The International Franchise Association estimates that there are currently more than 2,000 different brands operating over 700,000 franchised units in the United States. Based on the number of people who own franchises, it may seem like an easy route to owning a private business. But not all franchises are created equal, resulting in unique valuation challenges leading to the question: What’s the Value of My Franchise?
As with any business, the value of a franchise is a function of risk and return. A franchised business may seem to carry little risk because its brand is established and the franchisor provides administrative support, including marketing programs, accounting systems, operating manuals and training. The franchisor also may pass along volume purchasing discounts from suppliers to its franchisees.
All of these factors suggest that a franchise is significantly more valuable than an otherwise identical standalone business. But that’s not always the case for a variety of reasons.
The franchisor’s support comes at a substantial cost, which lowers the franchisee’s return. First, the owner must pay an upfront franchise fee, which typically ranges from about $50,000 to $200,000, though some franchise fees may be higher or lower depending on the brand and geographic market. Additionally, the franchisee must pay professional fees to get started.
Once open, the franchisee must pay ongoing royalties that typically range from 4% to 8% of gross revenues and include an ongoing assessment for a joint marketing and advertising fund. The franchisee also may be required to purchase uniforms, inventory and other supplies from the franchisor, as well as build out (or update) the facilities to comply with the franchisor’s appearance standards.
As a result of these costs, most franchisees don’t report positive operating cash flow until they’ve been in business for several years. To help forecast revenue and costs, a valuator will ask for a copy of the franchise disclosure document. Required by the Federal Trade Commission, this document provides insight into start-up costs and fees, average monthly sales and projected revenue growth.
A franchised business may look even less attractive to investors if the franchisor restricts the owner’s actions. Examples include independent marketing efforts, relocation and ownership transfers.
Valuators typically review the franchise agreement to get a handle on these restrictions. A discount may be warranted if the agreement limits the franchisee’s rights to expand, sell to a third party or respond to changing trends and market demographics.
Franchisees are most satisfied when franchisors continually reinvent their brands and offerings, invest in training programs, support customer retention efforts and grant flexibility to respond to changing market conditions. Strong franchisors also adapt to regulatory challenges, such as changes in health care reporting and the minimum wage and overtime rules. Valuators ask, “How does this brand and its industry measure up to others?”
The Franchise Business Review included franchises in these five industries as the top franchise groups recently, based on franchisee satisfaction:
Franchises offer investors many pros and cons. When valuing a franchise business, appraisers look beyond the person investing in the franchise and the specific location. Thorough due diligence includes evaluating the franchisor’s business plans and the industry’s overall prospects.