Economy & Finances Explained

Assuming your franchise business has the qualities that enable it to be sold for value, two questions still need to be addressed, which are:

Do you own the business?

Are you entitled to sell it for value?

The answers to these questions will depend primarily on the terms of the franchise or licence agreement under which you trade and the exit policy that your principal has adopted. (Please note we will use the word ‘principal’ here to cover the principals of licensees, or franchisees or selfemployed agents.) In the case of most franchise agreements, ownership per se is not an issue.

It is usually clear that the franchisee owns the franchise business. The exit questions that arise are how, and to whom, is the franchisee able to dispose of his businesses when, and if, he wishes to do so?

If you are a self-employed agent, or trade under a franchise (or licence), you own a business that has a value to you because you earn an income from it; but does it also have a capital value? In previous articles I explained that capital value in a business derives from its income (or profits) and that the quantum (or amount) of value is usually arrived at by capitalising estimated future profits by a multiple such as a P/E ratio. I explained, also, that for there to be value for the owner, the business and the income deriving from it has to be capable of being transferred to a third party. Most franchisees earn income, like any other business, by buying and selling goods and services, but the key difference for franchisees is that they are only able to continue this trade as long as their franchise agreement is in place. Also, their ability to exit the business by selling it on to another owner is subject to their agreement.

All business valuations involve individuals estimating what they think a business is worth (or will be worth) on a particular day, assuming certain circumstances. Valuation is, therefore, not an exact science. However, if you follow the guidelines in this article you should be able to have a reasonable idea of what your business is currently worth and a basis on which to estimate what it could be worth in the future.

In planning your exit you need to know with some certainty not only how much your business is worth now, but also what it is likely to be worth when you plan to exit. This puts all your plans in context and helps you decide such things as your likely exit timetable and even your retirement planning.

We started this blog by considering the owner’s business aims. These will usually include achieving certain target values for the business by the time of exit. Estimates of future value will be based on profit projections, which will rely on certain operating objectives being achieved within the business. Naturally, there will be a degree of uncertainty surrounding future values, especially if your projections are several years ahead. However, it is better to have some parameters and goals to aim at (despite their uncertainty) than merely to soldier on with no idea where you want to go and what you are trying to achieve.

You will need to assemble the following information when you are preparing an opinion as to the value of your business. Professional valuers will, as a minimum, also require this information to provide you with a formal valuation.

Background information

A short narrative background of the business. (Type of business, date commenced, location, number of employees, number of owners, plus anything else you think is relevant.) Legal structure of business; company or trust or partnership. Provide diagrammatic structure if necessary.

Finaneials

Full financials (profit and loss and balance sheets) for at least the previous three years of all entities involved in the business. Profit and loss and cash flow projections for at least two years. Full debtors’ listing. Stock details. List of assets – depreciation schedule.

Premises details:

a) Location of business, clarify whether city, suburban or country where this is not obvious.

b) Number of branches and locations.

c) Properties owned or leased?

d) Lease details, plus a copy of all leases.

e) Owned property details, including: Description and estimated value. Is property to be valued? (If so, the valuer will advise what information is required.)

Taxation returns

Where business is sole trader or partnership, taxation returns for the last three years should be provided. Taxation returns are not usually required to value companies.

Franchises, licences, etc.

If the business operates under a franchise or licence agreement, or is reliant on agency agreements for its trade, full details of these and copies of the relevant agreements should be provided.

Staff details

These should include: Management: number and qualifications. Technical: number and qualifications. Support staff: number and qualifications.

It is clear from the responses of business owners that most consider wealth creation and independence to be their primary objectives. But, it is worth asking whether these objectives are achieved more easily through owning a business than they could be through working for someone else. Similarly, will you, as head of the family, create more wealth for your family by going into business than you could by being employed?

The most obvious difference between owning a business and having a job is that with a business you have the potential to create wealth in two ways, firstly by earning income and secondly by building capital value in the business. With regard to income generation, the average small business owner probably earns less than an employee in a senior management role, either because he is putting back most of the profits into the business, or because profits are not large or predictable enough to allow for generous drawings. So, in most cases, if a business owner is to create greater wealth than an employee, it is necessary for him to build capital value in the business.

