FRANCHISING, LICENSING, & HARVESTING: CASHING IN YOUR BRAND UNIT 5• CASHING IN THE BRAND FRANCHISING, LICENSING, & HARVESTING: CASHING IN YOUR BRAND Class Name Instructor Name Date, Semester

Learning Objectives After this lecture, you should be able to complete the following Learning Outcomes 1. Determine how you want to grow your business and eventually exit from it. 2. Describe how businesses use licensing to profit from their brands. 3. Explain how a business can be franchised. 4. Learn methods of valuing a business. 5. Discuss five ways to harvest a business.

14 What do You Want from Your Business? Sell Maintain Grow Close Sell to others Merge Maintain Grow Generate internally Acquire others License your brand Franchise the business Close Cease Operations Bankrupt

14 What Do You Want from Your Business (cont.) Continuing the Business for the family Growth through Diversification Diversification – the addition of product or service offerings beyond a business’s core product or service.

14 Growth through Licensing and Franchising Licensing - “renting” you brand or other intellectual property to increase sales. Replication Strategy – (franchising) a way to obtain money from a business by letting other copy it for a fee.

14 Focus Your Brand A name, term, sign, logo, design that identifies a product/service Represents a promise to consistently meet customer expectations Line Extension – the use of an established brand to promote different kinds of products Can work if brand is very strong & new products relate well Potential damage if products don’t reinforce the brand

Franchising Revisited from the Franchisor Perspective 14 There are both benefits and drawbacks to being a franchisor. The benefits include: Growth with minimal capital investment. Lower marketing and promotional costs Royalties The drawbacks of franchising to the franchisor include: The franchisee may disregard training and fail to operate the business properly. It can be difficult to find qualified or trustworthy franchisees. Franchisees that do not experience success may withhold payment and/or sue the franchisor. There are many federal & state regulations in franchising making it difficult and costly in some circumstances.

14 How a McDonald’s Franchise Works McDonald’s franchisees are taught precisely how many minutes to fry potatoes and when to turn a burger, among a host of other details including how to greet customers. A McDonald’s franchisee owns the restaurant, but agrees to market the food under the McDonald’s name and trademark in the exact fashion developed by Ray Kroc. McDonald’s, as a franchisor, receives a franchise fee and royalties.

14 Do Your Research before You Franchise Consult with a franchise attorney Visit the International Franchise Association (http://www.franchise.org) & the American Association of Franchisee & Dealers (http://www.aafd.org ) websites Create a Franchise Agreement

14 Harvesting & Exiting Options Harvesting – the act of selling, taking public offering, or merging a company to yield proceeds for the owner(s). When to Harvest Your Business: Usually takes at least 10 years to build a company of sufficient value to harvest. Founder may remain with the business in the case of a merger. Exiting - leaving the business through closure, liquidation or bankruptcy Loaded with debt No product or service of lasting value Liquidation – the sale of all assets of a business concurrent with its being closed.

14 How to Value a Business A business that is profitable and likely to be so in the future can be sold for a sum that represents its net present value today. Value, after all, is subjective, meaning it is conditional on individual opinion or preference. Methods some entrepreneurs use to estimate value of a business: Compare it with similar businesses. In most industries, there are one or two key benchmarks that help to value a business. Look at multiple net earnings. Fair Market Value – the price at which a property or business is valued by the marketplace; the price it would fetch on the open market.

14 The Science of Valuation Popular methods of valuation: Book value (Net Worth = Assets – Liabilities) valuation of a company as assets – liabilities. Future earnings – it is the main determinant of its value. This method of valuation must take into account the time value of money, as well as the rate of return. Market-based (Value = P/E Ratio x Estimated Future Net Earnings ) P/E = company stock price/earnings per share Applies only to publicly traded stocks

Creating Wealth By Selling a Profitable Business 14 A successful small business can usually be sold for between three and five times its yearly net profit, because the buyer expects the business to continue to keep generating income. For example, net profit for one year is $10,000, you should be able to get $30,000 (3 x $10,000). Entrepreneurs establish successful businesses, sell them, and use the resulting wealth to create new enterprises and wealth.

14 Harvesting Options Increase free cash flows – for the first 7 to 10 years of business, you will want to reinvest as much profit as possible into the company in order for it to grow. Advantages: You can retain ownership of the firm with this strategy. You do not have to seek a buyer. Disadvantages: You will need a good accountant to help avoid major taxes. It can take a long time to execute this exit strategy

14 Harvesting Options (cont.) 2. Management Buyout (MBO) – In this strategy, the entrepreneur sells the firm to its managers, who raise the money to buy it via personal savings and debt. Advantages: If the business has value, the managers often do want to buy it. The entrepreneur has the emotional satisfaction of selling to people he knows and has trained. Disadvantages: If the managers use primarily debt to buy the company, they may not be able to finish paying off the arrangements. If the final payment to entrepreneur depends on the company’s earnings during the past few quarters, the may have an incentive to attempt to lower profits.

14 Harvesting Options (cont.) 3. Employee Stock Ownership Plan (ESOP) – This strategy both provides an employee retirement plan and allows the entrepreneur and partners to sell their stock and exit the company. Advantages: The ESOP has some special tax advantages; among them are that the company can deduct both the principal and interest payments on the loan and that the dividends paid on any stock held in the ESOP are considered a tax-deductible expense. Disadvantages: This is not a good strategy if the entrepreneur does not want the employees to have control of the company. The ESOP must extend to all employees and requires the entrepreneur to open up the company’s books.

14 Harvesting Options (cont.) 4. Merging or Being Acquired – Selling the company to another company can be an exciting exit strategy for an entrepreneur who would like to see his or her creation have an opportunity to grow significantly by using another company’s funds. Advantages: The strategy can finance growth that the company could not achieve on its own; the entrepreneur can either exit the company at the time of the merger or acquisition, or be part of the growth and exit later. Disadvantages: This can be an emotionally draining strategy, with a lot of ups and downs during negotiations; a sale can take over a year to finalize.

14 Harvesting Options (cont.) 5. Initial Public Offering (IPO) – An initial public offering, or “going public,” will mean selling shares of your company in the stock market. Advantages: If your business is hot, this can be a very profitable way to harvest it. The market may place a sizeable premium on your company’s value. Disadvantages: An IPO is a very exciting, but stressful, all-consuming, and very expensive way to harvest a company, and it requires a lot of work from the entrepreneur – and ultimately it is the market that will determine the outcome.

14 Exit Strategies for Investors Acquisition = someone buys the corporation & they are bought out or paid back Earn out = investors are bought out with company cash flow over time

14 Exit Strategies for Investors (cont.) Debt-equity exchange = trade equity for portions of debt over time to change lenders into owners Merger = value is created through combining with another company

Investors Will Care about Your Exit Strategy, Too 14 Investors care about your exit strategy because it will affect their investment & how they will eventually get their ROI. Spell out your exit strategy in your business plan. Simply claiming you will “go public” is not adequate.

Key Terms book value diversification fair market value harvesting licensing line extension liquidation merger replication strategy