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Most Influential Lenders in L.A. County: Drawing Investors as You Grow Your Business

The value of any asset is what someone is willing to pay for it. Usually valuation is presented as an objective analytical process to measure value. While financial analysis is important, decisions, even financial ones, are primarily emotional. Analysis and logic serve to justify emotional decisions.

Many of us experience this when purchasing a home. We must justify paying more for a home because we want a particular design, location or quality of workmanship. We may pay a higher price even though a more analytical measure, such as cost per square foot, may indicate that we are paying too much.

Likewise, when business owners are asked what they are willing to sell their company for versus the price they would pay for their company, the answers are very different. Would you like to guess which number is higher?

So what can you do as a business owner to generate excitement and maximize the valuation of your company in the private market?

PRIVATE MARKET PLAYERS

The private market is composed of three major groups: financial investors, buy-out groups and strategic investors.

A financial investor prefers to invest with the existing management team. The investor may be a private individual (an “angel”) or may be an institutional venture capital fund. These investors do not want to manage or control the company’s operations.

Buy-out groups, however, do want operating control and often will replace existing management.

A strategic buyer invests because of perceived “synergies” or overlaps between companies. A franchisee acquiring another franchisee would be an example of a strategic purchase.

VALUATION YARDSTICK

In the private market, your company’s EBITDA (earnings before interest, taxes, depreciation and amortization), is a common yardstick for establishing a value. Your company’s value will be a multiple of EBITDA.

Private market multiples are seen in the following ranges:

• “Typical” non franchising company 6-9X

• Pure Franchisor (no company stores) 3-5X

• Franchisor with at least 30% of stores corporate 5-8X

• Franchisee 2-4X

Investors miss many good opportunities because small-business owners fail to educate them about their business in terms the investor can understand, both intellectually and emotionally.

As you can see, the private investor market is not as comfortable with a pure franchisor. One concern is that a pure franchisor will have greater difficulty reaching the size and growth plateaus required to generate an appropriate return for the investor. It is feared that a franchisor will have difficulty maintaining a secure cash flow because franchisees will use at the least provocation and stop paying royalties. Another concern is that a pure franchisor does not have an operating infrastructure to be an effective “marketmaker” in their system to buy and sell existing franchisee operations and maintain ongoing concern values. A mature pure franchisor exhibits more characteristics of a financial management than a retail operating company. As a result, franchisors with a significant percentage of corporate stores trade at higher multiples.

If you are a franchisee, the value of your company is discounted by an investor’s perception of your ability to control your own destiny. To an extent, your future is dependent on the franchisor. Also, your growth may be limited by the territory the franchisor is willing to grant you.

BEYOND THE EBITDA VALUATION

Investors miss many good opportunities because small-business owners fail to educate them about their business in terms the investor can understand, both intellectually and emotionally. If you can overcome some investor concerns, you may obtain higher valuations.

This is done by pushing beyond the standard EBITDA-type analysis. Companies are positioned along the following:

1) Concept

2) Management

3) Unit Economics

4) Systems

5) Historical Performance

First, your concept is the value-added service you bring to your customers. Hopefully, this success formula can be articulated in 10 words or less, like Boston Market’s “Quality of eating at home with a convenience of eating out” or Arrow Prescription Center’s “cost-effective delivery of pharmaceutical services.” Investors like concepts they can understand. Make it simple and intuitive.

Second, you need to demonstrate why your management team is up to the task of fulfilling your plan. This is not the time for rambling resumes. Make the key management team come alive and drive home that they have succeeded, an will continue to succeed in replicating your success formula and building future value.

Compelling unit economics for franchised concepts can translate into 25 percent or higher return on capital. You need to get beyond EBITDA margins at the unit level and analyze volume, cash flow and investment.

Systems are necessary because “retail is detail.” Appropriate and timely customer and cost data is one of the cornerstones for growing your business.

Finally, you want to show how your historical performance validates your success formula. Your approach to your business should give confidence that you can achieve your business plan.

This may sound simple until you try to do it, especially before an unfamiliar audience or on the telephone. Remember, the key is to generate excitement and to push an investor’s emotional “hot button.”

Madeleine Juarez is a freelance writer and business investment consultant.

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