Valuation multiples - Franchise vs. Independent
August 17, 2023
by an investor from New York University - Leonard N. Stern School of Business in New York, NY, USA
Hi all, I have looked at acquiring both franchises and independent operators in a number of sectors. Is there a rule of thumb on the valuation multiple spread between a franchise (resale) and an independent operator, assuming the businesses are identical in all other aspects? Obviously franchises have the additional fees (royalty, marketing, etc.) and there are also upfront transfer fees. Assuming after fees the 2 businesses have identical EBITDAs, growth patterns, margins, etc., what is your take on which should command a higher multiple, and what type of premium? I can see arguments on both sides for which should command a higher multiple - franchises offer something of a safety net with corporate support, name recognition and potentially less downside, though the franchisee is also constrained in what they can do with the business in terms of new services, geographical expansion, acquisitions, and also the franchisor will have a big say on the exit. In case you're curious, this relates mostly to residential and commercial services, but I would be curious if there is a general rule of thumb that is applied across the board. Thanks!
from University of Pennsylvania in Los Angeles, CA, USA
I would assume that the severely limited exit alternatives (all buyers must be approved by the franchisor) is the primary factor that'd put downward pressure on franchise business multiples. If you achieve meaningful scale within a system, that system will only have a small handful of potential buyers - who will be further filtered down once you take into account their capital availability / level of leverage, whether the asset makes sense to own, etc. That, and the fact that franchisors won't let you operate more than X% of total units, basically puts a cap on both future earnings potential and monetization potential of the business, and thus, the valuation multiple.
from University of Virginia in Charlottesville, VA, USA
When evaluating a franchise acquisition, I would think about 2 things:
1) What ongoing service does the franchise provide? How much do you pay for that service in terms of franchise fees? What would be cost to outsource / hire that service if you were not a franchise? Think of the franchise like a vendor.
2) Exit strategy - does being part of a franchise make it easier or harder to sell your business? Is the industry primed for a roll up? If so, being a star in a franchise network could help you hold out for a big multiple. Or could position you well to buy other franchisors? Conversely, maybe being part of that franchise makes it hard to sell if the franchise agreement is overly restrictive.