Acquiring franchise network

[SteveF]

Hi folks,
I have an opportunity to acquire a small franchise network with 11 franchisees. The franchisees provide non-medical home healthcare services (like staffing sitters and nurses for older and disabled people), and there are no franchise locations owned by the network.

The owner of the network has been ill himself, and has not been actively involved in the business since 2012. He's looking to sell it at what I would consider a VERY rich price (I'll lay out the details below), but I wanted to get some thoughts on this.

OPERATING NUMBERS:
-Fee per new franchise: $35K
-# existing franchises: 11
-System sales: $5.5M
-Net recurring/royalty sales (in 2014): $285K

DETAILS:
-1 long-term employee who runs the business (overpaid at $115K salary a year)
-Sytems, training manuals, platforms and trademarks are owned by the company; franchisees have to sign non-compete clauses, so they can't just leave the network and start a competitor
-Business provides back office services to the franchisees, and also arranges conferences and such
-Business is earning about $70K a year in pre-tax cash flow (after advertising, overhead, etc...), and this includes the payment of salary for the employee above

PROS:
-Potential for new markets across the country/new franchisees
-Low capital costs
-Business not heavily reliant on technology
-Already established with good branding and known in region where most franchisees located

CONS:
-"Key man"; if this long-term employee quits or decides to open her own business, how will I run it? I could hire someone else, but they won't come cheap. The current owner is pretty much uninvolved at this point, and the business is on cruise control.
-Competitive; there are a couple of much bigger franchise networks across the country
-Potential for franchisees going bankrupt; I have not seen P&L from the franchisees, and also have not spoken to any of them yet. I don't know how they are performing, but I know that one (in a relatively isolated area away from HQ) is not doing well
-If franchisees fold or don't renew the agreements, there is a potential loss of income

PRICE:
-Asking price is $850K, and he's willing to carry a $150K note for 5 years at 7%
-I have $300K in liquid cash (plus retirement assets, but I can't cash those out)
-Vendor is not willing to explore an earn-out/contingency deal for the business
-I would have to borrow the remaining purchase price (whatever it may be), and since the business has no tangible collateral, I'm looking at a personal guarantee for the balance.

Overall, you guys can probably figure out my biggest concerns (key man, bad franchisees, outrageous asking price), but I also feel like if I could get price down to something more reasonable, then this might be a good opportunity.

The owner thinks this should be priced like an "owner operator" business, in which case it would be amazingly profitable, but I don't want to do that. I want to have someone continue overseeing the day-to-day operations and support the franchisees, while I work on the business by thinking of new marketing initiatives to grow revenues FOR the franchisees, and also expand the number of franchisees. I think there is a market to at least double the number of franchisees across the country in the next 2-3 years, in which case it would make a great purchase, but I am also unwilling to pay upfront for some opportunity that may never happen.

I'm meeting with the owner next week for the first time, but I wanted to get some thought on this from the generous folks on this site. Let me know what you think.

 

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[JDM]

I don't understand your figures. What is the gross turnover of the business and what is the profit (before or after tax)?

You've mentioned $70k/year in pre-tax cash flow. If so, the business is horribly overpriced at $850k. That's nearly 12x earnings.

 

[SteveF]

The gross revenues are $285K (just under 5% of system-wide sales), and expenses are $210K. I realize the business is vastly overpriced at $850K - the seller is free to ask whatever he wants, so I can't stop him from asking that price. If I put in an offer, it will be at a much more realistic price, but I wanted to get some insight on what people on the board thought.

 

[Veloce Grey]

Not an area I can claim to have any specialised knowledge in but my first thought is that in your situation I'd want to do some decent research on potential improvements/expansion potential before taking on such a degree of risk in a business lacking tangible assets that can be sold if it goes bad. Some more info from and about the franchisees would be a good start.

I'm not sure if they're are any other potential buyers in talks with the guy but it sounds like it would be more appetising to an owner-operator type who could get heavily involved and realise any growth potential. If I were going to buy a relatively passive income business I'd want lower risk and/or much lower cost.

Regarding the price I'm reminded of a quote from Gordon Bizar (I think)
"The only value of a business is based on its profit over and above what it pays the owner to work there. The fact that you can increase its sales is not an asset owned by the seller for which he has the right to charge you. The seller can only sell what he has, not what you may or may not add."

 

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[vinylawesome]

The good news is that the company is in a growth industry. The historical growth of Brightstar, Comfort Keepers, etc.... has been phenomenal. The age demographics are in your favor.

The bad news; the valuation.


A few thoughts and questions for you to ponder:

1. Have you had a chance to read the Franchise Disclosure Agreement yet?

2. How many lawsuits pending, if any?

3. How many units have closed during the historical life of the company?

4. Of the 11 units what are the sales revenue for each?

-Is revenue evenly spread across units or are their one or two who derive a majority of the revenue?

-Have an attorney go over the franchise agreement and make sure its defensible.

-In some cases, franchisees have been able to get out of their agreements and keep their clients. (I've seen it happen in the Franchise Cleaning Industry.)



