Musings on business value, sale preparation, sale negotiations, sale structure.

Posts Tagged ‘franchises’

Middle management cripples

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Last week I sat with a client helping him to assess the value of his business. His is a very smart retail operation. Successful retail stores go into the valuation process a few yards ahead of their similarly profitable manufacturing and wholesaler cousins because their risk associated with customers is hugely spread. In a popular shopping centre they are pretty much guaranteed a wide variety of clientele. All the better if the retailer is also part of a successful franchise group.

Retail customers are less worried about the socially engineered aspects of our society like skin colour of the owners and management, and more worried about the reality of quality, service and price. Mess with any of those definitives and the business has a problem which is soon seen in the income statement, and ultimately the core business value.

The downside of the retail trade is in the big suppliers; banks, landlords and franchisor masters. The typical new franchisee sees herself as stepping out into the world of entrepreneurship. Nothing can be further from the truth. Frankly, franchisors do not see their new franchisees as entrepreneurs. At best, the owner franchisee can hope to become a variation of the middle management level in a larger organisation similar to that from which she recently exited. The abuse is no less severe, except that there is no simple resignation, no CCMA dispute procedure and no early retirement. Once you’re in, it’s going to be for a while.

Abuse? Yip. “These are the rules, and they will be policed by mystery, faceless shoppers and the more overt local representatives”. Penalties are related in one way or another to the bottom line. And therefore the value of the business.

“The store will be revamped every three to five years, in line with latest marketing concept, and this revamp is for your account.”

The landlord presents quite another problem: He has a shopping centre to run, and expects to turn a profit. He knows that he has the franchisee locked in. So while there was a status quo which sold to the new franchisee and tenant five years ago, it becomes something of a movable feast. When it becomes obvious that charging for parking is a great way of gearing one’s investment in the property; well why the hell not? The South African consumer has proven himself extremely accepting of all sorts of salami takings from his disposable income. so charge for that parking!

With investment made in parking bays, ticket billing and the rest, more money can be made by getting them to work for longer. An empty parking bay at midnight is fairly useless, but a full one at 8pm is great. So let’s force shops to remain open to 9pm. The landlord makes more money from a few more parked cars for a few more hours, at very little extra cost. But not many people want their hair done at dinner time, nor do people generally want to have a dinner with their family at a coffee shop. But these guys have to stay open, pay staff, run up unproductive electricity bills on unwelcomed air conditioners, display lighting, music, televisions and so on.

For the small franchise owner, well she probably got into this mess by putting the family home on the line on day 1. In the five years since, that loan has been serviced and reduced, the interest having been a major expense. With that light of value gain and much reduced loan repayment fast growing at the end of the tunnel, she gets an unwelcome wakeup call:

While all other business types have been careful to sit on their profits over the last five years, cautious in the continued uncertainty of what the economy holds for us, the landlord, the franchisor and the bank need to generate cash.

The franchisor exercises his insistence on having the store refurbished. This will almost certainly be an expensive exercise. Probably in the region of R500,000. That is serious dosh for the franchisee. She knows she can access it with the renewed security of her home, but heck, what does this franchisor ever do for her anyway? The opportunities in defranchising suddenly beckon with a glint in the eye and a crooked smile.

So off to the landlord she gaily trips. The lease is up for renewal anyway, and the franchisor had nothing to do with negotiating the lease apart from finding the space.

“Absolutely no way”, says the landlord. “We want a franchise coffee shop in that space. If you defranchise, we will not renew your lease”.

Without a lease, any retail operation has no business worth anything at all .

So options and the future suddenly look bleak. If she parts company with the franchisor, the landlord cuts her off at the knees, and she loses the lot. To raise the required funds for the refurbishment means tying up her house for another five years. The franchisor is secure, the landlord is secure. The bank will be secure. She will work. Perhaps she can delay bringing in that new manager who would have allowed her some spare time…

Wait… What if she sells? Surely this place is worth something by now. Then she can buy a real business with the proceeds of the sale. But here too, are issues.

The broker who sells the business is going to be charging a commission for the job. Of course it’s possible to sell without an agent, although that often results in a below par price. Further to that, the franchise agreement revolves around two other ambush items: The franchisor has to approve the new sucker, and will charge what is called “key money” to him.

Then there is the continued question of that refurbishment. This still has to happen. So here’s the thing: Any buyer with any advice will have an idea of what the business is worth, and this value includes all costs of entry. So that R500,000 is in the value, and so is the key money. The buyer will look for a return on his entire investment.

While independent businesses are able to keep their powder dry, and decide when they intend to pay for new signs and livery, she has to pay for the flipping refurbishment, no matter which way she slices this cake.

Talk about being trapped in a job!

The reliance on suppliers this franchisee has, as a retail operation generally, and a franchise operation in particular is a crippling one. And this ladies and gentlemen, is a fairly typical story in the retail franchise game. When you line up to buy one, the best and greatest in the group will be wheeled out for you to oggle over – the top ten percent – because that is who you want to be compared against.