Breaking Down a $10M Primrose Franchise Resale

0:00Welcome to another episode of Acquisitions Anonymous. I'm Heather Anderson. And today it's just Connor and myself talking about a franchise. And this is a really interesting preschool franchise in Texas. And we get into some of the nitty gritty on the differences between the valuing an enterprise and the real estate that it occupies and whether you should buy one or both or different options you can look at when they're both being offered, which is the case here. So hope you enjoy the episode.

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1:36V-E-R-I-V-E-N-D.com. Connor, it's great to see you. Likewise, Heather, good to see you. Well, they've left us in charge. So watch out. Connor and Heather are running the podcast today. That is very dangerous. What should we talk about? Anything. I mean, let's just go for it. Let's go wild. How about franchises? We could do that. I was going to talk about Bill Belichick. That's what everybody wants to talk to me about these days. Since I have the UNC football helmet, everybody wants to hear my take on Bill Belichick, but that's not something I'm... It's not really him, right? It's the girlfriend.

2:13That is correct. That is correct. But yeah, let's talk franchises. I brought this deal. This is a Primrose School franchise resale in the DFW market, which is interesting because it includes real estate. I have never done a deal where the real estate is included, so I'm interested to learn from you how that impacts things with regard to diligence, financing, etc. So the title is Top DFW Suburban Primrose School, and the asking price is$10.9 million. Gross revenue is$3 million. Cash flow SDE is$1.3 million. The business description, this may be the best opportunity for a buyer to own one of the best Primrose schools without being placed on a waiting list.

2:52That is true, by the way. This highly sought after child care franchise brand is one in the rapidly growing suburbs of DFW. This gorgeous school has been in operation for several years and has an excellent reputation within the community. You will have positive cash flow from the first day and you will avoid the risk of building a new location. Due to the popularity of this brand and of the community that it is in, the center will sell quickly. The center has sales of over$3 million and SDCF of over 1.3 million. The school has been pre-approved for SBA financing with between 10 to 15 % down based on buyer qualifications.

3:27If you've been wanting to build or buy primary school, please do not wait. This will go fast. So inventories included in the asking price, real estate is owned and including in the asking price, they do not tell us how much the real estate is worth, which would be my first question, But that is what we have here. Okay. Wow. I do know a little bit about Primrose Preschools. I have done some deals with SBA debt on them. And, you know, it is a very good brand as far as I know. And, you know, the tuition is on the higher side, you know, so this is going to be a higher end clientele. The kinds of things I wish they would have included that they didn't is sort of enrollment, you know, any trends that they've had recently.

4:09And of course, yeah, it would be really nice if they would break out the real estate from the enterprise value. But you can kind of guess at it here. I mean, a million three primrose probably goes for what? A little over four? Would you say four and a half? Four or five? Yeah, somewhere in that range. We'll say four and a half. So that would be$5 ,850 ,000 maybe for the enterprise and the rest for the real estate, which is interesting then. It's a little more enterprise value than real estate. The reason I wanted to do that math is with SBA loans, if the real estate is worth more than the enterprise, you could put them together sometimes in one SBA 7A loan for a 25-year term on the whole thing instead of 10 on the enterprise and 25 on the real estate.

4:54This one's probably just too big for that because the enterprise itself is already at the cap. The value is probably over the cap of the$5 million SBA loan amount. So you're going to have to probably use an SBA loan for the enterprise and a conventional loan for the real estate. So how would that work in terms of just bifurcating the P &Ls of the operating entity versus the real estate? Because I'm assuming, by the way, SDCF, is that seller discounted cash flow? That's a new one on me. I've never heard that. SD, yeah, whatever it is. It must be cash flow. Yeah. So the question is, is if they're including the presumably what the rent would be in that, how do we go about backing that out?

