estate market conditions in the surrounding area, and more. Restaurants with near-term remodeling obligations without longer-term lease lives are also questionable. Using a multiple of future earnings. G&A assumptions might change based on in-line vs. standalone restaurants. For … Lots of uncollected revenue that makes the P&L look good will create a large accounts receivable balance that makes the cash flow statement anemic. As with EBITDA, multiples of three to four times cash flow are a reasonable basis for valuation. The multiplier that you use, and hence the final valuation, will depend on multiple … Poorly performing fee-owned restaurants with near-term remodels might have a higher valuation if closed and sold for a different use. Five key Company factors to consider when determining where a franchise multiple … Finally, EBITDA multiples are sensitive to interest rates, general availability of capital, overall business climate, brand performance, buyer demand, yields in other asset categories, and many other factors. Lastly, there are usually other adjustments and add backs; these will vary from franchisee to franchisee. Do you have a special expertise in the industry that will allow you to improve operations and revenue? In order to value a fee-owned real estate property, first assume an implied rent (generally as a percentage of sales not to exceed about 8% of sales) and assign a cap rate. So until you sell and “lock in” the gain, it is an unrealized or “paper” gain and nothing more. Franchise restaurant EBITDA multiples are then determined and multiplied by actual EBITDA calculated above. I find this technique a good guide and a quick way to assess whether a seller is pricing his or her business at least somewhat reasonably. EV to EBIT and EBITDA. If valuing fee-owned real estate, an implied rent assumption should be subtracted as well. If you’ve ever bought a new car and experienced the sharp drop in value that takes place the moment it is driven off the lot, you know that even if it’s nearly new, the FF&E in this restaurant is no longer worth the $300,000 that for the purposes of this example we’ll say it cost. The FF&E number is probably excessive. Keep in mind that the balance sheet is a product of accounting practices, and while I am a CFO and accounting practices are certainly dear to my heart, it is important to understand the limitations those practices bring to the balance sheet. Do you have the financial wherewithal to catch up deferred maintenance, renovate tired facilities, hire new operations talent, or answer other currently unfunded needs? If a franchise business has a large geographical reach, standard G&A assumptions might be too low. But the small, privately-held businesses that change hands on a daily basis lack the luxury of such a clear-cut benchmark. One type of asset we did not touch on is the intangible asset. For poor performing legacy brands, a buyer might deduct the present value of 5-10 years of future remodeling expenses from the final valuation before making an offer. Unless you plan to turn around and sell within a very few years, these things matter. Typical value multiples. 5. Determining what this contributes to valuation is a question of what it would cost to buy into the franchise today and more importantly how much of the original term of the franchise agreement remains (assuming the franchisor’s practice is to transfer the existing agreement). First, is the business growing, stable, or declining? At the highest end, there is a feeding frenzy for a few select brands, most notably Taco Bell – where EBITDA multiples have eclipsed 8.0X. The franchisor-franchisee relationship creates special nuances for the valuation of intangible value. It’s highly unlikely that everything could be sold for that amount. In some situations the P&L can make things look rosier than they are. The reduction of principal hits the cash flow statement and balance sheet. In reality there are a plethora of reasons to value a franchise company. Obviously, if the FF&E is seven or more years old, it has no value for transaction purposes. It can look better than the P&L might indicate if bills aren’t being paid timely and accounts payable are piling up, which conserves cash in the short term but isn’t good for continued operations in the long term. In franchised businesses the franchise fee itself, which represents the right to do business using that brand, has value. Many brands are valued in the 4.0X – 5.5X range, including legacy brands with consistent performance, second tier franchise brands, and growth-oriented fast-casual concepts. Fast-forward ten years. If arbitrary values must be assigned, a safe rule of thumb is to allot 85 percent of the purchase price to the building and 15 percent to the land. Conversely, the seller might be in debt up to his eyebrows while the buyer will make a straight cash purchase. A sound valuation relies on multiple factors, all vetted to the extent possible by due diligence. 2. Let’s start with a very basic (and very fair) question: Where do the numbers on the balance sheet originate? Cap rates vary based on several factors: brand, geography, financial performance of the restaurant business, and number of restaurants sold. The valuation of franchise companies tends to be viewed simply as an exercise undertaken when a sale of the business is to take place. The P&L, balance sheet, and cash flow statement must all be evaluated to properly gauge the health of a business. Maybe, and maybe not. • Historic multiples may not be relevant. The valuation basis of most franchises is a multiple of future maintainable earnings. If we assume that the FF&E in our hypothetical restaurant is three years old, we can assign it a value of (in round numbers) $171,500. Franchise Valuation Methods and Multiples … We can’t stop there, however. This is particularly pertinent for multi-brand restaurants. 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High-Growth appeal or attractive EBITDA and development opportunities of restaurants sold on how to value,... Larger businesses than those smaller from cash flow ( SDCF or SDE.! Of a business diligence process must include a careful examination of the exact nature of purchase. Beverage rebates should be subtracted as well the type found in restaurants is depreciated over seven years in. Did not touch on is the intangible asset and sold for that amount anything to make the sale—is major. Seven or more the transaction in my opinion leaves much to be done, however the... The business growing, stable, or has the brand stagnated of 3.0X – 8.0X assets ( valued... Shares outstanding legacy or struggling brands, the seller might be too low flow—sometimes resulting from who...: 50 % to 80 % s discretionary cash flow statement and balance sheet originate market for. Million dollars each ) also, remember that debt maintenance does not appear on the balance sheet, those! 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