The third conclusion is that most owners have an unrealistic idea of business values and have no firm plans to build the business to reach the target value they have hoped to achieve. Does this also apply to you? Have you based your answers on an up-to-date, formal valuation provided by a professional valuer, or your own estimates? If you have used your own estimates, what valuation methods have you used?

The last conclusion is that most business owners have a limited understanding of the range of exit options available to them and hence, in most cases, fall back on a trade sale ‘to some interested party’ (or a handover to a family member), without having analysed who the interested party would be (or whether the chosen family member is suitable, or even
willing to take on the business). Also, without a clear exit option in mind, most of them have made no effort to tailor the growth and development of their business to the type of exit they believe is the optimum one.

How do you shape up here? Could some of these conclusions also apply to you? Have you got a plan, or do you fall into the large category of business owners described by John H. Brown in Exit Planning Review when he said: ‘… few owners reach their objectives. Why? Because they don’t have a plan to achieve them.’

The first conclusion that can be drawn is that financial reward and independence are the most important business objectives for existing small to medium sized enterprise (SME) owners and those considering going into business. For family business owners, passing on something of value to heirs was a major objective.

How does this apply to you? If wealth creation and independence were also your primary objectives, do you think that you can create more real wealth through your business than you are likely to generate by working for someone else? Also, have you considered whether this increased reward will come from income generation, or building capital growth? If you have a family business, have you considered whether your designated heir will be capable of running a business and what steps you intend to take to prepare him or her for the task?

The second conclusion is that most owners have not sufficiently thought about when they will exit their businesses, leaving it to chance or fate, or believing that the decision can be made (or will become obvious) later on. When you gave your answer about the timing of your exit did this follow a carefully thought-out plan and is this part of your operational business plan? Have you considered whether your time target is likely to be a good period in which to sell with regard to market conditions in your industry?

Most owners gave an answer based on their age, such as ‘When I am 55.’ The impression was that most had not really thought this through and were content to let things develop naturally and hoped that ‘perhaps, something would come up’. A minority group, whose ambition was to buy and sell several businesses in their lifetime (known by some as ’serial entrepreneurs’), had a clearer idea of their exit timing, which was usually about five to eight years from acquisition. Finally, there were those who seemed content to stay in business to the end and had no time scale to exit at all (known as ‘managers for life’).

Most business owners had a limited view of the exit options that might be available to them. Family business owners were, naturally, usually focussed on a handover to a designated family member; whilst for those without families a trade sale was the favoured option. Others had considered a sale to management or employees. In most cases the merits of one exit option over another had not been thought through. Few owners had a plan B should their favoured exit option prove not to be feasible.

As you might expect, most business owners put ‘making more money’, or ‘creating more wealth’ (and variants thereof) high on their list, although ‘being independent’ was not too far behind. For many owners, independence meant financial independence, although for some independence in the sense of being your own boss and having the freedom to do what you want, was also important.

For owners with a business in which family members work or are intending to work, a major objective was to ‘build up value for the family’, or ‘to pass on the business to my family’. This objective can be seen as a mixture of wealth creation and the desire to be a benefactor.

Most business owners are clear about their overall wealth-creation strategy, which is to start (or acquire) a business, build it up, sell it and retire on the proceeds. But for many, the strategy is vague when it comes to method and timescale for exit and the amount of capital that is necessary for a comfortable retirement.

For family business owners the strategy is similar in terms of building up the business, but the main objective is usually to pass on the business to heirs, with the exiting owner receiving some, but not necessarily all, of the capital value on retirement.

Having collated your objectives, test your assumptions by asking yourself the following questions:

How realistic are your plans? Is your value target reasonable and is it based on both a real current value and achievable growth targets?

Are your objectives consistent with each other? (Using our example, is it realistic here to assume that that your management will be able to raise the £500000 you hope to get for your business? Are there hard assets in the business that will make this borrowing possible?)

Are you expecting to be paid in cash, or can you retire comfortably and receive payment over time?

In reality (as opposed to the theory) is your business likely to be attractive to buyers at the price you are talking about? (To assist you in this, list three good reasons why someone would buy your business at the price you are asking.)

And finally, how are you going to achieve your plans?