5:38Or how would the lender go about looking at that when they're determining how much they would be willing to lend against the operating entity? Would they just assume, you know, a certain rent payment and then split it between entities? They don't really underwrite them as separate entities if they're doing it as an SBA. If you're looking at owner-occupied real estate, and frankly, I think a conventional lender would probably use the same approach on the real estate, what you do is you underwrite the underlying cash flow of the business that's occupying the property, not the rent. you know in you know if they were owned by completely unrelated parties you would underwrite the rent but this is the same group you would presume buying the enterprise and owning the real estate or pretty pretty interrelated and as such you basically take the guarantees of everybody you tie everybody to both loans all the owners over 20 percent all the entities and then you underwrite it as one package so then you look at the cash flow of the primrose how much rent they've been paying themselves historically, right?

6:36That should be in the P &L. You would add that back and then you'd have this pro forma or this historical free cash flow or adjusted EBITDA, I guess. And then you would deduct the payment for the enterprise loan and the real estate loan and look for a debt coverage of at least 1.3 probably for something like this. I did misspeak. There is a way you could maybe do this thing as two SBA loans. And I've done it before. It's a little tricky, but you can max out your 5 ,000 ,000 7A enterprise loan. And then you still have 1 ,250 ,000 left over for a 504 real estate loan, SBA 504, 1 ,250 ,000 for the second trustee loan.

7:22So what would happen if the real estate is worth 5 million, which is kind of what I'm guessing here, $1 ,250 ,000 divided by$5 ,000 ,000 is 25%. So it's not the normal 504 loan scenario, but the second trustee that the SBA would take could be as much as 25 % of the value. And then you could have a bank do the 504 conventional first at the rest, basically. So that would be higher than their usual 50%. They'd have to be at 75%, but that's still a very good loan to value and you could still get in, I should say 65 % and you could still get in with 10 % down. So there is a way to do this as a 7A, 504 combo.

8:04I know that what I just said sounds confusing and it confused me while I was trying to say it, but that is a possibility here. And it doesn't happen very often where we have a scenario that might fit that, but they will underwrite it as one big cashflow here. So if I was in a situation where I didn't want, I just didn't like the investment profile of the real estate. I did like the investment profile of the operating business. Is it even possible for me to go and find somebody else who would like to buy the real estate and then get an SBA loan, taking into account the rent that we would pay them?

8:38Could you bifurcate the deal like that if you wanted to? Even within SBA, you can. So the rule is that the eligible, they call the holding company of the real estate in SBA speak, it's called eligible passive concern. The eligible passive concern does not have to have at all the same ownership structure as the operating concern, as long as the operating concern will guarantee the loan. So the problem is if you have completely different groups, the operating company probably doesn't want to guarantee the real estate loan of somebody. If it's slightly different, if the cap tables are somewhat different, you might be able to work something like that out.

9:14Alternatively, what some people are doing, I don't know if I would do it here in a primrose because you really want probably to keep that real estate long-term. But some people will also do a sale lease back when they've got to buy both. It usually works best, however, when you think you're getting the real estate at a somewhat below market price so that there's a delta there where you might actually recoup some cash when you go to finalize the sale lease back. But you basically are entering into a 15-year lease with an investment fund usually that's going to buy the real estate and lease it to you long-term.

9:48And like I said, sometimes there's a delta between what you're paying from this seller and what they're buying it from you for. And you might actually be able to receive some proceeds from that upon close of the real estate. So there's a lot of options here. Yeah. And when you see a sale lease back scenario, is the profile of buyer that would typically go towards that? Is that kind of like viewed as a financing tool or is it just there again, they like the investment profile of an operating business and they're not real estate people, they don't want that on their cap table. Does that question make sense?

10:19Yeah, it does. And I think it's usually both. The type of person that decides to do it is probably for both reasons. I don't really want to own this real estate and maintain it long-term. And I don't think it's necessary for my business to have it long, long-term. And it's a financing vehicle. If they think they can get some cash out of it, they view that side of it very favorably as well. But it's usually a combination of both. Like I said, I think in a business that is location dependent, which a Primrose totally is, you probably want to own this real estate long term. I wouldn't want to be in a long term lease for something like this.

