There are a number of ways of valuing a business (and, by extension, franchise businesses or franchise resales as we call them). The highs & lows of the stock markets show that perceived value can be a factor. In this article, we’ll discuss the most common quantitative factors (financial metrics) and qualitative factors (business attributes) in order to help take emotion out of the business opportunity.
While there’s no one-size-fits-all approach, several methods are commonly applied:
- Historical Earnings: Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a common metric used to value businesses. A multiple is then applied to this figure to arrive at a valuation. The multiple will depend upon a number of items including the industry & the growth prospects of the franchise for sale
- Projected Earnings: If the franchise for resale has a solid growth track, then forecasted earnings might also be considered
- Revenue: Some businesses may be valued based on a multiple of revenue, especially if they are not currently profitable but have strong growth potential
Assets and Liabilities:
- Tangible Assets: Physical assets such as property, equipment, and inventory.
- Intangible Assets: Brand value, customer lists, intellectual property, and the franchise license itself
- Liabilities: Outstanding debts and other obligations that would reduce the value.
- Market Comparables: One can compare the franchise to other similar businesses that have recently sold. This gives an idea of what investors are currently willing to pay for similar businesses
Franchise Agreement Terms:
- Duration and terms of the franchise agreement
- Restrictions or obligations placed on the franchisee
- Royalty and fee structures
The location of the franchise unit can significantly influence its value, especially for businesses where location is key, like retail or food service
A well-known and respected franchisor can increase the value of a franchise business because of their brand recognition & the work they are doing to ensure that the purchaser will be more likely to win business than their competitors
Franchises in emerging markets or sectors with a high growth rate will generally command a higher valuation.
Economic and Industry Factors:
External factors like the state of the economy, market demand, competition, and industry trends can influence the value.
Efficient operations, a solid management team, and effective marketing strategies can increase the perceived value of a franchise.
- Lease terms and conditions if the premises are rented
- Employee contracts and liabilities
- Supplier agreements
- Discounted Cash Flow (DCF): This valuation method projects the franchise’s future cash flows and discounts them to present value based on a discount rate, providing an estimate of the business’s intrinsic value
- When valuing a franchise business in the UK, it’s common to engage a professional business valuator or an accountant with experience in valuations. They’ll consider the above factors and potentially use a combination of methods to arrive at a comprehensive valuation
There is also subjectivity & the human element in the valuation of the business: the seller will naturally want the best price for their business and the buyer may prefer to be cautious but the items above show some of the common factors that affect the price of the business in order to help you judge the franchise value.
What is EBITDA?
EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization.” It is used to assess a company’s operational profitability and performance, excluding the potentially distorting effects of financing decisions, tax environments, and differing capital structures.
The elements of EBITDA are:
- Earnings: This refers to the company’s net profit or the bottom line. It’s what’s left after all expenses are subtracted from revenues
- Interest: This is the cost of borrowing money, or how much a company pays in interest on its debts
- Taxes: This refers to the income tax a company pays. Tax situations can vary widely depending on country, region, and individual company decisions, so EBITDA omits this to get a clearer picture of operational performance
- Depreciation: This is an accounting method used to allocate the cost of a tangible asset over its useful life. For example, if a company buys a piece of machinery, it doesn’t write off the entire cost in one year; instead, it writes off a portion of the cost each year
- Amortization: Similar to depreciation, but it’s for intangible assets like patents, copyrights, and goodwill. Again, instead of writing off the entire cost of an intangible asset in one year, the cost is spread out over multiple years
EBITDA provides a view of a company’s profitability without the influence of how it’s financed, how it’s taxed, or non-cash expenses like depreciation and amortization. This makes it useful for comparing the performance of different companies, especially across industries or regions where those factors can vary significantly. It’s an important part of any franchise appraisal as it gives an easily comparable benchmark.
However, it’s important to note that EBITDA has its critics. Some argue that it can paint an overly optimistic picture of a company’s financial health since it doesn’t consider the costs of replacing aging equipment (depreciation) or paying down debt (interest). As with all financial metrics, it’s important to use EBITDA in conjunction with other measures and not rely on it exclusively.
Is EBITDA a good way to value a company?
In business valuation as well as in the stock market, EBITDA is a useful tool because it makes it easy to compare one business with another.
Using it as the sole method for valuing a company can be misleading, however. Here are some advantages and drawbacks of using EBITDA for valuation purposes:
- Operational Profitability: EBITDA provides a clear view of a company’s profitability derived solely from its operations, without considering the influence of financial structure, taxation, or non-cash expenses like depreciation and amortization
- Comparison Across Companies: EBITDA can be a helpful metric when comparing the profitability of different companies, especially if they operate in different industries, tax jurisdictions, or have varying capital structures.
- Simplicity: EBITDA is straightforward to calculate and understand, making it accessible for investors and stakeholders
- Ignores Capital Expenditure: Since EBITDA adds back depreciation and amortization, it doesn’t account for the capital expenditure (CapEx) required for business growth or to maintain assets. Two companies might have similar EBITDA, but if one has much higher CapEx requirements, its free cash flow and intrinsic value might be significantly lower.
- No Debt Consideration: By excluding interest payments, EBITDA doesn’t consider the cost or structure of a company’s debt. A highly leveraged company might appear healthier than it truly is when assessing EBITDA alone.
