Are You Truly a Seller?: The Market is Ready--are You?
You've heard it before, and have likely seen it firsthand 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? To help you make that determination, let's address some critical considerations.
- Timing. 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 you are merely being seduced by the market and do not have a solid strategic reason for selling, this path will likely lead to a failed transaction. To consummate a successful sale, first be sure a sale is right for you--then determine if it is a favorable time for you 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 their business, and attempted to apply that 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 this, that information is more rumor than data, and 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--who is on your side and holds your best interests first and foremost. The market understands that operators take great pride in their companies, and that it took sacrifices and hard work 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 sellers can command an unreasonable premium for their business. Unrealistic expectations will likely ensure that no transaction takes place.
- Buyer's perspective. 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 percent 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 support only 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 buyers have sufficient equity to "make up the difference," they 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.
- Capex. 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 that, 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 at any time in the past 10 years. This seems to be especially true in the QSR 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.
- Adjustments. 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 that result in an overstated G&A expense. But some sellers want to make unrealistic adjustments to their financials; these 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 early on, rather than reacting to them when they crop up during the process. Rely on your trusted advisor to help you navigate through the process to ensure a successful outcome.
Dean Zuccarello, CEO and founder of The Cypress Group, has more than 30 years of financial and transactional experience in mergers, acquisitions, divestitures, strategic planning, and financing in the restaurant industry. The Cypress Group is a privately owned investment bank and advisory services firm focused exclusively on the multi-unit and franchise business for more than 22 years. Contact him at 303-680-4141 or firstname.lastname@example.org.
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