Franchisors like many growing, successful businesses often consider listing on a stock exchange (e.g. ASX). The appeal of listing is varied ranging from the desire to extract value from the business by selling equity to the public to having the ability to raise funds, and personal profile.

However, with only a small number of franchisors listed on the ASX it begs the question, is there value in listing a franchise?

To answer that question and better understand the value of listing we first need to take a step back and understand what investors are looking for, whether or not franchises are a good investment, the cost of listing and franchisor reservations.

WHAT ARE INVESTORS LOOKING FOR?

Typically, investors are looking for a business that provides a good return in the form of income from dividends and/or capital growth.

Capital growth, which is usually measured by the increase in a company’s share price, is driven by investors’ perception that a business will be able to generate an increased income stream in the future that will ultimately pass onto shareholders.

In assessing growth potential of a business, investors may look at:

• Industry conditions: overall growth (of the sector and over any particular timeframe), barriers to entry, extent of competition, and regulatory regimes
• Industry position: how is the business positioned within the industry, is it the market leader, is market share increasing, is it generating superior margins to its competitors, does it have a sustainable competitive advantage?
• Business model: is the business model appropriate for the industry, suitably robust to withstand industry shocks and changes and able to support continued growth?
• Strength of management: is management suitably structured and qualified to guide the business into the future, looking after the interests of shareholders?

WHAT MAKES FRANCHISES A GOOD INVESTMENT?

Franchisors have low revenue turnover compared to equivalent non-franchised businesses because they usually receive the majority of their revenue from royalties/franchise fees; successful franchise systems are highly profitable.

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Successful franchise systems typically have stable earnings streams and are able to consistently pay dividends to shareholders.

WHY ARE THERE SO FEW LISTED FRANCHISES?

Despite being a good investment there are only a few franchise businesses that are listed on the ASX.

There are a number of reasons for this including:

1. The ability to self fund expansion

When new franchise systems are growing, profitability is often low because infrastructure is built for a large system and critical mass hasn’t yet been achieved.

Once a system achieves critical mass, it usually generates strong cash flow. If a franchisor is happy to expand within the constraints of the cash being generated there is no need to list. The reasons for listing would be if the franchisors wished to extract value from the business or needed to raise funds, above what the bank would lend, for expansion and acquisition.

2. Demands investors place on business growth

The licence fee nature of income means typically franchisors need to open a greater number of franchises compared to company owned stores to achieve the same bottom line growth. This often means that unless a franchisor is willing to consider acquisitions or overseas expansion as viable avenues of growth, investors may lose interest in the business.

3. Cost of listing and staying listed

The cost of listing and staying listed is not just monetary. Most franchisors are tightly held, privately operated businesses and may choose to avoid the governance and reporting requirements of a stock exchange.

4. Cost of equity

Equity is far more expensive than debt. If you are borrowing debt, it can cost between seven and nine percent in interest.

On the other hand, investors are typically looking for returns of between 11 and 13 percent for investment in a company with an average risk profile.

But remember, equity investors require a greater return because they have no security, unlike a bank which will require security over assets of the business and sometimes even private family assets.

TO LIST OR NOT TO LIST

As a guide, a small listing of less than $100m market capitalisation, and raising less than $20m (the majority of franchisors), will cost between 7.5 percent and 12.5 percent of funds raised. This covers the costs of listing and services provided by financial advisers, brokers, legal advisers, due diligence providers.

Annually, there are listing costs and the franchisor will need to employ someone familiar with stock exchange reporting requirements. They will also need to engage an auditor who the investors feel they can rely on, which usually means one of the big four or second tier accounting firms. These costs can range from $1m to $1.5m per year, depending on the size and complexity of the operation.

FUTURE OF FRANCHISE LISTING    

Many businesses are rapidly nearing, or have already reached the critical mass that is arguably necessary for a stock exchange listing.

Listing has very real benefits for businesses on aggressive growth paths ranging from access to equity capital to fund expansion and acquisition, to extracting a percentage of value from the years invested in building the business, while still retaining control.

In addition, there is a powerful and often underestimated benefit of listing – the ability to attract and retain franchisees and employees because of a higher public profile and the ability to offer unique remuneration structures using the listed company’s shares.

With the domestic franchise market rapidly approaching saturation point and the competition for quality franchisees stronger than ever, it could be this last point that makes the difference between sustained growth and stagnation.

Greg Hodson is the national leader of PricewaterhouseCoopers’ franchising practice and has been a partner with PwC for 20 years