Franchisees need to make money. That sounds so simple and obvious; however, not all franchisors have this as their most important guiding principle. The value proposition for a franchisor is their future growth, scalability and sustainability of the business model. By Tom Spadea
Dig Into Due Diligence
by Diana Capirano
Certified Franchise Consultant
When exploring a resale, the level of due diligence will be driven by the complexity of the business model and how the owner is performing. Evaluation of resales must be comprehensive, even granular to mitigate risk. Although franchise systems are the same, owners are not, which leads to a great degree of variability in financial and operational performance.
A holistic approach is best in assessing the overall health of the business. Many buyers think they just need to evaluate financials. Not so! If you’re not prepared to ask the how and why behind the numbers, you may miss a whole lot more.
Following are the 3 most important categories and items that are fundamental in disclosure.
Standard disclosure is the past three years’ tax returns and corresponding profit-and-loss statements (P&Ls) and balance sheets. Also request current YTD (Year-to-Date) information. Tax returns tend to be of most value because they are holistic. Make sure the financials are verifiable or reviewed by a CPA as they are not audited. In some cases, a cash-flow analysis may be available. If not, view bank statements to verify money in and money out.
- If the business carries accounts receivable (AR), you’ll need an AR aging report to see money that’s due, collection trends, and the largest outstanding AR sources considered an asset in the purchase that may not attach to the sale.
- A current asset list should be documented in the tax returns if they are still being depreciated. These items may be cars, equipment, computers, furniture, etc. Get an updated list from the seller, and an inspection should occur later in the process.
- Other supporting information will be required for owner salaries or distributions; adjustments to earnings before interest, tax, depreciation and amortization (EBITDA), and any irregular items that don’t really attach to running the business. These should be discussed with the seller as they were discretionary, not necessary (examples: extravagant staff party or personal expenditures). These numbers will help you validate the Seller Discretionary Earnings (SDE), which is significant because some sellers set their asking price based on a multiple of the SDE.
Leases, organizational charts, contracts, price lists, payroll, staff records, third-party companies utilized, and a review of SOP are just a few on my checklist. The more complex the business model, the more items you can expect to dig into.
You’ll need to verify the business license(s), insurance policies, lawsuits/claims, liens, and other licensures (if required). Even if not planning a stock sale, any litigation is important as it can speak to the reputation of the brand name or future financial vulnerabilities. Businesses related to health and the trades tend to have more regulations. Make sure you check federal, state, and local requirements to operate this business. Verify that the existing business has been complying and is in good standing through past surveys or copies of licenses.
This is more about you than the seller. It’s how you can improve the top and bottom lines. Financials are a great indication of how the current owner is operating but not how you will run business. For example, if the seller has been in business for two to four years and revenue is declining rather than growing—why? This is a prime time for a great growth trajectory. For an owner after 10-plus years, declining sales may indicate burnout, not utilizing new or updated franchise processes, or in some cases, the competitive landscape changed and the owner did not adapt. Good data does not lie, and intangibles are harder to value but just as valuable!
Don’t be afraid if your due diligence doesn’t reveal great results. They may serve you well as leverage in negotiating. The nightmare would be not knowing the real deal and entering blindly into a sale.
Diana Capirano, CFC, has an expansive career which includes corporate and franchise sales and development, marketing and operations, merger and acquisitions, structuring and negotiations as well as business ownership. As a highly-respected consultant and mentor, Diana espouses a profound commitment to help prospective business owners and investors understand and navigate the process of deciding on a franchise business. Contact Diana at 941-999-0095, email email@example.com, or visit http://www.focusfranchise.com.
Getting Real About Resales
by Diana Capirano
Certified Franchise Consultant
As a specialist in franchise resales, I’ll go on record saying that you’re as likely to find a flawless resale as hit a mega-lotto jackpot. But people continue to search for the diamond in the rough. “I’m looking for a business with a motivated seller, with low investment/high return, excellent cash flow (mid-six digits), and seller financing.” Sound familiar? Newsflash: EVERYONE is looking for the same thing. Lightheartedly I respond, “Wow! That sounds great. I’ll take 10!”
Many resales fall into the distressed category, something like buying a house with good bones but needing work and TLC. Premium resales may never even hit the open market because they sell internally (within the franchise system) or to personal/professional referral networks. Most great resales that hit the web portals come and go very quickly.
Some business seekers who concentrate only on existing entities can search web portals as a full-time job for years, logging countless hours, only to get beat out and then feel beat up. I’m not saying this to discourage you from looking for resales, but to caution you to be realistic and consider using a reputable resale consultant who can inventively search for them and then help navigate and vet the opportunities (Part 2 of this article in next month’s issue).
Three Major Considerations
- Investment level: First, determine a comfortable investment level, the necessary profitability, and a desirable industry. Please understand that you will probably not get high cash flow from a low investment. Also, be aware that businesses with great value potential could fail to qualify for Small Business Administration (SBA) or other traditional loans, so have a backup plan for financing if you can’t pay cash. Additional sources of income, such as a spouse’s paycheck, rental property, etc., may help you qualify for a loan.
- Owner benefit: If you’re looking to replace income immediately, what’s the target amount? Remember that you’ll have to fund the sale and need more time and capital injection so this “benefit” number will change.
- Desired industry: What are the requirements of the business model? Can you be an owner-operator if the franchisor mandates it? And don’t discount the fact that you should like what you’ll be doing. If it’s just a passive investment, you still need to get connected with growing the business.
Resale vs. Start-Up
A resale may be a good fit if you:
- Like to improve things and consider yourself a fixer who thrives on challenges.
- Are adept at problem-solving and at adapting when the unexpected happens.
- Don’t make a practice of blaming others.
- Want to buy low and sell high, assuming you’re putting in the sweat equity to grow it.
- Don’t mind—in some cases—overpaying for the foundation, good will, your opportunity value, or the extra work needed to right the ship.
- Have the financial bandwidth for an additional cash injection (operating capital) and don’t need to finance with a traditional loan such as one from the SBA.
- Have the time and wherewithal to complete granular due diligence and go the long haul.
A start-up may be better if you:
- Don’t want to inherit others’ problems or put in the time required to right the ship.
- Enjoy developing things from scratch.
- Need to fund with a loan.
- Feel there is better opportunity in an open franchise area.
- Have other sources of income or enough for living expenses while you ramp up.
- Are not prepared to do a deep dive into due diligence before investing.
Both resale and start-up franchises require you to undertake thorough due diligence, investment of time and financial capital, and full-on commitment. Following the franchise training and systems will be necessary in both cases, but may be even more important in a resale because the previous owner might have strayed from the proven process.
Diana Capirano, CFC, has an expansive career that includes corporate and franchise sales and development, marketing and operations, mergers and acquisitions, structuring and negotiations, and business ownership. As a highly respected consultant and mentor, Diana espouses a profound commitment to help prospective business owners and investors understand and navigate the process of deciding on a franchise business. Contact Diana at 941- 999-0095, email firstname.lastname@example.org, or visit www.focusfranchise.com.