How to 'Reverse Engineer' Franchise Success
If you're planning to start a franchise with the aim of selling it one day, you'll need to plan ahead with your end goal in mind. Here's advice that can help get you started.
When Fred DeLuca and Peter Buck started Subway, they set an audacious goal. They wanted 34 restaurants in 10 years. What's more, they allowed this plan to drive their strategy and decision-making. When, after eight years, they were at only 16 stores, they knew they needed to do something different to reach their goal, so they turned to a new strategy: franchising.
Over the years, Subway set new goals. When a goal became unlikely to be met, the company made another change in strategy.
There's an important message here: Start your planning with the end in mind.
If your goal is to eventually sell your franchise, don’t ask yourself what you think it will be worth. Instead, plan for it to be worth what you want to fetch. Here's how to get started by "reverse engineering" your goal.
1. Estimate the earnings needed to secure your desired sale price. Once you know how much you want to sell for and by when, you are ready to start looking at valuation questions. Generally, the most common method of ascribing value to a company is through a "price/earnings ratio." The P/E ratio for any particular business will generally be a function of several factors such as your rate of growth, industry and how well the company is run. But an examination of the selling prices (and P/E ratios) of comparable companies can give you a good starting point. By dividing your desired selling price by this presumed P/E ratio, you can approximate the level of earnings that you may need to reach your objectives.
2. Estimate the number of franchises needed to reach your earnings goal. You will need to build a growth plan and financial model that will get you to that level of earnings. Start by approximating the number of franchises you will need to sell to get to an appropriate revenue level. This can be done by estimating the amount of royalty and product sales revenue that you'd need to generate from each franchisee.
3. Figure out a royalty rate. Determining the royalty can be tricky. Your royalty will need to be set at a level that will allow your franchisees to make an adequate return while providing you with an ability to provide needed support and provide a profit. A 1% error on the royalty can literally cost you millions. Determining the royalty will require benchmarking, analysis and financial modeling – but it is the most important financial decision you will make as a franchisor.
4. Map out your growth plan. The number of franchises you need to sell should dictate your growth plan. You will likely want to "ramp up" your franchises over time to optimize cash flow and valuation. You can use industry averages to figure the amount of franchise advertising you will need to spend in any given year. You can use standard staffing ratios (adjusted for your specific business) and pay scales to determine when you need to hire certain people, how much you will pay them, and even how much office space you will need at any given time. This data can be incorporated into a cash flow model that will outline how much money you will need to spend to meet these goals.
Sure, things rarely work out perfectly on the first go-round. Your analysis may tell you that you do not have enough money to meet your objectives in the time you have allotted. You may need to go back to the drawing board.
You can, of course, reduce your goal and start the exercise over. Or you can lengthen the amount of time that you will devote to reaching that goal. Alternatively, you can look to change your strategy.
All too often, entrepreneurs allow inertia to drive their success and direction. But if you want to get somewhere in particular, start with a goal, and then reduce it to specific action steps. While it can be an arduous process, your result will be a step-by-step roadmap to success on your terms.
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