Sleepless In Perth – Franchises

I have been having a sleepless night! Why? Because I know that in the morning I have to deliver some disappointing news to a prospective client. You see, I’ve been asked to do an appraisal on a business ahead of selling that business for the owners.

So what’s the problem?

The problem is that the business is a franchise business in a shopping centre.

So why is that a problem?

Generally in these cases the owners have invested an enormous amount of money to buy the franchise and pay for the fit out of the premises. Often this can be as much as $450,000 or $500,000. Just to get started in the business! Then, every month they are paying royalty fees to the franchisor of typically 7% to 9% and possibly a marketing fee on top of that. Then there are the very high lease costs for the premises to be in a ‘quality’ shopping centre where there are no options to renew on the lease and very little room for negotiation. Then of course the business needs stock as well. Depending upon the type of business the stock value can be anything up to $250,000 and more. I have seen these levels of stock in such businesses.

So the owners work long hours – often 7 days a week – to scrape together meagre profit of $80,000 to $100,000 per year. Great looking business but a long time to get the investment back. In some cases you are looking at 5 to 7 years just to get your investment back.

So after 4 or 5 years the owners are tired and working long hours and decide to call it a day and cash in their business – sell! They go to their accountant who, in most cases, sets an unrealistically high figure on what the business is worth. You see, the accountant looks at what was put in to the business and says, OK, you have a written down value of $250,000 on the fit out of the premises, plus $20,000 plant and equipment, plus $200,000 of stock and you make $100,000 per year net profit. That makes your business worth – $250,000 plus $20,000 plus $200,000 plus $100,000. A total of $570,000.

Wrong! When selling a business as a ‘going concern’ the normal valuation method, in the vast majority of cases, is based upon the maintainable net profit after add-backs and adjustments multiplied by an ROI factor. (For detailed explanation of this visit http://www.businessreadyforsale.com/ArticleKey2.html).

So in the case of my current prospective client they have a maintainable net profit in the region of $80,000 and the business type will attract at VERY BEST a maximum of 40% ROI. That is a multiplier of 2 1/2 times. In other words $200,000 tops! And that is inclusive of stock and plant and equipment and everything else. Not a lot of reward for 5 years of effort. And on top of all of that, the franchisor wants the new owner to upgrade the fit-out (cost of $25,000) and there is only two years left on the lease with no guarantees of a renewal. Would YOU buy that business?

So you see why I am sleepless in Perth. By the way, this is a very typical scenario for a retail franchise business in a shopping centre! Remember, franchising is having a license to operate a business – not necessarily owning a business.