Many people understandably think that owning a...
Assigning a value to a Canadian franchisor is similar to the valuation of other business types in several ways, namely a function of cash flow level forecasting with the risks associated with that cash flow. However, there are some aspects that can make valuing a franchisor a bit more complicated, so here's what to know when you're trying to assign a value to the franchisors you're considering.
Know which type of franchisor you're valuing
In broad terms, a franchisor earns income by granting franchisees the right to do business while offering them oversight and assistance. Beyond that, there are different business structures at play, so you need to know which type the ones you're valuing fall under in order to come up with an accurate result.
"Pure play" franchisors receive most of their income from royalties and sales of franchises, while "royalty income funds" take part of the royalties from franchisees but have the expenses operating the system handled by another company. Last but not least are hybrids, which have revenue largely coming from corporate-owned locations and/or inventory sales to franchisees.
Approaching the valuation
Two forms of valuation are applicable to franchises: the income approach and the market approach.
With the income approach, you look at the value of future cashflows discounted by a return rate that reflects the risks associated with those cashflows. Under the market approach, you consider the fair market value of the business based on comparable companies. The former is more complicated, with the latter being easier to do with franchisors in industries that have a lot of competition.
The method you prefer is an individual choice, but it's essential to account for the different business structures when you're doing so.
The growth factor
Growth is another key factor at play to keep in mind, and it often comes from two main sources: growth in income per franchisee and growth in the total number of franchisees. Acquisition, of course, can also bring immediate growth.
Don't just consider how well a franchisor is growing; there are issues with growth, too. Finding new franchisees in new areas costs money, which is why many franchisors use master franchisees to do so. Growth within the same territory can also cause problems with existing franchisees.
The levels of risk
An established franchisor will generally be immune to small trends because of the sheer size of the system, which is an advantage. However, there are risk factors that are more specific to franchisors than other business types, such as class-action lawsuits that hit against Canada's tough disclosure laws in many provinces.
Consider the franchisor's industry growth levels to get the clearest picture of its true value. While you don't need to get a pinpoint figure, having some idea of a franchisor's true worth can help you avoid a weaker or endangered system.