So until you sell and “lock in” the gain, it is an unrealized or “paper” gain and nothing more. One type of asset we did not touch on is the intangible asset. 4. Let’s start with a very basic (and very fair) question: Where do the numbers on the balance sheet originate? There’s more work to be done, however. A sound valuation relies on multiple factors, all vetted to the extent … How do we assess high-growth DMAs vs. saturated ones? So how to value it? Lots of uncollected revenue that makes the P&L look good will create a large accounts receivable balance that makes the cash flow statement anemic. The market approach, via the comparable companies method and the precedent transaction method, where the value is estimated based on exchange prices in actual transactions and on asking prices for assets currently offered for sale. How established is the franchise system, and how quickly is it growing? The valuation basis of most franchises is a multiple of future maintainable earnings. Using a multiple of the business’s net earnings or free cash flow, usually 1-4 times EBITDA. What is the impact on remodeling a restaurant and then selling it vs. selling before a remodel is due? That leaves $578,500 for the land and building, which based on the 85/15 rule means the building is valued at $491,725 and the land at $86,775. As you probably already know, "high multiples" describes … Will the franchisor allow for renewal upon expiration of the franchise? As such, you have likely heard of cap rates and their application in ascertaining value for fee-owned restaurant real estate. Whether you are buying such a business or preparing to sell one (a topic I’ll be tackling in the next article), determining a fair and realistic price is one of the greatest challenges. Determining what this contributes to valuation is a question of what it would cost to buy into the franchise today and more importantly how much of the original term of the franchise agreement remains (assuming the franchisor’s practice is to transfer the existing agreement). Also, remember that debt maintenance does not appear on the P&L aside from the interest portion. One must first understand what remodeling action is needed on a by-store basis, when it is required by the franchisor, and the expected expense. Valuation, a business valuation and equipment appraisal firm specialized in SBA related valuations nationwide. Consider investing in stocks. I find this technique a good guide and a quick way to assess whether a seller is pricing his or her business at least somewhat reasonably. G&A assumptions might change based on in-line vs. standalone restaurants. This is perhaps the most widely variable aspect of a restaurant valuation. We can open that can of worms later.). The selection of appropriate valuation multiples is a function of the specific facts and circumstances extant at the valuation date. Do you have a special expertise in the industry that will allow you to improve operations and revenue? It can look better than the P&L might indicate if bills aren’t being paid timely and accounts payable are piling up, which conserves cash in the short term but isn’t good for continued operations in the long term. Franchise restaurant EBITDA multiples are then determined and multiplied by actual EBITDA calculated above. G&A% is generally lower for larger businesses than those smaller. Email firstname.lastname@example.org. Public companies have it easy. By way of illustration, we provide a brief example of a major league baseball (MLB) franchise valuation … The balance sheet is one of the triumvirate of basic financial reports (the other two being the income statement, also known as the profit and loss statement or just P&L, and the statement of cash flows). First, is the business growing, stable, or declining? As for the land and building, it depends on the condition of the building, the location of the lot, economic and real estate market conditions in the surrounding area, and more. They may also pay themselves (and often family members as well) generous salaries and bonuses. If you have found this overview insightful or if it has peaked your curiosity, please feel free to reach out to me for a deeper discussion. This might not be the case for smaller cities or in different regional areas of the US. Maybe, and maybe not. Warmest regards,Rick OrmsbyNDA - Restaurant M&Aricko@ndainc.net 502-493-9958 (p), 25 Critical Trends in Restaurant M&A – a…. Similarly, taxes are a product of the owner’s financial circumstances and should therefore be estimated based on the buyer’s tax burden. In the absence of an appraisal or other objective source that assigns separate values, we must somehow distinguish between the value of the land and the value of the building. Any brand trading above 5.5X will likely have high-growth appeal or attractive EBITDA and development opportunities. The valuation of franchise companies tends to be viewed simply as an exercise undertaken when a sale of the business is to take place. I’d be honored to talk with you anytime on a personal and confidential basis. For example, a business that sells extensively on credit will