10 Reasons Why You Shouldn't Delay in Considering a Sale

The tone of this topic will be a bit pessimistic, which is different from my style and general demeanor. Franchise valuations are really high right now, so much of the news is still very good. However, I think you need to hear a different perspective too – balance is a good thing. I’m not trying to be a fear-monger, but every franchisee should consider these 10 reasons when evaluating their strategy and legacy. Here they are:

  1. Historically-High Prices Persist – The last few years have created a massive shift in the franchise industry as family-offices have entered the space with increasing regularity. Franchisees have gotten larger, become more acquisitive and are diversifying across several brands. Consolidation is the name of the day, and smaller franchisees are selling at a fast clip. Why? Because prices are way up, and they’ve been there for a few years. Most brands are trading at EBITDA multiples and cap rates that are 15-30% higher than just several years ago. Pricing remains very attractive, and it can’t stay at this level forever. Reversion to the historical mean would imply a huge drop in valuations for sellers in the near term.
  2. Restaurant Sales and Comps – By one source, July 2019 comp sales were lower than they’ve been since September 2017 at (1%). Comp traffic was a horrific (4%). No one seems to be predicting a turnaround here – sales and traffic problems may worsen. Additionally, third party delivery is largely unprofitable, yet it is propping up sales numbers across many parts of the country and potentially hiding a deepening problem.
  3. Labor Pressures – About half of the states have now implemented a minimum wage that is higher than the federal minimum wage. I’ve personally seen what rising minimum wage has done to restaurant P&Ls, and it is very, very ugly in almost all instances unless your brand has a ton of pricing power. Congress is trying to pass aggressive federal minimum wage increases currently. And as an aside, most of my friends in the Southeast – particularly – are ignoring the impending wrecking ball. Minimum wage won’t stay the same forever in these states, and when it changes, you could lose 10-15% or more of your EBITDA
    overnight.
  4. High Amount of Leverage – The M&A boom over the last few years has been driven by cheap debt and easy borrowing. Even though they have plenty of cash, family offices and private equity buyers want to spend as little of it as possible. High prices and big consolidation have led to a huge amount of leverage in the franchise space. Some franchisees are now close to breaching covenants, and a downturn would mean immediate workout or bankruptcy. Also, many of the new buyers are young millennials – they simply don’t have the experience to know what it was like in 2009-2010. Why does this matter? It is simply a question of supply and demand. Distress causes more supply – more people are forced to sell or restructure – and that, in turn, causes less demand. Prices drop for even the best franchise businesses, and it can happen fast.
  5. Chilliness from the Lending Community – Several banks have recently shuttered their national lending platforms. Others have started to ratchet down their loan originations, even though they won’t loudly proclaim it. Still further, some healthy lenders are reducing their lease adjusted leverage when issuing loans. Off the record, many lenders tell me that trouble is brewing in parts of their portfolios in several brands and geographies. Right now, a restriction in lending isn’t a problem because there has been such an over saturation of lenders in the past few years. However, my guess is that the chilliness in the lending community will continue. When fewer lenders compete, loan terms worsen. For franchisees, this means that buyers simply won’t pay as much for your business.
  6. Overdevelopment – Drive down to the nearest retail area in your community. What do you notice? Too many restaurants, and many new names. In Louisville, I sit in franchises almost every week that have very little business. Overdevelopment is hurting the industry – restaurants are not the tech sector; it is a very slow and steady industry. When overdevelopment leads to mass store closures – which is sure to happen at some point – valuations will drop like a lead weight. Especially on the West Coast, expect to see a bunch of large franchisees close the doors unless franchisors step in and save them.
  7. Third Party Delivery Economics – Again, most of my contacts are lukewarm at best on third-party delivery. The economics for the franchisee stink currently, and business is propped up right now with a ton of free delivery coupons and incentives. The future of delivery is likely not going to save a struggling franchisee. People are price sensitive, and when they must pay $25 for a burger to be delivered to them, I believe that most will choose not to do it. Delivery is not a panacea.
  8. Geo-political Risk – The presidential election in late 2020 is likely to bring uncertainty. 4 of the top 10 one- day losses in Dow Jones history occurred during the lead-up to the Presidential election at the end ofGeorge W. Bush’s second term. Could the same thing happen again? Who knows, but with trade wars with China and in-fighting like I’ve never seen it in Washington, risks certainly seem to be rising.
  9. Tax Risk – Like it or hate it, the current administration has implemented some favorable tax policies for many of us. Some of these policies are helping sellers of franchise companies with higher take-home proceeds and easier allocations of assets negotiations. One can only opine that a change in administration would bring negative tax consequences for sellers. While some of the political rhetoric on tax changes is far-fetched, a few of the proposals I’ve heard are downright frightening and would make me want to retire and go fishing.
  10. Increasing Likelihood of Massive Collective Risk – what happens if several of these negative items come to fruition at the same time? The chance of a cataclysmic shock to the system – meaning a drop of 25- 50% in valuation of your franchise business – is still low but is increasing. True, we are all generally screwed if this happens, but if you can avoid this risk by accelerating your timeline of selling your franchise business, why wouldn’t you consider it? None of us lives forever, and most of our children want nothing to do with the restaurant industry. Thanks for watching – hope I haven’t been a downer for you! Realism can be a good thing. Give us a call and let’s talk about what your business is worth and how to monetize your life’s work for the greatest possible price and the lowest risk – before the headwinds start. We’d be honored to hear from you anytime.

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