Valuing Franchises - Beyond Restaurants

Valuing Franchises – Beyond Restaurants
Presented by :
Mr. Nevin Sanli, ASA
President & Founder
Sanli Pastore & Hill, Inc.
September 13, 2017
CE CODES: 5822, 6130,0974

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Questions@BVResources.com
© 2017 Business Valuation Resources, LLC
Professional Credentials & Education
• ASA of the American Society of Appraisers, Business Valuation
• B.A., Honors Economics, from UC Irvine
About the Presenter
Nevin has been President and Founder of Sanli Pastore &
Hill, Inc. (“SP&H”) since 1992, specializing in business
valuation, litigation consulting, and economic and financial
research, statistical and investment analysis, and mergers
and acquisitions advisory.
Nevin has valued over 2,500 businesses and conducted over
100 fairness and solvency opinions. He has testified over 60
times in trial and over 200 times in deposition.

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Today’s Goals
Key Learning Objectives
• Franchises and the Franchisor/Franchisee Relationship
• Understanding Franchisor/Franchisee Valuations
• Key Franchise-related Documents
• Types of Franchises
• Value of scaling/size
• Data analysis

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What is a Franchise?
Introduction
A Franchise is a type of license/right to operate granted to the Franchisee to use the Franchisor’s proprietary trademarks,
systems, processes, etc. to sell products and/or services. In exchange, the Franchisee pays the Franchisor fees: start-up,
royalties, etc.
• Planet Fitness, Inc. (“Planet Fitness”) allows franchisees to start a new gym under the Planet Fitness® trademark
and operating guidelines
Typical Franchisee Applicant Requirements
• Minimum Franchise Investment
❖ Planet Fitness Initial Franchise Investment range is $850,000 to over $4M
• Minimum requirements for net worth
❖ Franchisor may require that applicants have minimum net worth of $1.5 million with liquid capital available of
$600,000.
• Length of Franchise agreement: 5-30 years
• Adherence to business practices and policies
• Completion of training program (for a fee to attend) – Training workshops from Planet Fitness are $500 to $1,500.

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What’s in it For Me?
Why and When Should a Company Start Franchising?
• Ability to grow the business faster
❖ Increased geographic penetration and marketing
❖ Stronger brand awareness
❖ Leverage fixed costs over a wider base of sales, e.g. advertising
❖ Strengthened purchasing power
❖ Leverage capital of Franchisees to grow
• Stream of franchising fees and royalties
• Developed sufficient track record, i.e. multiple locations, to attract potential Franchisees
Why Buy a Franchise?
• Leverage existing brand name recognition
• Saves time and reduces uncertainty
❖ Immediate access to suppliers, business plans, trademarks, and business processes
❖ Access to training and support

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Franchisor/Franchisee Economics
Franchise relationships may include the following:
• Upfront Fee – Initial startup fee
❖ Planet Fitness charges an upfront fee of $20,000
• Royalty Fee – Ongoing fee (typically a percentage of sales)
❖ Franchisees pay 7% of all sales to Planet Fitness
• Advertising Fee – Franchisor’s advertising budget (typically a percentage of sales)
❖ Franchisees pay 2% and 7% of all sales to Planet Fitness for national and local advertising,
respectively
• Sale of Supplies/Equipment
❖ Planet Fitness sells fitness equipment to Franchisees
• Facility Lease
❖ Franchisor may lease property to Franchisee and receive rent or a percentage of sales

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• Franchisor’s Background
• Business Background
• Litigation History
• Bankruptcy
• Initial and Ongoing Costs
• Supplier, Trade Area, and Customer Restriction
• Franchisor’s Advertising and Training
• Renewal, Termination, Transfer and Dispute
Resolution
• Financial Performance Representation
• Franchisee and Franchise System Information
• Financial Statements
Franchise Disclosure Document
Key Items

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• Trade Area Provisions
• Non-Compete Provisions
• Successor Franchise or Renewal Provisions
• Transfer Provisions
• Cooperative Advertising Provisions
• Automatic or Immediate Termination
Provisions
• Termination with Opportunity to Cure
• Dispute Resolution
• Attorney’s Fees Provisions
• Require Purchases
Franchise Agreement
Key Items

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Types of Franchisor/Franchisee Arrangements
Single-Unit Individual Franchise Multi-Unit (Master) Franchise
Franchisor
Franchisee Franchisee Franchisee
Franchisor
Master Franchisee
Franchisee Franchisee Franchisee Franchisee

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Franchise Examples
Source: Franchise Times, Top 200 by Total Locations

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Valuing the Franchisor
• Compare royalty rates to similar franchisors
• Units owned vs. Units franchised
• Systemwide revenues vs. Franchisor revenues
• Higher multiples for franchises vs. non-franchises
• Market size and market share
• Terms and conditions with Franchisees
❖ Franchise agreement renewal options, e.g. ability to increase royalties, fees, rents,
etc.
❖ The length or term of the Franchise agreement
❖ Trade area depends on density
❖ Termination clauses
• Value of intangible assets, e.g. brand, trademarks, systems, processes, etc.
Valuation Considerations - Franchisor