generate all kinds of revenue and may even have a great net income number. Interest is based on debt maintenance, which will vary based on the new owner’s circumstances and so bears little relation to the status quo. Common EBITDA multiples are three or four, though as low as two and as high as five are sometimes seen as well. EV to net income. In order to value a fee-owned real estate property, first assume an implied rent (generally as a percentage of sales not to exceed about 8% of sales) and assign a cap rate. Using “comps” of similar franchise sales obtained from either the franchisor or a franchise… Do you have the financial wherewithal to catch up deferred maintenance, renovate tired facilities, hire new operations talent, or answer other currently unfunded needs? EV to seller’s discretionary cash flow(SDCF or SDE). Why? An asset might be worth significantly less than its booked value, as in the case of FF&E. Finally, multiply net sales by the implied rent to cap rate ratio. If we assume that the FF&E in our hypothetical restaurant is three years old, we can assign it a value of (in round numbers) $171,500. At the highest end, there is a feeding frenzy for a few select brands, most notably Taco Bell – where EBITDA multiples have eclipsed 8.0X. If you want to invest in a franchise company and feel confident you won’t have buyer’s remorse, it helps if there are high multiples. I think probably the value of an existing franchise which has been in business for only a year would be around two times the correctly calculated discretionary earnings, including any franchise transfer fee due the franchisor. Whether the mergers and acquisitions market is in a hot upswing or in a down cycle, one valuation measure remains the primary focus in nearly all transactions: the multiple of EBITDA (or cash flow). (This is an oversimplification, because capital improvements like the aforementioned renovation would have been booked to improvements and would also appear on the balance sheet, but bear with me.) The asset-based approach, wh… If a business has future maintainable earnings of $150,000 and a multiple of 3 times, the business is worth $450,000 ($150,000 multiplied by 3… Plenty of statistical data is available indicating what a “typical” multiple of revenue is used to value companies in a particular industry. 6. Finally, depreciation and amortization are non-cash expenses (that is, they do not detract from cash flow). These EBITDA multiples are generally in the range of 3.0X – 8.0X. Using a multiple of future earnings. Originally just a valuation solidity check, multiples have become a popular approach to value young, fast growing companies. For any franchised restaurant, this figure can be simply calculated from the most recent P&L (on a by-store basis). (The building will age, wear, and eventually have to be renovated or replaced to remain useful, but the lot upon which it stands will still be there.) 5. In some situations the P&L can make things look rosier than they are. Five key Company factors to consider when determining where a franchise multiple … We find that market multiples and the cost of capital are normally more generous to franchisees than similar unaffiliated operations. The restaurant also contains equipment and furnishings, and those have some value. Those are the numbers that will appear on the balance sheet. As with EBITDA, multiples of three to four times cash flow are a reasonable basis for valuation. Lastly, there are usually other adjustments and add backs; these will vary from franchisee to franchisee. Once actual G&A is added back and other adjustments are made to the store-level P&Ls, an assumed G&A is deducted from EBITDA before the multiple is applied. • High multiples and speculation are gone. The final aspect involves some prognostication and your best estimate of future conditions. Second, what significant difference can you make in the acquired business? Valuing a franchise system, or “franchisor”, is in many ways very similar to the valuation of any other type of business; it is a function of the forecasted levels of cash flows that the business will generate, and … Finally, EBITDA multiples are sensitive to interest rates, general availability of capital, overall business climate, brand performance, buyer demand, yields in other asset categories, and many other factors. While the owner’s debt does not affect what the business will be worth to you as a buyer, it can provide a clue as to why the seller is willing to accept what seems to be an unusually low price—something that should always be cause for suspicion. If you buy 1,000 shares of a stock at $50 and the share price rises to $70, its value is now $70,000 versus the $50,000 you paid. That means you can deduct one-seventh of the original purchase price per year of age to arrive at a fair market value (FMV) that the IRS would not likely challenge. Franchise Costs: Detailed Estimates of Planet Beach Contempo Spa Franchise Costs (2013 FDD), Franchise Chatter Guide: How Dunkin’ Donuts and Krispy Kreme Are Faring in the Fast-Food Breakfast Wars. Here is our short list of the valuation multiples most