Franchise Opportunities with Low Startup Cost
A couple weeks ago, a good friend approached me with a business idea. He owns a yogurt franchise and was offered an amazing deal, so he thought, to acquire another franchise – a nitrogen ice cream.
When we first met 5 years ago, I was financing businesses on behalf of a private lender, and my friend was a single location Franchisee in a declining yogurt franchise. He approached his Franchisor with an offer to buy that yogurt franchise and wanted me to finance part of the deal. The other part would come from friends and family.
My friend had a plan to borrow the money and pay it back through the business cash-flow. I asked him for the numbers, crunched them and noticed his small yogurt shop could not afford the payments in the long run. I advised him to wait for the right time and negotiate a better deal.
If I agreed to finance the deal, I would have made my money. My company would have made money. He might have gotten the franchise on paper. Maybe paid the first installment, perhaps the second, but by the time it came for the third installment, he would have been out of cash, deep in debt, and with no franchise.
Risky business.
The smart man that he is, he understood that, went back to his franchisor, who was now more anxious to sell after suffering the loss of his son, and negotiated the deal down to $450,000 from $600,000.
He got a proven business model with a brand name and good cash flow for the price it will take to open one location.
Can Franchise Owners make Money?
My Friend’s Yogurt Franchise has 26 locations. The ice cream franchise he wishes to buy had 28 locations as of December 2022. Combining both will generate a hell lot of cash-flow and leverage power over suppliers, vendors, and business system providers.
A Franchisor with a lot of locations and good contracts could create new revenue streams.
Credit card processing companies, for example, can be negotiated down on processing fees in return for transferring all Franchisees to one Merchant Processing Company. By doing so, The Franchisor can cut a 1.5% – 3% split of every transaction made by his Franchisees to himself for brining that much business for a single processing company.
A good Franchise generates for its Franchisor anywhere between 3%-12% of his Franchisees’ gross revenue. Some charge extra for marketing. Some have weekly cash-flows funneling into the franchisor’s office. Others funnel it monthly.
A new Franchisee pays his Franchisor $20,000 – $100,000 setup fee on top of the cost of opening shop and buying equipment.
Great deal for everyone, right?
Which Business Valuation Method is Best?
The problem with businesses up for sale will always be the elusive valuation.
A business’s value is what someone is willing to pay for it. The Seller will always pull towards a higher valuation and the Buyer for a lower one.
The Seller, being more attached to the business, will have a hard time severing the bond for a lower valuation.
There are lots of ways to speculate the value of a private business. You can find them all over the internet. Some will argue it is worth the annual revenue 1X.
Others love to put higher multiples on established brands for the value of the brand name and other intangibles. These cannot be calculated with solid numbers like other valuation methods such as DCFs (Discounted Cash Flow) Enterprise value or Book value (Total Assets minus total Liabilities).
Multiples of free cash flow (cash left after operation expenses and capital expenditure) or EBITDA (earnings before taxes, interest, depreciation, and amortization) can soar to 10X, even 20X.
Free Cash Flow is loved by analysts because it is a good sign to the healthiness of a business.
What other Questions should be asked?
The way I see it, from the buyer’s standpoint, you should have a number that you are willing to pay and move on to the more important numbers that will shed light on the robustness of the business:
- What is the net burn rate (how much money the business loses monthly)?
- What do the owners pay themselves?
- How much debt does the business have?
- How much business (Customers / Franchisees / Money) are they losing?
If someone is parting ways with the baby, he/she nurtured for years, something is wrong. There’s a money pit. A big debt. Cash flow problems. Problems with silent partners. Personal problems…
No one wants to part ways with a great business. A buyer should always get a business for a steal and walk away from a big deal. Always shoot for a margin of safety.
Which Business to Invest In?
My friend sent me a printout of the ice cream franchise royalties in crooked PDF file. Red flag number one. Always ask for an Excel file when dealing with numbers. I had to convert that PDF file into Excel to crunch the numbers. Not easy fit when the PDF file is crooked.
Best way to do that is through Adobe PDF. But you can always find free websites on the internet that will convert a decent file to start with, such as https://pdftoexcel.com.
I found that the Franchisees were jumping ship by the dozens. The cash flow was high six figures yearly, streaming in weekly, which is great, but there was a steep drop in revenue in 2023 as compared to 2022.
The expenses were just there to support the Owners’ lavish lifestyle. It’s a company that can be brought back to life with the right cuts. But the business wasn’t healthy and wasn’t worth what the Seller was locked on, and he wasn’t budging on the price.
I learned one important thing in my 14 years in the alternative lending industry and having financed thousands of high-risk businesses with little to no fico scores. When it comes to a business investment, all you can do is evaluate the risk, because the future is uncertain.
I’ve come across businesses that I’ve speculated won’t last the next 4 months and they ended up lasting 10 years, while others, which I deemed great businesses went insolvent within a short period of time.
ROI, IRR & Safety of the Principal
Speculate how deep the hole they’re in because that’s all that matters. When it comes to investments, the safety of the principal is the most important thing. So, if you can speculate on how deep the rabbit hole is. How long until this company becomes insolvent, you’ll know how much time you need to recoup your investment.
More than the stream of cash flow and nice revenue, the business expenses are a much better indicator for the health of the business. The balance sheet, Profit and Loss, etc.
To figure out whether the money you will put into purchasing the company is a viable investment, use the IRR or XIRR function in excel. You will receive a series of cash flows – the money that flows to the Franchisor from all Franchisees’ locations.
To speculate on future cash flow streams, use the FORECAST function or the MOVING-AVERAGE-METHOD in data analysis in Excel to project the stream of cash flows for the next few years.
Deduct from the cash flow all your forecasted expenses: salaries, accounting, subscriptions, gas, insurance, car lease, etc. Figure out how much percentage is left in your hands after all expenses paid – that is the free cash flow from which you’ll recoup your investment as fast as possible. From that amount calculate the Internal Rate of Return as so:
Speculate on how much the income will be in Year 1, Year 2, Year 3, etc. Then run the IRR function – Remember that the first number on your list should be negative and will be your initial investment.
If the annual IRR is 15%, it means you’ll have 15% more money than you put into the business as your investment 12 months before.
If your IRR is less than 8%, depending on the amount of money you are expected to invest, consider investing in real estate or a stocks index, you’ll get a better return on your investment. If your IRR is less than 5% consider investing in bonds. An IRR above 10% will be a good investment. Above 20% is ideal.
You can download the file here: IRR Example.
Why Franchise is Better?
- Tax benefits of opening a franchise. You can report losses for quite some time.
- The brand name was already established.
- Support from the franchisor.
- A good customer base.
- Stability of the brand.
- Marketing is handled by the franchise.
Where to Buy Franchise Business?
Or you might know somebody who knows somebody.
Google:
- Local franchise opportunities
- Franchise opportunities in Florida
- Franchise opportunities in Texas
- Franchise opportunities near Georgia
- Franchise opportunities near Tampa FL
- Franchise opportunities for Veterans
Author
Asaf Antman is a pioneer of the alternative lending industry with more than two decades of extensive experience in the business world under his belt. Throughout his career, he dissected thousands of businesses; underwrote, analyzed, advised, negotiated debts, secured deals, and funded small to mid-size companies in a variety of industries and locations across the U.S.