Note: Comfort keepers was acquired for 13 x Ebitda a few years ago. But they were at about $7 million in Ebidta and $300 million in system wide revenue.


http://www.levinassociates.com/sites/default/files/1301_speakerslides.pdf

Edit:

Shelly Sun founder of BrightStar wrote a book on "franchising your business", might be worth checking out.

http://www.amazon.com/dp/1608322025/?tag=tff-amazonparser-20

 

[Vassilios]

From my understanding, if everything remained the same after you purchased it, you would be earning 70k/yr with 11 locations. If you were to double sales by adding 11 more locations, or expanding the reach of each current location, you would still only bring in 140K per year. That doesn't seem worth the effort.

You likely wouldn't be able to let it remain on auto-pilate when shooting for major growth. Not sure if growth is even in your plans though

 

[SteveF]

Yup - I would have to put in a non-binding LOI before I could get to look at the franchise agreement, but that's definitely one of the key items I will have to review.

From what I understand, each franchisee is doing about $425-600K a year in sales, and most of them (with the exception of one) are doing well, but I don't know how evenly it is spread across all of them. Also, I am curious as to why none of the franchisees is interested in acquiring the network, since it would make sense for them to do that.

I do agree with you all on the fact it makes no sense to pay upfront for potential increases in profit down the line. The acquisition price must be based on the current operations, not pie-in-the-sky potential.

In terms of growth, the company does have a good reputation in the marketplace (good reviews online, and growing business), but that is not enough.

In terms of leveraging the opportunity, the marginal cost of supporting additional franchisees is not that high, because the software and overhead is already established, so the franchise revenues would be mostly profit, but I also have to dig into the specific details.

Anyhow, I am meeting the owner tomorrow at his office, so we'll see what happens. I feel like he has a price in his mind and probably won't budge from it, so none of this may matter, anyways.

 

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[MJ DeMarco]

Business is earning about $70K a year in pre-tax cash flow (after advertising, overhead, etc...), and this includes the payment of salary for the employee above

Seems like an awful load for $70K/year. Is it truly on cruise control?

Vendor is not willing to explore an earn-out/contingency deal for the business

This would be a concern for me.

The gross revenues are $285K

Asking 3X revenue is ludicrous.

 

[ClaytonAlbright]

You realize you can make 80k from 1 Subway which costs around 100k. Why on earth would anyone pay that much for this?

 

[SteveF]

Well, I don't know about Subway franchises, but the point is that I DO NOT want to buy a job. I like the fact that this is a network and not the franchises themselves, but I realize the owner is completely unrealistic about pricing.

In terms of it being on auto-pilot, I know for a fact that the owner has not been involved day-to-day since 2012 due to serious illness, and it seems to have run pretty well. I don't know how much of that is attributable to leg work he did in the first 9 years of the business, or if it's due to the aptitude of his employee, but I can only state fact (and I've seen the financial statements and tax returns, so the income amount is verified).

Anyhow, I'll meet with him tomorrow and here what he has to say. If he's still going to insist on a crazy price for the business, then I'll just wish him good luck and move on. I doubt he will find someone else to pay his price, so I can always wait in the wings if he wants to sell later.

 

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[SteveF]

Just an update - I met with the owner and his accountant today. He gave me a whole spiel on how the business is undervalued at $850K, and that it's a great opportunity "if you can grow it". He also informed me that two of the franchisees are looking to sell their businesses (if they can't, they will close up - they were almost inactive anyways, and the revenues earned from them were minimal), so the current network is really 9 active franchisees. Of those 9, about 5 of them are performing very well, and 4 are treading water.

I asked a lot of probing questions and he was quite open about everything, but overall, I just think he's unrealistic about the price. I told him that the upfront cost would have to be way less than he's asking, and that I would be open to an earn-out based on subsequent performance of the current franchisees and sales to new franchisees, but he didn't seem too interested in that.

I'll get back to him next week on this, and will give him a "soft" price before bothering to have a lawyer draft an LOI, but here's what I am thinking:

1) $300K upfront - equal to ~4x EBITDA (and this is current EBITDA with a Manager currently running the business)

2) Tiered earn-out:
$10K upfront to the vendor for each new franchise sold (I keep the other $30K) over the next four years, PLUS
25% of EBITDA (normalized for any salary compensation to me) for the next 4 years, to be capped at $350K

This seems like a pretty simple earn out to me, and under the best case scenario, he earns up to $650K. If the business continues to earn $70K a year for the next four years with no growth in the number of franchisees, he will earn ($70K x 4 x 25%) an additional $70K in deferred compensation (leading to a total purchase price of $300K + $70K = $370K).

I know he won't go for this deal, but I don't see any additional value beyond this. Any thoughts on this?

 

[gottheworm]

SteveF - I am very familiar with this industry. I am curious if you ever developed further? I would be interested to discuss.

 

[SteveF]

Nothing ever happened. He scoffed at my offer, and as far as I know he still has not sold the business. Perhaps he'll change his mind one day and lower the price to a more realistic value, but I'm not holding my breath.

Either way, there are lots of competitors from the US opening up here (I'm in Canada), so I don't see this as a huge loss for me.

 

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