commonly used to value private businesses: 1. Even using the mean (average) multiple makes a lot of assumptions about how comparable some very different companies might be. Here is some helpful information to get you to a successful valuation and faster sale of your business. If you’ve ever bought a new car and experienced the sharp drop in value that takes place the moment it is driven off the lot, you know that even if it’s nearly new, the FF&E in this restaurant is no longer worth the $300,000 that for the purposes of this example we’ll say it cost. Here is a non-comprehensive list of other considerations: As you can see, restaurant valuations are a complicated topic. Now, are they realistic? True…to an extent. Poorly performing fee-owned restaurants with near-term remodels might have a higher valuation if closed and sold for a different use. We did about $1 billion a year in revenue—people have to eat, after all. Once the valuation analyst selects the range of multiples for the franchises being valued, factors that are unique to the Company must also be considered to arrive at an appropriate multiple. Keep in mind that the balance sheet is a product of accounting practices, and while I am a CFO and accounting practices are certainly dear to my heart, it is important to understand the limitations those practices bring to the balance sheet. Small business owners in particular often transfer what would normally be personal expenses such as car notes, insurance, cell phone bills, travel and entertainment expenses, and the like to the business. You can calculate the estimate of business market value using a number of valuation multiples– each establishing business value in relation to some measure of its financial performance. This Franchise Chatter Guide on how to value a business was written by Daniel Slone. EV to owners’ equity. Yet even if the land and building are now worth $800,000, that’s not what the balance sheet will say. I have previously discussed the mechanics of buying an existing franchised business as an alternative to establishing a new franchise, especially in systems that are mature and have few open markets remaining. Franchise Valuations Ltd. provides fair market valuations for franchised businesses. EV to EBIT and EBITDA. • Historic multiples may not be relevant. Normally, I would look at valuing Tier Three franchisees in the 4.5x to 6x EBITDA range. This inspired me to share a general overview of how to think about restaurant valuations.Restaurants are unique in that they have very little inventory and accounts receivable, making the valuation techniques oftentimes different in practice to discounted cash flow calculations learned in business school or on Wall Street. These EBITDA multiples are generally in the range of 3.0X – 8.0X. Franchise brands have routine remodeling programs – every 5, 10, 20, or 25 years. Fast food franchises… The best valuation method is to use a multiple of the net cash flow you will receive from the business. Be certain to deduct any assets not conveyed by the transaction. Franchise business sales transactions that occurred six months prior to your valuation … 3. Using revenue for valuation, however, in my opinion leaves much to be desired. In some industries this might be intellectual property like patents (which can easily be worth a million dollars each). Unless you plan to turn around and sell within a very few years, these things matter. Valuation Guideline: Tier Three franchisees are probably the most difficult franchise businesses to value. The seller might have almost no debt (and therefore almost no interest expense) while the buyer is about to be mortgaged to the hilt to swing the purchase and therefore will carry a much higher interest cost. The reduction of principal hits the cash flow statement and balance sheet. No buyer would pay that for it. 2. If not allocated at the store-level, beverage rebates should be added back, while credit card fees and bank charges need be subtracted. Big or small, most restaurant owners I know do not apply these drivers correctly and thus are poorly informed about the value of their companies. The income approach, via the discounted cash flow method, where the value is estimated based on the cash flows a business can expect to generate over its remaining useful life. Is the franchisor innovating, or has the brand stagnated? Restaurants with short-term leases and no extensions have questionable value. You can sell things all day long, day in and day out, and still produce very little cash. So if we buy a hypothetical restaurant and pay $750,000 in cash, our hypothetical accountant must enter the transaction into our books and assign values to each component. In other words, until you actually sell it for $800,000, it’s not worth that much. Assuming that the restaurant has been renovated (most franchisors will require a “reimage” at least that often) and that nothing strange has happened to the real estate market (à la the 2008 debacle), the land and building will actually be worth more than the $578,500 that appears on the balance sheet.
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