“Ten Ideas To Increase The Value Of Your Franchisee Business”		«BACK
	by Dennis L. Monroe - Krass Monroe, P.A.
	from Reprinted from Franchise Times April 2005 Issue

Over the next two months this column will focus on creating value in franchise businesses. This month’s column focuses on increasing the value of a franchisee business. (Next month’s column will focus on increasing the value of a franchisor business.)

The unique aspect of the franchisee business is the operation of a concept owned by another business through the entry into a franchise agreement or some type of license arrangement. It is not a true asset but a right to use an asset. Therefore, the creation of value takes a different approach.

Due to the special relationship between the franchisee and franchisor, it is difficult to obtain a significantly high goodwill value for a franchisee business. (This may not be the case for a franchisor.) As has been stated many times in this column, we know that franchisee businesses are valued and sold based on a multiple of cash flow earnings from the franchise units. Additionally, one of the more recent unique aspects of franchisee businesses has been the real estate component. With the high prices paid for real estate in the sale/leaseback market, many franchisees have determined that the value of their business is much higher than it may actually be because of the favorable prices paid by 1031 investors who want to own real estate and lease it back to franchise operators. This, in and of itself, can be an artificial aspect of valuation.

Let’s look at the ten ways a franchisee can increase the value of his or her business:

1. Cash Flow . Eliminate units that do not have positive cash flow. Even though a franchisee business with 20 to 30 locations can be very profitable, it can still have three or four units that are not profitable and might have negative cash flow. This also applies to start-up units. Allow the store a reasonable amount of time to “season” and achieve a positive cash flow before assessing long-term viability. Eliminating negative units is an important element in maximizing business valuation.

2. G & A. Keep the general and administrative expenses (“G&A”) at the lowest possible percentage of sales. Unless a company is in the process of actively developing a substantial number of new stores, it is important that the G&A factor be maintained at the lowest possible level. Higher G&A, even though adjusted by a potential buyer for purposes of determining a purchase price valuation, overall still results in a lower business valuation.

3. Management Team . Develop a key, competent management team at both the store level and over-store management level so if the business is sold, these employees could be retained by the potential buyer to bring true value to the company as a going concern. The more a business is dependent upon the owner, the more suspect the valuation. This suspicion occurs because the owner desires to sell the business and eliminate on-going and future involvement (even though the owner might have a contractual obligation to do so). Therefore, preserving the current management team should continue profitable operations. After the sale, it is also helpful to have (i) strong employment agreements that include incentives to stay if the business is sold; (ii) effective non-competes; and (iii) non-solicitation agreements. All of these agreements bring additional value to the company.

4. Leases. If the real estate is not owned by the business or the principal, make sure the leases are at market rates and have a term equal to the franchise agreements with extension options at or below fair market value. Again, in most cases, the value of a franchisee business is dependent upon ongoing cash flow, and cash flow is discounted substantially if the lease terms are shorter than the franchise or license agreements and do not have effective and reasonable renewal options.

5. Capital Improvements . Make sure the capital improvements are made on an annual basis so the company does not incur what is called “Deferred Cap-Ex.” These are capital improvements that were not timely made. Such Deferred Cap-Ex expenses are direct offsets to the value of the company. In many cases, the potential buyer is going to look at these Deferred Cap-Ex expenses as probably more costly than they actually turn out to be.

6. Franchisor Relationship. One of the keys to great franchisee business value is having a strong relationship with the franchisor. A strong relationship and cooperation between both parties provides a potential opportunity as it relates to franchise renewals and the potential sale of the business.

7. Development Rights. Secure the greatest level of development rights possible. Development rights significantly increase the value of the company.

8. Real Estate. Carefully consider real estate ownership. As stated in the beginning of this article, it is very tempting to undertake a sale/leaseback of the real estate. The rates on sale/leasebacks are very attractive, and the money obtained under a sale/leaseback, by not owning the real estate, may be invested effectively in growing the business. However, this may not be the right choice. By giving up ownership of the real estate, the multiple that will be obtained or financed on the business enterprise portion of the business will be less. Controlling real estate is very important, and the value that buyers recognize is often money in the bank. It may not be the best strategy for increasing value to do substantial sale/leasebacks. The more real estate that is owned by the franchisee business, the higher the potential value of the business.

9. Ownership Structure . Keep the ownership structure as simple as possible. In most cases it is effective to have a three-entity structure for a franchisee business as follows: (i) a management company that provides over store management for a specific percentage of sales; (ii) a real estate entity that owns the real estate and leases it to the operating company; and (iii)an operating company which holds the franchise rights and operates the business.

10. Financing. Use effective and flexible financing. Try to limit the amount of financing that has significant prepayment penalties. If the business is sold, in most cases the prepayment penalties will have to be paid, thus decreasing the net proceeds to the Seller. If undertaking a sale/leaseback, obtain repurchase rights as to the real estate.

In summary, it is essential for the success of your company to consider the available options to increase the value of your business. There are numerous other subtle actions that can be taken (such as making sure you have audited financial statements, not being overly aggressive on tax matters, and keeping your balance sheet clean), and when all of these elements are in place, they help create substantial value for a franchisee business.

Dennis L. Monroe is a partner and the chairman of Krass Monroe, P.A., a law firm specializing in multiunit franchise finance, mergers and acquisitions, and taxation. A special thanks to Jodie L. Grabarski,

Esq., for her contribution on this article. The firm is located at 8000 Norman Center Drive, Suite 1000 , Minneapolis , MN 55437-1178 ; (952) 885-5999. For previously published articles, and other Krass Monroe information, please refer to our Web site at www.krassmonroe.com