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Are you TRULY a seller?
You’ve heard it before, and have likely seen it first hand in the market: interest rates are at historic lows, franchisee consolidations and refranchisings are prevalent, lenders are hungry, pent-up equity is available and waiting to be deployed, and deal activity is high. You might be contemplating taking advantage of this environment. But are you truly a seller? Let’s address some critical considerations to help you make that determination.
While the market factors may be aligned to create an opportune time to sell, a more important consideration is where you are in your entrepreneurial life cycle. If you have been contemplating retirement, getting into a different business, or some other major life change, the timing may well be right for you to sell. But if a seller is merely being seduced by the market and does not have a solid strategic reason for selling, this path will likely lead to a failed transaction. To consummate a successful sale, make sure a sale is right for you first, and then determine if it is a favorable time in the market to sell.
Valuation and Expectations
If you have determined that a sale is right for you strategically, it is critical that you get an accurate market valuation of your company. You may have heard about a price an acquaintance or fellow franchisee received on the sale of his business, and attempted to apply this to your business. But typically there is not enough information available to make an accurate assessment. For example, was it based on Store EBITDA or Corporate EBITDA? Pre-G & A or post-G & A? Were there Capex requirements? Without knowing these, the information is more rumor than data, and these rumors are notoriously inaccurate. There is no substitute for using a competent industry professional to determine the value of your business.
In terms of expectations, don’t make the mistake of expecting an unrealistic valuation for your company. Listen to your advisor: remember that he is on your side and holds your best interest first and foremost. The market understands that operators take great pride in their companies, and that there has been hard work and sacrifices to build them. The market takes this into account in determining what a business is worth. The deal market may be quite active, but that does not mean a seller can command an unreasonable premium for his business. Unrealistic expectations will likely ensure that no transaction takes place.
One excellent way to check the validity of the valuation of your business is to take a buyer’s perspective. Would you pay the asking price for your business? What kind of return would that yield? How much equity would you have to contribute? What leverage constraints are imposed by available financing?
Approximately 95% of transactions involve lender financing. A buyer’s lender will run leverage calculations, such as Lease Adjusted Leverage, on a proposed purchase. Based on financial performance, a business can only support a certain amount of debt. The balance of the price is made up of equity from the buyer. If a price is higher than the amount of debt a lender is willing to extend plus the amount of equity a buyer is willing to contribute, the transaction cannot take place. Even if a buyer has sufficient equity to “make up the difference”, he must take into account what the return on that equity is. Paying an unreasonable premium over market will result in a low return on equity for the buyer.
Capital expenditure requirements are also a very important factor to consider, and can have a dramatic impact on valuation. We think about Capex as falling into the following two buckets:
Deferred Maintenance Capex: Buyers expect a business to be fully functioning, while sellers may take an “as-is” perspective. When a buyer discovers non-working items during a walkthrough, this becomes an issue which, if not handled properly, can cause a deal to collapse. The franchisor will often require that deferred maintenance Capex is satisfied as part of the transfer. Most often, these expenses are primarily the seller’s responsibility.
Image Capex: Franchisors are very cognizant of image requirements, more so in this environment than any time in the last 10 years. This seems to be especially true in the Quick Serve Restaurant sector, although we expect this will expand to cover most franchise businesses in the near future. As part of the process to approve the transfer of the franchise agreement, the franchisor will enforce the remodel requirements. The buyer and seller will each take the position that it’s the other party’s obligation. If this is not contemplated and agreed to early in the process, the deal is most likely over.
Add backs and adjustments to a seller’s financials are a normal process. For example, there may be an adjustment to eliminate intercompany rent, non-recurring costs, or to normalize G & A to industry standards in the event an operator is expensing personal items through the company resulting in an overstated G & A expense. But some sellers want to make unrealistic adjustments to their financials. This might include eliminating a valid operating expense or compensation. This is not the seller you want to be. Most buyers will figure this out quickly, and will perceive the seller with mistrust.
If you think you are really ready to sell, have you considered the points presented above? The solutions are not always simple, but not having a solution is certain to derail your transaction. Proactively deal with these issues in the early stages of the process rather than reacting to them when the crop up during the process. Rely on your trusted advisor to help you navigate through the process to ensure a successful outcome.