Selling Your Franchise? Read This
Five factors to consider when pondering the sale of a franchise unit or units.
By Todd Recknagel
If you’re a single-unit or multi-unit franchisee and contemplating selling your entity, consider these business lessons I’ve gained from serving as franchisor, large multi-unit franchisee and private equity investor.
Not long after we had opened several franchised restaurants, one of my managers said she had a wealthy backer and wanted to acquire one of our stores. The new store was our worst-performing store, losing money in the start-up phase. At that time, I knew it was likely to sell for less than I had invested in it.
Factor 1: Fix It First
A business lesson dawned on me from the example above: We need to fix it, whether we keep it or sell it.
We had to step up and fix the issues and get to positive cash flow. If this happens to you, you need to dive in and examine how to grow sales, upgrade management, and focus on improving operations. In my example, the store quickly became cash flow positive and provided great returns for the next 10 years. Many franchisees might find themselves in a similar position with a struggling unit and might be tempted to bail by selling. However, to maximize your gains, you need to fix the issues.
Factor 2: Clean Up Your Numbers
Many opportunity seekers ask similar questions about why one unit is so much more, or less, profitable than another unit owned by the same group. Their answers: “We run our salary through this unit,” or “These expenses for all of our stores are processed through this unit,” etc. For owners’ salaries, or compensation and other expenses like vehicles and cell phones, consider the true operating profit from your enterprise without your personal expenses, pay/draw or your time. Plan how the business would operate with a manager in place without your time and compensation. All revenue and expenses associated with a single unit’s direct operations need to be attributed to that unit’s P&L to have a picture of its true EBITDA, or operating profit – otherwise you’re leaving money on the table or overvaluing EBITDA.
Factor 3: Duplicate in Each Unit
I have been a private equity investor in multiple companies both franchise and non-franchise. People often ask, why franchising? I’m a fan of franchise systems; their greatest benefit is they are duplicative in nature. Because each franchisor has a defined system, it makes it easier for a multi-unit owner to maintain and provide oversight and accountability, rather than having to work in direct unit-level role. This can only take place with proper funding and strong management, while the goal is to allow your role to be “duplicative vs. divided.”
What does that mean? Rather than trying to divide your time stopping in to micro-manage each unit’s team, you should hire and incentivize managers who will align with your interests and duplicate (act as you) in each unit. This allows me to be in the role to regularly review the metrics, cash flow and P&L, providing oversight and accountability.
“You should hire and incentivize managers who will align with your interests.”
Factor 4: Modernize Accounting Methods
Holding management team members accountable can only happen if you have good metrics at your fingertips. In one deal, where we had amazing growth in a niche business, I had a private equity friend/investor ask me, “How can you live with this cigar box accounting?” He meant it was extremely difficult to determine the real metrics and profitability of the business with our antiquated accounting methods manually producing separate spreadsheets, making it difficult to tie all numbers together. It was a great lesson – consider using state of the art online accounting for your business, if you don’t already.
Factor 5: Work on the Metrics
I recently saw an opportunity where the owner was quoting the business metrics including profit margins and it looked exciting. However, after taking a deeper dive, the numbers were good, but not as good as the owner originally thought. The owner worked on improving metrics and expense line items as a result.
Proving that business case may come in the form a Confidential Information Memorandum (CIM) when selling to private equity. A CIM is essentially a book on the history, strategic information and the future potential of the business. It is similar to a business plan combined with a strategic plan. You need one even if you are not selling. In addition, private equity representatives will be looking for the data to back up that information, and that data is stored in a virtual “data room.” Start your data room now. Creating a data room with years of information will help you save time in the future.
“Capital is very plentiful; successful operators are rare.”
It may be time for you to consider a capital partner at a more modest level to sell part of your business and assist in your growth. A capital partner helps bring funding for growth, and is going to look deeper into the metrics. Capital is a commodity and very plentiful, while you are the operator; successful operators are rare.
“It may be time for you to consider a capital partner…”
When evaluating the best timing of when to put a business up for sale, another useful practice is to regularly “sell the business to yourself.” If you have utilized some of the five lessons above, you can evaluate for yourself whether the units are productive for you – or ready for a sale to someone else. With a few of our investments, once we became disciplined and productive unit by unit, we realized the true results and potential and essentially decided not to sell. We took our own advice.
Todd Recknagel is Managing Partner of Three20 Capital Group. He has worked more than 30 years as franchisee, franchisor and private equity investor.