Know the steps and methods to value a franchise business. The value of a company's assets, the market approach to value, and the price-to-earnings (PE) ratio should all be considered before buying a franchise or any business.
Franchise Appraisal: How to Value a Franchise Business
What is a Franchise’s Worth?
Table of contents
- Franchise Appraisal: How to Value a Franchise Business
- What is a Franchise’s Worth?
- What is a franchise?
- What does it mean to buy an existing business?
- Consider these factors before buying a franchise or buying any business:
- Asset Approach to Business Valuation
- Market Approach to Business Valuation
- Price-To-Earnings Ratio (P/E)
- Valuing a Franchise Conclusion:
If you are an entrepreneur, you have considered buying a franchise or a business. For many, franchising or buying an existing business is a great option to bypass many challenging initial stages of starting a business from scratch.
Regardless, there are many differences between franchising and buying that would impact your level of control over the business. This article explains some of those differences and the steps you might consider before facilitating a purchase or deal.
What is a franchise?
Through a franchise, a business owner (the “franchisor”) sells the rights of their business to an independent entrepreneur (the “franchisee”).
The franchisee would have access to the business name, logo, and products of the larger brand. As an entrepreneur, this also means that you will benefit from brand recognition, brand-wide marketing campaigns, and promotions. It also means that you will have to follow the rules of the brand on how to manage the business.
Franchising tends to occur in the restaurant, hotel, and service-oriented industries. However, there are still variances within the facilitation of the business model. Specifically, there are two common franchising types: product/trade name franchising and business format franchising.
- Product/trade name franchising: With this form of franchising, the franchisor sells the right to use the business name or trademark to a franchisee. This sort of franchising is common in supply chain management, where products may be manufactured or supplied by the franchisor and then delivered to the franchisee to sell.
- Business format franchising: Through this kind of franchising, a relationship persists between the franchisor and the franchisee. This franchising style includes business management because the franchisor tends to support the franchisee in site selection, training, product supply, marketing, and funding if needed.
What does it mean to buy an existing business?
Buying an existing business is a common and popular option among potential entrepreneurs. In fact, the practice has become especially common as millions of baby boomers retire and sell their businesses.
By buying an operating company, potential entrepreneurs can avoid startup costs and growing pains that often accompany creating businesses from scratch. It also means that the buyer will have full ownership of the business. And, thus, can control its direction and growth.
Consider these factors before buying a franchise or buying any business:
1. Quantify your investment:
Before pursuing a franchise or venture, ensure you understand how much of an investment you are willing to make in the business. This insight can help you determine what type of business or brand might be best for your financial goals. Also, understand your cash flow needs or burn rate. How long will it take you to have positive cash flow?
2. Analyze the business’ worth:
Most important, you must consider the true economic worth of the business and understand the steps taken to maximize value. You and the seller or franchisor can seek independent valuators, like BA FL|GA|HI, to help you determine which appraisal service best suits the situation.
Although the valuation methods used to conduct the appraisal may vary, the factors included in such analysis remain the same. Often, the financial health of a business is assessed by considering its team, assets, earnings, growth, and losses within the context of the firm’s specific industry.
Asset Approach to Business Valuation
Although imperfect, this method determines the value of a business by taking the difference between the company’s assets and liabilities. Assets analyzed include physical items like machinery, property, raw materials, and intangible items like intellectual property. Each asset’s value will be summed up before any debts or liabilities are subtracted.
This approach’s valuation is much lower than the business’s true worth because it fails to consider expected revenue and earnings. Regardless, it is a great starting point for appraising a business.
Market Approach to Business Valuation
This approach determines the value of a business by considering the market prices of similar assets or businesses that have been recently sold or are in the process of selling. It also considers the value of the business based on geographical location and area. Publicly available data regarding company comparisons and transactions are usually utilized for this method. Adjustments should be made for different quantities, qualities, or sizes when comparing assets.
Price-To-Earnings Ratio (P/E)
The P/E ratio, or multiples of profit, is a method often used to evaluate small businesses’ worth with an established annual record.
Expert valuators use this method to inform forecasted return growth through prior profits. A higher P/E ratio would be used for companies with high forecasted return growth or repeat earnings.
Although the calculations used to reach the valuation are straightforward, expert valuators like BA FL|GA|HI can suggest the correct number for your P/E ratio. This is because the P/E ratio often varies from business to business. Startups, for example, often have high ratios because they are high-growth companies. More established companies, on the other hand, like auto shops or local insurance agencies, experience less drastic growth and will likely have a lower P/E ratio.
Valuing a Franchise Conclusion:
Purchasing a franchise or existing business is a great step to take if you want to avoid the costs that often accompany launching a business. But it’s important to note that entering a franchise deal or buying an existing business often imposes unique risks and challenges.
Understanding the true worth of the venture you aim to get involved with can be extremely helpful as you strategize and execute a potential business arrangement or sale. BA FL|GA|HI can help you value a new or existing franchise.