Franchising

Franchise resales as a measure of system performance

Engel Schmidl /

When looking at the health of a franchise network, the quantity and nature or resales of existing outlets can provide several useful indicators.

The first of these is the proportion of total existing outlets available for sale at any one time. (For ease of reference, this will be referred to as the resale percentage from here on).

If the resale percentage seems excessively high, this will indicate problems such as a lack of profitability, a loss of confidence in the business model or the franchisor, or other issues in a network that can cause a stampede to exit in the same manner that a fire will cause the occupants to abandon a building.

Alternatively, if the resale percentage is very low, this is likely to indicate a high degree of satisfaction with the business.

To calculate the resale percentage of a network, divide the number of all existing outlets available for sale by the total number of outlets in the network, and multiply by 100.

Average resale percentages will differ from one industry to another and from one network to another. For example, resale percentages in blue-collar home services franchises where the work typically performed by the franchisee is physically demanding can be expected to be higher than the resale percentages of say a white-collar management franchise.

Likewise, the resale percentage may differ significantly between two franchise networks which operate in the same industry. For example, Coffee Franchise A may have a lower resale percentage than in Coffee Franchise B because franchisees in network A may be more profitable than those in network B.

Resale percentages often range between five and 25%. If the resale percentage is more than this, there may be other factors to consider, such as the following:

Time on market

The resale percentage of a network can begin to climb if it takes longer for existing businesses to sell, particularly as more businesses are listed for sale before existing listings are sold.

This time on market indicator may increase as a result of excessive prices sought by vendors, by financing problems among buyers, a change in the market itself, or a flooding of the market by listings triggered by changes in the franchise business model or ownership or management of the franchisor.

The time a property takes to sell has been a common measure of the buoyancy of the residential real estate markets for several years, and increasingly is now being applied to understand the sales cycle of existing businesses.

Time on market is particularly affected by price, and can range from days to months, and even years for some businesses.

Sale price multiples

There are two types of sale price multiples to consider when assessing the resale of an existing franchise.

The first is the profit multiple used to measure prices of both independent and franchised businesses. The profit multiple method can see business sale prices range from as little as one times profit to five or six times profit, depending on the nature of the business and the industry in which it operates (and assumes of course, that the business is actually profitable).

Another price multiple measure is a comparison of the sale price of an established franchise with that of a greenfield (i.e. yet to commence trading) outlet. If resales are sold for consistently lower prices than greenfield outlets in the same network, the network may well have fundamental problems it needs to address among its existing franchisees before it can hope to recruit others.

Similarly, if the average price multiple of existing outlets are greater than for a greenfield site, then these businesses should be expected to be profitable and delivering a capitable gain to their sellers.

Tenure of selling franchisees

Another factor than can indicate the health of a franchise network is the average tenure of franchisees who list their businesses for sale relative to the initial term of the franchise.

If, for example, franchisees are listing their businesses on average half-way through the initial term of the franchise, this may indicate issues around profitability, the business model, confidence in the franchisor, etc, subject to some of the other issues listed previously.

In other words, the longer a franchisee has operated the business before offering it for sale, the more likely it is that the franchisee has been satisfied with the performance of the business, and hence the more desirable it may be in the eyes of a potential buyer.

Conclusion

Potential franchisees who explore these issues in detail when undertaking their due diligence will be better-equipped to make more informed decisions about the future viability of their investment.

This article does not represent an exhaustive list of measures to assess resales as an indicator of system health, but can be a key starting point for observers of the sector to monitor system performance, as well as for franchisors themselves to better understand their points of differentiation in a highly competitive franchise marketplace.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for 20 years at franchisee, franchisor and advisor level.

He advises both potential and existing franchisors and franchisees, and conducts franchise education programs throughout Australia, and publishes Franchise News & Events, a fortnightly email news bulletin on franchising issues and trends.

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