Hidden risks make franchise valuations tricky

BVWire reports on a recent lawsuit that points up the unique nature of franchise businesses—and how this affects valuation. A group of Papa Murphy’s franchisees are suing the take-and-bake pizza chain, accusing the franchisor of misleading them about the financial results they could expect and forcing them to pay more for advertising than they were told.

Valuation analysts need to understand the unique characteristics of the franchising industry. One is the huge imbalance of power between the franchisor and franchisee. The franchisor has significant control over many aspects of the franchisee’s  operations, such as location, choice of suppliers, hours of operation, signage, and so on. The franchisee  must also make required payments during the year. Another characteristic is that there is a wide disparity of relationships between franchisees and  franchisors.

What to do: When valuing a  franchise, carefully examine the franchise agreement because it “really drives the risk and the value of the business,” says Theresa Zeidler-Shonat (Smith & Gesteland). Speaking  during a recent webinar on valuing  franchises, she also advises that you look closely at the franchise disclosure documents. “These documents are incredibly important to understand because the provisions within them can significantly impact company value.”