A business valuation is the process whereby one would estimate what a business is worth in terms of monetary value. Often franchised businesses need to be valued for the purposes of resale of the business. Selling the business is the main opportunity for a successful franchisee to create wealth and benefit from years of hard work put into the business. For the buyer, it’s important to know that sound valuation principles were used and to prove this to potential buyers.
Business valuation can become tricky due to the type of items that might need to be valued:
- assets that have monetary value (eg: land, equipment, stock, cash at hand etc) and
- assets that do not have monetary value (eg: goodwill, licenses and trademarks etc)
- liabilities (eg: loans, creditors etc)
The good news is that there is usually a formula or calculation that is agreed upon in order to ascertain the value of a business.
Here are some of the most common formulas or methods of calculating the value of a standard business:
1. Net Asset Value: This approach looks at the value of assets rather than the earnings which the business generates and is often used in capital intensive businesses where much of the value consists of tangible assets. The net value of a company will be the value of the assets less its liabilities.
2. Price Earnings Ratio (PE ratio): The PE ratio is the current share price divided by the earnings per share (EPS). The PE ratio is obtainable for listed companies as the shares are publicly traded. The approximate value of a private company can be determined by reference to similar publicly traded companies. Since a privately owned business cannot freely trade its shares the PE ratio applied to it would often be lower than a listed company in a similar industry.
3. Discounted Cash Flow (DCF): With this approach the free cash flow projections are discounted to work out a present value. If the value that is calculated is higher than the current selling price, then the opportunity is possibly a good one
In the case of franchises, the valuation of the franchised business is a lot easier because the franchisor would usually have a standard valuation method to be applied to all the business within the franchise concept. These are usually simple formulas which use a multiple of either turnover or profitability of the business to determine a value. Here are a few examples of the valuation methods that some franchisors use:
- Quick Service Restaurant – a number of different methods are used depending on the brand, the most common methods being: Discounted Cash Flow; Price Earnings Ratio; a multiple on profits (eg. 5 x net profit before tax)
- Retail Stores – 2 to 2.5 x average monthly turnover .
- Fuel Retailers – 36 x EBITDA (Earnings before Interest, Tax, Depreciation and Amortisation). Owners Drawings should be excluded when doing this calculation.
The bank will also usually assess the method of business valuation used, when they assess financing a franchise resale. They ensure that the valuation is in their opinion realistic and market related. The banks usually confirm that the valuation is fair and in line with the franchisor’s guidance.
Therefore if you are purchasing or selling a franchised business, we recommend your refer to the franchisor in order to understand the business valuation method to arrive at a fair purchase price of the business. You can also engage the experts to help you derive a realistic and achievable selling price for your business.