|
Economically,
nothing is more important to a business owner than maximizing
the value of his or her business interest. The ultimate
value of the company is generally not realized until
the business is either sold or merged with another company.
However, by the time a business owner has decided to
exit the business (either through a sale or merger) or
has decided it is time to plan an exit strategy; it is
often too late to bring optimum value to the company.
In today’s
post dot.com world, people are focusing on real cash flow
and the value of hard assets rather than speculative values.
Such values are often difficult to develop in the shortterm.
In fact, attempts to maximize value in the short run not
only tend to be very problematic from an operational standpoint;
they also have a tendency to lower the long-term value
of the business. Therefore, it is crucial from the beginning
of a business to arrange the company’s affairs so
over time value can be maximized.
How can value be maximized
for both franchisors and franchisees? This article
will address the issue of value maximization from both
perspectives. In the end, the reader will find that the
principles of maximizing value are consistent for both
franchisees and franchisors.
Maximizing Value for the
Franchisor.
In order to maximize the value of its business
in the long term, franchisors need to concentrate on
three major areas: (a) a flexible legal structure,
(b) a clearly defined capital structure; and (c) and
an efficient operational structure.
a. Legal Structure
Because the goal is to maximize long-term value, a
franchisor should legally structure its franchise system
in a manner attractive to potential buyers. This can
generally be accomplished if the structure meets two
equally important criteria: (i) the structure chosen
affords potential buyers with a large amount of latitude
in their selection of the form of the asset or equity
purchase mechanism that best suits their individual
situation; and (ii) the structure of the franchise system
allows the franchisor to freely transfer all of the franchisor’s
rights and obligations under its franchise agreements.
As to (i), the type of entity selected should be determined
in light of the potential or prospective purchaser.
For example, the use of a flow through entity (i.e. a
partnership, limited liability company or a Sub-Chapter
S corporation) may allow the owner to maximize after-tax
value in the short-term; however, such entities may not
provide the type of flexibility that is attractive to
potential buyers. As to (ii), while almost all UFOCs
allow the franchisor to transfer their interests without
franchisee approval or consent, a franchisor does not
have free-reign over the selection of a transferee. In
fact, a franchisor has the legal obligation to make a
sound business judgment as to any transfer and to make
sure the new franchisor is an organization that can effectively
perform the obligations of a franchisor under prepayments
(where applicable) or factor them into the valuation.
Because franchisees are more likely than franchisors
to be involved with friends and family as equity holders
(and possibly even lenders), they may be able to obtain
(i) more favorable pay off terms and (ii) less restrictive
transfer limitations (although these arrangements add
an additional emotional element that does not exist with
third party lenders and non-related equity holders).
However, no matter from whom the financing is received,
the key to maximizing value remains the same: the franchisee
owner must control the selling process.
b. Operations
Operations and profitability are always key issues
with respect to maximizing the value of the franchisee.
To make yourself attractive to buyers, profitability
should be measured not only with respect to your own
operations, but also as to how your operations compare
with those of your peers. As a franchisee, you want
to make sure your profitability is some of the best in
the system.
With respect to operations, three elements
are given heightened significance: (i) general and
administrative expenses (“G&A”); (ii) management retention;
and (iii) stated profitability on the balance sheet.
With respect to G&A, it is very important that your
actual G&A is kept reasonably low. Although in the
past it was customary to review G&A on a proforma
basis, today purchasers are considering only the actual
G&A associated with operating the business. It is
also important to assure potential purchasers that good
management is in existence and will remain with the business
after the sale. Nothing will undermine the purchase price
as quickly as the concern that the existing management
staff will leave immediately after the sale and that
profitability will decline as a result. Finally, balance
sheets of franchisees should, in almost all cases, reflect
positive net worth. Even though the concept may be generating
significant cash flow, unless the company has been able
to retain net earnings for future growth and down turns,
many potential buyers will be concerned about the long-term
stability of the company and the purchase price will
suffer as a result.
Summary
As soon as you buy and finance
assets, you need to be thinking about valuations
and exit strategies. Hopefully this article has laid
out some of the balance sheet, franchise and operational
issues you should consider.
|
