This article by Tom Spadea was featured in the January issue of Franchise Dictionary Magazine.
As a franchise attorney, I have had the good fortune to watch a number of brands grow from small businesses that looked more like a side hustle to enterprises courted by multiple private equity firms willing to dish out 8-figures to the founders. In our day to day work we try to build systems to maximize the exit, be prepared for the due diligence these private equity suiters demand and coach and guide our clients to avoid the myriad of potholes and traps that derail the climb to an 8-figure exit. As the new year starts and we work with our franchisors to refresh and renew their FDDs, I thought it was worth reflecting on why successful franchisors command such high valuations.
In my opinion there are three primary value drivers for franchisors: RARITY • TIME • SCALABILITY
A franchisor becomes really valuable when it reaches the point where its royalty stream alone is sufficient to cover expenses (“royalty break-even”). There are only so many that reach this point and have a growing sustainable system. Good old-fashioned supply and demand drives up valuations. I must get a call or email a week from private equity firms looking for franchisors. There are many more buyers than suitable targets, which basic economics tell us will drive prices higher. In every successful exit I have been involved with, there were always multiple parties interested.
You can’t duplicate the years it takes to work out the kinks and get it right. It takes a tremendous effort, and sometimes years of little to no profitability to get the system to the point where franchisees are able to open up profitable units consistently. Even well-funded startups with the cash to do everything by the book still make lots of mistakes, missteps and course adjustments to get it right. Like a fine wine, you just can’t rush it.
This is the number one reason stated by buyers on “why” they buy. Each new franchisee and additional revenue stream is less expensive than the last. The incremental cost for growth is where the upside lies. If they can see a path to double or triple the system with only nominal increases to their cost, they will step up to the plate and pay big money to take over the system.
The bottom line is, if you are a franchisor you need to focus internally on getting it right. It will take time, but the buyers will be there when you and your system are ready.
To see all of Tom’s featured articles on The Franchise Dictionary Magazine, visit this page.