Before you Buy your Franchise - Know how to Sell your Franchise
Rick Chittley-Young, Partner
BDO Dunwoody
If you are a prospective franchisee, and you are reviewing a franchise agreement prior to purchasing a franchise, what is one of the most important pieces of information you should look for?
This may be surprising to many, but the answer is: the options for selling the franchise. Unfortunately, this information is more often a last consideration for prospective franchisees. Rule number one, however, when buying a franchise is: never enter a deal that you don’t know how you will exit.
Some prospective franchisees hope to buy a franchise, work in it for a few years until it’s profitable, sell it and then start a new venture. Others hope to pass along their franchise to family members. Still others intend to work in the franchise until they retire, then sell it and use the proceeds for their retirement. None of these options may be possible, however, unless you take the following steps.
1. Review transfer of interest restrictions before signing an agreement
One of the key provisions in any franchise agreement is “transfer of interest.” This section of the document deals with issues related to the transfer of the franchisee’s ownership interest in such situations as death, disability or sale.
When it comes to the potential sale or succession of a franchise, agreements may include a variety of restrictions. These might be, for example, requirements that the franchisor must consent to the transfer of any ownership interest or controlling interest in the franchise, or that the franchise must be sold back to the franchisor.
In the first instance, some agreements establish the right of the franchisor to approve a new franchisee and the selling price of the franchise. For example, the contract may stipulate that the franchisor has the right to purchase the franchise back for the same terms as an offer to a prospective purchaser.
Other franchise agreements do not include any option for a sale, requiring instead that the franchisee must sell the franchise back to the franchisor. This is most common for capital intensive franchises where the financial outlay to establish a business is simply too high for most potential purchasers.
In such situations, the franchise agreement will typically set out buy-back terms based on a certain form of valuation of the business. These terms can make a significant difference regarding what you realize in a sale. For example, if the agreement stipulates a “net book value” for your franchise, this would be calculated as the book value of assets, less liabilities. Based on the franchise’s most recent balance sheet, net book value does not include leases or other items that are not included in this document. In some agreements, net book value does not include goodwill; other contracts do include it. This is also important to consider since goodwill may account for as much as two to three times the average earnings of a franchise over a one- to two-year period.
If the agreement proposes a “fair market value” assessment of the price of the franchise, this is usually calculated as the cash equivalent price for which a franchise would change hands in current market conditions. These valuations typically include some measure of goodwill and future earnings.
Therefore, before signing an agreement, it’s important to know the sale or succession options available to you, for two reasons. First of all, you need to be comfortable that the alternatives will enable you to meet your financial goals. Secondly, you need to know how to manage your business so that you can maximize the value of your franchise when you sell it. For example, if the franchise agreement includes a buy-back clause stipulating net book value with no compensation for goodwill, you would not want to accumulate profits in the business, but rather, should plan to reinvest them elsewhere.
Once you are satisfied that the sale or succession options set out in a franchise agreement are acceptable to you, you should begin to think ahead toward the day when you might sell or pass along your franchise. To properly prepare a business for sale requires at least three years. The sooner you begin planning, the better your chances of meeting your financial goals.
2. Consult an accountant
In order to plan appropriately, you need to understand the financial and tax implications of the potential future sale of your franchise. Consult with an accountant to help you structure your business and personal financial affairs so that you will realize the best financial outcome when that time is at hand.
3. Get a business valuation
If you intend to sell your franchise, obtain a business valuation at least three years prior to your planned sale. You want to ensure that you will secure the best possible price, and in order to do that you need to know what it is worth today – and what you can do to maximize the future return.
A professional valuator can give you an idea of the proceeds you can expect from the sale – along with valuable information regarding your businesses’ strengths and weaknesses, financial situation and market position. These insights will enable you to address problems and will also establish a benchmark price. You can then update the valuation prior to putting the franchise up for sale and will be able to measure how much value you have added to the business.
4. Address weaknesses and resolve problems
Following are some of the key internal factors that can affect the value of your business.
- Current and projected profits and cash flow
- Cost controls
- Value of tangible assets
- Value of intangible assets such as goodwill and intellectual property
- Value of liabilities and level of debt Current and future orders
- Value of customer relationships
- Growth potential of the franchise
By focusing your efforts on improving the performance of your business in these areas, you can enhance the value of your franchise to realize higher returns in a future sale.
5. Plan for management succession
In many franchises, the franchisee is essential to the smooth operation of the enterprise. If you hope to sell your franchise, you need to have a plan in place to allow for a successful transition to a new owner. Assess the experience and commitment of your management team and determine what this team needs to support a new franchise owner.
6. Organize your financial records
Any prospective purchaser will look at the financial statements of the franchise to determine its current and future performance. Most will want to see at least three years of financial information, including balance sheets, income statements, and cash flow statements.
Financial records must be accurate, up-to-date, and impressive indicators of the owner's business ability. The more comprehensive and professional these documents are, the more credible they will be to potential buyers. Engage a reputable accounting firm to help you prepare these documents in order that they clearly reflect the value of your franchise.
7. Seek professional advice
When it comes time to sell your franchise, consult with an accountant and a lawyer to ensure that you have all of your financial, tax and legal matters properly assembled – and showing your franchise in the best possible light. These professionals can also assist with negotiations between you, the franchisor and prospective purchasers to ensure the process goes smoothly – and that you realize the best possible returns on the sale.
Buying a franchise may be one of the most important financial decisions of your life, so be sure going in that you know how to strike the best deal when you decide that it’s time to exit.
Rick Chittley-Young, CGA, is a principal of BDO Dunwoody LLP (www.bdo.ca). One of Canada’s leading accounting and advisory firms, BDO helps entrepreneurs, family businesses, franchisors and franchisees succeed. If you have questions about this article or would like to receive BDO’s “Tax Factor” newsletter, contact Rick in the Oakville office at (905) 844-3206 or rchittley@bdo.ca.