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Valuing the Franchisee
• Single-Unit vs. Multi-Unit (Master) Franchisee Arrangements
• Rights and restrictions of Franchise Agreement
❖ Trade area restrictions
❖ Required to buy from certain suppliers
❖ Required to honor marketing promotions
• Costs/benefits of being a Franchisee
• Dependent on the success of brand name
• Real-estate owned by Franchisee or leased from Franchisor?
• Franchisee transfer/sale restrictions, i.e. lack of marketability.
❖ Franchisor may have buyer requirements, e.g. experience and/or net worth
• Larger base of interested buyers for strong franchise relative to non-branded competitors
• Training and support from Franchisor helps reduce risk
Valuation Considerations - Franchisee

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Valuation Method: Cost Approach
Introduction
Cost to build an equivalent business and costs to replace all tangible and intangible
assets
Key Considerations
• Cost Structure
• Time
• Risk and uncertainty

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Valuation Method: Market Approach
Introduction
Assess market valuation metrics, e.g. EBITDA or Revenue multiples, from sale of
comparable businesses as an indication of relative value
Key Considerations
• Operate in the same or similar industry
• Single-unit vs. multi-unit franchisee sales
• Franchisor mix of franchised or company-owned operations
• Size
• Geography
• Time period of sale

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Valuation Method: Income Approach
Introduction
Present value of projected future cash flows over the life of the company or holding
period of the asset
❖ Discount for risk and uncertainty
Key Considerations
• Reliance on financial projections
• Timing of cash flows
• Discount rates
• Projection: # of years
• Terminal value or Exit Valuation

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Case Study – Planet Fitness
CE CODES: 5822, 6130,0974

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Overview
Planet Fitness (NYSE: PLNT) is one of the largest
and fastest-growing fitness club operators in the
U.S.
• 8.3 million members (2016)
• 1,171 stores in 47 states (2016)
• Average club 2016 gross revenue:
❖ Corporate-owned $1.7 million
❖ Franchisee $1.5 million
Source: Planet Fitness, Inc. Form 10-K, March 6, 2017
488
606
749
918
1,124
2011 2012 2013 2014 2015
Total stores
(franchised and corporate owned)
23.2% CAGR
2.9
3.7
4.8
6.1
7.3
2011 2012 2013 2014 2015
Total membership (millions)
(franchised and corporate owned)
25.8% CAGR

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Business Model
Franchisee buys right from Franchisor to operate a Planet Fitness gym under these terms:
• 10 year term
• Franchisee minimum net worth: $1.5M with $600,000 liquid
• Upfront franchise fee: $20,000
• Royalty: 7.0% of monthly gross revenue
• National Advertising fees: 2.0% of monthly gross revenue
• Local Advertising fees: 7.0% of quarterly gross revenue
• New equipment lease every 4-7 years
• Other fees including building improvement payments, inspection fees, application
fees, training fees, etc.
Franchisee pays for initial investment costs, i.e. construction and gym opening costs, which
ranges from $1.3M to $4.2M

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Benefits for the Franchisee
• Pre-opening Support
❖ Site Selection, Design, Construction, Financing, Training, and Grand-opening
program
• Ongoing Support
❖ Operating procedures, operational assistance, training, and management support
• Strong reputation and brand recognition
• Proven management and work practices
• National advertising
• Business systems
• Lower failure rate

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Historical Financials of Franchisee with 3 Planet Fitness Clubs
2013 2014 2015 2016
(1) (2) (3) (4)
Net Revenue $4,821,571 100.0% $4,924,996 100.0% $5,030,639 100.0% $5,138,549 100.0%
Operating Costs and Expenses
Payroll Related $876,033 18.2% $885,777 18.0% $897,443 17.8% $914,825 17.8%
Marketing Expenses 442,645 9.2% 451,218 9.2% 462,314 9.2% 471,749 9.2%
Royalties 327,828 6.8% 334,860 6.8% 342,043 6.8% 349,380 6.8%
Utilities 207,294 4.3% 214,812 4.4% 222,603 4.4% 226,684 4.4%
Supplies and Maintenance 293,060 6.1% 299,346 6.1% 305,768 6.1% 312,326 6.1%
Miscellaneous 266,567 5.5% 273,402 5.6% 283,318 5.6% 289,395 5.6%
Total Operating Costs and Expenses, Excl. Rent $2,413,426 50.1% $2,459,415 49.9% $2,513,488 50.0% $2,564,359 49.9%
EBITDAR $2,408,144 49.9% $2,465,581 50.1% $2,517,151 50.0% $2,574,190 50.1%
Rent Expense 954,588 19.8% 975,065 19.8% 995,980 19.8% 1,017,344 19.8%
EBITDA $1,453,556 30.1% $1,490,516 30.3% $1,521,170 30.2% $1,556,846 30.3%
Depreciation and Amortization 408,315 8.5% 417,073 8.5% 426,020 8.5% 435,158 8.5%
EBIT $1,045,241 21.7% $1,073,443 21.8% $1,095,151 21.8% $1,121,688 21.8%