- Not a Cash Flow Measure: EBITDA does not represent cash earnings, as it doesn’t consider changes in working capital, taxes, interest, or capital expenditures, all of which impact a company’s cash flow.
- Potential for Manipulation: Some critics argue that EBITDA can be used by companies to present a rosier financial picture than what’s genuinely occurring. For example, a company might focus on boosting EBITDA at the expense of long-term investments or necessary maintenance.
- Not Suitable for All Industries: For industries where capital expenditures or debt structure are significant components of their financial profile (like manufacturing or telecom), relying on EBITDA alone may not provide a comprehensive view of the company’s value.
What is a good EBITDA for a franchise?
A ‘good’ EBITDA for a franchise can vary widely depending on several factors, including the industry, location, size of the business, competitive landscape, market conditions, and more. Here are some general guidelines and considerations:
- Industry Norms: The most appropriate way to gauge if an EBITDA is ‘good’ is by comparing it to industry averages or benchmarks. For example, EBITDA margins in a high-capital, low-margin industry (e.g., grocery retail) will differ significantly from those in a low-capital, high-margin industry (e.g., software services)
- Size and Scale: Larger franchises might have better EBITDA margins due to economies of scale, while smaller franchises might have tighter margins but quicker growth potential
- Location: A franchise in a prime, high-traffic location might command better margins than one in a more remote area. Conversely, costs (rent, wages, etc.) might be higher in prime locations, affecting EBITDA
- Age of the Franchise: New franchises might initially have lower EBITDA margins due to startup costs and initial investments. Established franchises might have stabilized or even optimized their operations, leading to better EBITDA figures
- Operational Efficiency: How well the franchise is managed can greatly affect its EBITDA. This includes factors like inventory management, staffing efficiencies, marketing ROI, and other operational aspects
- Brand Strength: Franchises under a well-known, reputable brand might have better EBITDA margins due to higher customer demand and trust in the brand
- Royalties and Fees: Remember that franchisees typically pay royalties and other fees to the franchisor. These will affect net earnings, and different franchises have different fee structures, which can impact EBITDA
- Economic Factors: External factors such as economic downturns, new regulations, or shifts in consumer behavior can affect EBITDA
- Debt and Financial Structure: If the franchise has taken on a significant amount of debt, interest payments can impact net earnings. However, remember that EBITDA excludes interest
- Reinvestment and Growth: If a franchise is heavily reinvesting its earnings into growth or improvements, its EBITDA might be lower than another franchise opting for less aggressive expansion
A ‘good’ EBITDA margin could range anywhere from 10% to 30% or more, but it’s crucial to compare it to industry averages and peer franchises. It’s also important to consider absolute EBITDA values in conjunction with margins, as a high margin on a very low revenue might not necessarily indicate a successful franchise.
In the property industry, an EBITDA of 25 – 30% would be considered ‘good’ for a lettings business. For an estate agents, a ‘good’ EBITDA would be 20%.l
What is a good profit margin for a franchise?
A ‘good’ profit margin for a franchise can vary significantly based on the type of franchise, industry, location, scale etc. Here are some general insights regarding profit margins for franchises:
Each industry has its typical profit margin range. For instance:
- Fast Food Restaurants: Often operate on thinner profit margins, sometimes between 5% to 15%
- Service-based Franchises (like consulting or certain types of repair services): Can have profit margins ranging from 15% to 35% or even higher because they don’t have the inventory costs associated with product-based businesses
- Retail: Can vary widely, but margins often fall in the 10% to 20% range, though luxury goods or niche markets might see higher margins
In the property industry, where Belvoir Group operates, a ‘good’ profit margin would be around 25%.
A franchise in a high-rent district or an area with high wages might have a lower profit margin than the same franchise type in a more affordable location. Conversely, high-traffic, prime locations might command higher sales volumes, potentially offsetting the higher costs
Scale and Size:
Larger franchises or those with multiple outlets might benefit from economies of scale, leading to better profit margins. However, the upfront investment for larger operations might be significantly higher.
Franchise Brand and Royalties:
Well-established franchises might command higher prices and, thus, better profit margins. In addition, they may benefit from economies of scale. In addition, franchise fees may result in support that will increase profitability over time.
Good management, efficient operations, and effective marketing strategies can significantly impact profit margins.
Economic and Market Factors:
External factors, such as the overall state of the economy, competition, market saturation, and consumer preferences, can influence profit margins.
Initial Investment and Ongoing Costs:
High startup costs might result in lower profit margins initially. Similarly, franchises requiring regular upgrades or updates might see periodic dips in their margins.
Debt and Financing:
If a franchisee has taken on significant debt to start or grow the franchise, the interest and principal repayments can affect profit margins.
It’s essential to research industry-specific benchmarks and compare similar franchises to get an accurate sense of what a good profit margin looks like in a particular context.
If you are interested in purchasing a franchise, please speak to Belvoir Group’s franchise resales team. They undertake hundreds of business valuations & franchise appraisals & helped franchisees buy with confidence. The team not only arranges for new franchisees to buy an existing business (perhaps from someone who is retiring) but also arrange for existing franchisees to grow their business by acquiring others. This puts the team in a unique position. They are at the tip of the spear when it comes to understanding how franchises are valued & the current market. They also have a number of franchise resale opportunities available & more coming to market every month.