Exit strategies Flashcards
What is a lifestyle business?
Involves structuring the business in such in such a manner that free cash flow, profits after any necessary (essential) reinvestment in the business, is extracted by the owners for private use.
In some situations the objective is to reinvest the money into different companies in the knowledge that the life of the business is limited and that there is little point dedicating funds to support it except to the extent absolutely necessary to keep it solvent.
At an early stag, the franchisees should make a decision about whether they want to develop it to the maximum extent possible as quickly as possible and
then sell it as a valuable asset, or extract free cash to fund lifestyle or other investments.
What are the issues with a free cash strategy
A free cash strategy is a valid choice for franchisees but not for franchisors.
There might not be any free cash.
It is a feature of many small businesses, including franchising, that they operate with a modest profit after servicing debts and the owners drawing salaries, but
do not generate enough excess cash to fund reinvestment or a comfortable lifestyle.
There might be lean times and that if no reserves or contingency funds have been retained, there will be insufficient funds to permit trading through until profitability returns.
The terms of the franchise agreement must be complied with to avoid the possibility of termination and consequential loss of the business prematurely.
It is common that certain stock levels must be
retained and funds be dedicated for the refurbishing of premises and renewal of plant and equipment.
In some franchises there are minimum turnover targets that must be achieved to avoid a breach of the agreement.
Why is a free cash strategy not a valid choice for franchisors?
They have ethical or contractual obligations to keep the whole franchise system viable by expansion, support of franchisees, and undertaking research and development.
If the franchisor withdrew excess cash flow to support lifestyle choices or fund alternative investments it would be very detrimental to the system’s viability, possibly not in the short term, but it would send a strong message to prospective franchisees that the franchisor has decided to wind down the system.
What are the considerations in selling a franchise for a franchisee?
The health of the business at the time of sale and its position in the business life cycle.
Franchisees have fixed term businesses. At the beginning the value of the business might be equal to or even less than the amount of the initial investment because some of the initial investment costs are lost such as franchisor training fees.
If the business is immature the sale price might have only a modest goodwill factor.
The scarcity of the franchise may be a factor.
As the business matures it reaches a point at which there is still growth potential and goodwill have been established. This is an attractive time for investors.
As the duration of the franchise nears its end the value of the business drops considerably,
unless the outgoing franchisee is able to negotiate attractive terms of renewal with the
franchisor before offering the business for sale.
If the business reaches a point of stagnation, or market
saturation, investors would have to be able to see potentials not being realised by the current owners to pay a premium amount in a trade sale.
Franchisees might also be able to negotiate a buy-back by the franchisor. Sometimes franchisors would prefer to buy back floundering franchises rather than allow them to close.
What are the considerations in selling a franchise for a franchisor?
Unlike a franchise, The franchisor’s business does not have a fixed duration.
The health of the business at the time of sale and its position in the business life cycle.
Purchasers of the franchisor’s business would be limited to those with more expansive resources than those interested in purchasing a franchise business, most likely other businesses.
Other businesses may want to purchase a franchise for its franchising expertise.
If the business is in the business of supplying goods or services to the franchised system, its
acquisition can be a method of ensuring continued demand.
Trade mergers with complementary business of competitors are also possibilities
The essential requirement of a sale of a franchise system is that the franchisees are supported through the process and their businesses remain strong.
What steps should be taken to ensure the highest return in a sale?
There are a range of steps that should be taken in
the year or years prior to the sale to ensure the highest return, including:
1) increasing profitability from year to year
2) demonstrating a reliable customer base
3) having a strong management structure in place
4) providing high quality products and services
5) maintaining plant and equipment.
What is a management buyout?
Where management or existing people involved in the franchise purchase the business.
This is typically considered a staged exist because there will be a transitionary phase during which the expertise of the franchisee or franchisor is needed
What is dynastic succession
Passing on the business to family or heirs.
It is an exit strategy, but not one which yields a direct
return on investment for the exiting business owner. Some consider it a natural progression of a business empire.
The concept of succession implies longevity, and this is not one of the main attributes of the businesses of franchisees.
Franchisees would require the co-operation of the
franchisor to allow family members to enter the franchised business and to permit terms of
renewal that might not be required by the franchise agreement.
The idea of succession also requires the co-operation of the heirs. If not dedicated to the franchise system and displaying the attributes of suitable franchisees, it is unlikely that they (or the business) would flourish.
For the Franchisor there is potential longevity of the business and dynastic succession would instil confidence in franchisees. Of course the heirs are still required to co-operate and their wishes and plans could change over the course of their lives.
Different national and state based taxation and inheritance laws that can impact upon the feasibility or attractiveness of using this exit strategy
What are the considerations in closing the business for franchisees?
The ultimate exit strategy, though rarely planned (except in the situation of extracting free cash flow) is to simply turn off the lights and close the door on the business.
If the business in question is solvent and all of the debts can be paid, this is a viable, though not lucrative,
option unless there are contractual obligations that remain outstanding.
If the business closes leaving unpaid creditors there would almost certainly be consequences, the severity of which could depend upon the corporate structure used for the business and personal guarantees in place.
Sometimes closing the door is the best strategy as it might minimise losses and reduce the temptation to put more resources into a business that is already
doomed.
Franchisees will have ongoing obligations to maintain the business for the duration of their franchise agreements and often leases over premises and plant and equipment. If they close the business prematurely, the franchisor would lose the income from royalties.
Legal action could be taken against franchisees.
A planned closure at a time when there are no outstanding contractual obligations can be a viable exit strategy.
What are the considerations in closing the business for franchisors?
If there are any active franchise agreements, each
franchisee’s position must be considered.
The franchisees might be prepared to change their signage and continue to trade under their own individual names.
What are the considerations in a stock market flotation?
A stock market flotation is not a suitable exit strategy for franchisees because of the fixed duration and limited size of their businesses.
For franchisors they can be very appealing and lucrative, but they do not usually result in immediate exits from the business and are not without significant costs and risks.
If the franchisor is happy to divest some of the interest in the franchise system and remain in a consultancy position for a reasonable period, the public flotation might be appropriate.
The prerequisites are:
1) The franchise is in an expansion phase, possibly internationally
2) Consistent profitability over the preceding years
3) The projections of the business show sustained growth and rising profitability
4) The management team is extremely competent and settled
5) There is effective infrastructure in place to accommodate sustained growth
6) The current franchisees are performing well.
The next step is to seek the advice of specialist legal and accounting teams because a business plan, prospectus and director’s undertakings will be
required. The preparation of the necessary documents is a very expensive exercise and only franchisors with very solid company accounts should consider taking this path.
Listing is risky and must consider the economic conditions and market perceptions and valuations of the business. The business can lost substantial value if unfavourable but if favourable can far exceed the value of a straight sale.
