Understanding the Impact of Franchisor-Required Remodels on Business Valuation
What Should Not Be Overlooked When Valuing a Franchise
Bottom line, the first thing you should ask in dealing with a franchise acquisition is, “What are franchisor-required remodels, and how much will be required?” It cannot be overlooked. Here are the valuation approaches that could be impacted.
The Income Approach
Estimating Increased Revenue
From a valuation perspective, the income approach starts with estimating how a franchisor-required remodel could impact future revenue. Sometimes the impact could be minimal, but other times it could help lower attrition rates and improve overall profitability. For instance, Anytime Fitness is requiring older facilities to undergo remodels, which includes new equipment with a cost of up to $200,000. The company claims a 5% increase in revenue as a result, indicating a direct impact on reduced attrition.
Addressing Franchisor-Required Remodel Expenses
When considering income, it’s important to factor in the expenses associated with the franchisor-required remodel as well. Remodel costs are treated as capital expenditures rather than operating expenses. As such, you project revenue and profitability while deducting capital expenditures (to calculate debt-free net cash flow) for each year of the remodeling process. Some franchisors allow up to three years to complete remodels. After the remodel is complete, capital expenditures for that purpose will be zero. In calculating the Income Approach (Discounted Cash Flow because this change represents something new looking forward), for the terminal year you should average the remodel requirements over time, resulting in an estimated annual capital expenditure that’s included during the terminal year.
If you use a capitalization of earnings approach, the best practice is to value the business “as is” and then deduct the remodel requirement from the value.
The Market Approach
Challenges with Comparisons
The market approach can present challenges, particularly when attempting to find comparable businesses with similar remodel requirements. For a valid comparison, both the subject business and the comparable transactions selected should either be in the same franchisor’s system with similar franchisor-required remodel experiences, or the selected companies should have already completed their remodels. Without this alignment, the comparison may be invalid due to differing circumstances.
Adjusting for Franchisor-Required Remodel Requirements
When using the market approach, it is essential to account for the potential impact of future remodels. If the comparable transactions differ in terms of remodel requirements or at what stages of the remodel they are in, you should either not use the market approach or deduct the remodel requirement from the valuation.
Franchisor-Required Remodels are Crucial
It’s crucial to consider franchisor-required remodels when valuing a franchise business. Both the income and market approaches require careful adjustments to account for these requirements. When valuing a franchise, always begin by asking about the franchisor’s requirements for remodeling and the associated costs. This consideration is key to arriving at a more accurate and meaningful valuation.
Keep Learning About Business Valuations
How to Navigate The Business Valuation Process Successfully
The Great Debate: Business Valuation With or Without Inventory
What Is Business Valuation? Why & When You Need One
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Accredited Senior Appraiser (ASA) – is recognized as having achieved the highest level of education, training, and report writing for business valuations. The ASA designation is the gold standard for a business valuation professional. (source: American Society of Appraisers)
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