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Source: Planet Fitness, Inc. Franchise Disclosure Document 2017, with
adjustments from SP&H for illustrative purposes
Valuation of Franchisee with 3 Planet Fitness Clubs
• Representative Income Statement
based on median performance of
corporate-owned club
Net Revenue $5,248,773 100.0%
Operating Costs and Expenses
Payroll Related $865,713 16.5%
Marketing Expenses 488,859 9.3%
Royalties 356,874 6.8%
Utilities 232,020 4.4%
Supplies and Maintenance 319,026 6.1%
Miscellaneous 246,234 4.7%
Total Operating Costs and Expenses, Excl. Rent $2,508,726 47.8%
EBITDAR $2,740,047 52.2%
Rent Expense 1,039,167 19.8%
EBITDA $1,700,880 32.4%
Depreciation and Amortization 459,462 8.8%
EBIT $1,241,418 23.7%

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Key Considerations
• Rights and restrictions of Franchise Agreement
❖ Renewal rights, termination, resale policy, right of first refusal, consent to
transfer, i.e. marketability, cancellation policies, etc.
❖ Franchise term – 10 years
❖ Ability to renew or extend term
• Dependent on success of the Planet Fitness brand/concept
• Lack of control – Franchisor leadership and contractual rights/restrictions of
Franchise Agreement
• Ongoing or prior litigation
• Royalties, advertising fees, required capital expenditures
• Requirements to purchase from specific suppliers

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Method 1: After-Tax EBIT Capitalization Method
Representative EBIT $1,241,418
Less: Taxes (at 40%) (496,567)
After-Tax Operating Income $744,851
After-Tax Capitalization Rate 15.8%
Indicated Value of Invested Capital $4,714,246

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Method 2: Revenue Multiplier Method
Representative Revenue $5,248,773
Revenue Multiple 0.65x
Guideline Private Transactions
• SIC Code 7991 – Physical Fitness Facilities
• All Multi-unit Franchisees
Guideline Private Transactions - Summary Statistics
Net Sales EBITDA EBITDA Margin Deal Price
Deal Price To
Sales
Deal Price To
EBITDA
Count 22 17 14 21 21 14
Min $1,522,296 $77,292 3.0% $540,000 0.2x 1.1x
LQ $2,158,196 $676,724 13.0% $1,350,000 0.4x 2.2x
Median $3,506,481 $1,270,980 26.7% $2,340,000 0.6x 3.3x
Mean $5,067,629 $1,686,949 26.0% $4,072,200 0.7x 5.8x
UQ $5,406,611 $2,481,723 36.9% $5,220,000 0.9x 7.1x
Max $16,031,268 $3,904,056 56.9% $21,600,000 1.7x 17.0x
Std Dev $4,156,397 $1,476,994 18.0% $4,837,093 0.4x 5.6x
• Net Sales $500,000 - $1,500,000
• 1/1/2014 – 7/1/2017

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Method 3: EBITDA Multiplier Method
Representative EBITDA $1,700,880
EBITDA Multiple 4.00x
Guideline Private Transactions
• SIC Code 7991 – Physical Fitness Facilities
• All Multi-unit Franchisees
Guideline Private Transactions - Summary Statistics
Net Sales EBITDA EBITDA Margin Deal Price
Deal Price To
Sales
Deal Price To
EBITDA
Count 22 17 14 21 21 14
Min $1,522,296 $77,292 3.0% $540,000 0.2x 1.1x
LQ $2,158,196 $676,724 13.0% $1,350,000 0.4x 2.2x
Median $3,506,481 $1,270,980 26.7% $2,340,000 0.6x 3.3x
Mean $5,067,629 $1,686,949 26.0% $4,072,200 0.7x 5.8x
UQ $5,406,611 $2,481,723 36.9% $5,220,000 0.9x 7.1x
Max $16,031,268 $3,904,056 56.9% $21,600,000 1.7x 17.0x
Std Dev $4,156,397 $1,476,994 18.0% $4,837,093 0.4x 5.6x
• Net Sales $500,000 - $1,500,000
• 1/1/2014 – 7/1/2017

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Market Value of
Invested Capital Weight
Weighted Market
Value of Invested
Capital
Method 1: After-Tax EBIT Capitalization $4,714,246 25.0% $1,178,562
Method 2: Revenue Multiple $3,411,702 25.0% $852,926
Method 3: EBITDA Multiple $6,803,520 50.0% $3,401,760
Fair Market Value of Total Invested Capital 100.0% $5,433,247

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Questions?
CE CODES: 5822, 6130,0974

Valuing Franchises - Beyond Restaurants

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