10:53And I wonder also, and maybe you'll know the answer to this, would the Primrose franchisor even approve for you to come along and buy the enterprise and not own this real estate? Or would they want a buyer who can own it as a package? With Primrose specifically, not all of their franchisees, at least so far as I'm aware, own the real estate. It's a combination of some people rent their real estate, some people own it and build it out like this. I don't know if Primrose does this, but some franchisors are also landlords. So not for all of the locations, but they do own certain locations that some franchisees rent from them.

11:27So there are a lot of different ways that they address this, but I don't believe that they have restrictions on you have to own the real estate. What I don't know, though, is I don't know in a transfer like this whether they have to approve that or if they only have to approve the transfer of the franchise agreement that corresponds with the operating business. And it is the prerogative of the franchisee to enter into an agreement with the landlord, whether that's themselves or somebody else who would buy this business. Now, what I knew about Primrose as a concept previously was that they wanted owners who were really going to be hands-on, living in the community, which is this is the case with any SBA loan.

12:07But Primrose was very particular that they wanted the community that was sending their children to a school like this to kind of know who you are and for the owner to be sort of a pillar of the community and hands-on and very involved in care about the actual child care. I don't know if they've evolved away from that for these bigger transfers like this. What do you know about that? It's a good question. So everything that they said in the description about Primrose as being hard to come by is true. So by the time that I really was immersed in the franchise world, there wasn't a lot of activity in Primrose because they were all kind of snatched up.

12:46So I don't have a lot of firsthand insight into that. But what I do know is that the people that I know a couple of people who are franchisees in Primrose, and the reason that I know them is because Primrose has done very well and they wanted to diversify into other youth franchises. And I would say they fit the profile of what you just said. You know, people that are well capitalized, but are also very community oriented. And a lot of them have gotten into other, you know, youth enrichment franchises because that's the profile that they fit. But what I don't know is whether they would require you to run it on a day-to-day basis or by community involvement.

13:23They're just meaning they want you to have ties to the community. They don't want somebody presumably buying this in Dallas who lives in Denver, as an example. Yeah, for sure. I would say that would be something to consider. You need to be someone that lives in Dallas-Fort Worth to own this business. But I guess I've seen this in my practice. it's probably not a good option for someone who is just a financial background, you know, quote unquote, searcher type, because you're not really going to probably fit the profile of what the Primrose system really wants their ownership to look like, to be, you know, they want them to be very hands-on.

14:01All the better if you have young kids or, you know, you've had any kind of background in education. That's the kind of thing I think that would, you know, put you in a better spot to be an owner in this kind of system. Completely agree. And I have, you know, I'm not big on like following your passion in picking a business, but there are three lanes where I think that you do have to be passionate about it. One of which is youth enrichment. Don't, you know, if you hate kids, don't get into this lane. Pets, if you hate animals, don't get into that business. And home care, if you hate old people, do not get into the home care business.

14:33So, you know, as far as other services are concerned, you can be a little bit more free with what you choose. But yeah, if you, this is not the business to get into if you do not like, don't like children overall. And this is, it is children. And so this is a high trust kind of industry. And I think that's the other reason for, you know, the, the primrose system and probably the seller of this business to be very selective as well. You know, you have to just be sparkling clean in terms of your background to, to kind of garner that trust of taking care of people's kids. And there's risk with that because you're not the one actually doing the taking care of kids.

15:09You are hiring people to take care of the kids. And that is something to consider in any kind of business that's dealing with children. I completely agree. And the other thing is, is this is a national brand, which that can either work to your benefit or it can work to your detriment. Because something happens to someone's child at Primrose, 10 states away, and there's always the chance that that comes back to negatively harm you. But with that same thought in mind, that's why people a lot of times look to these brands that are reputable and are often willing to pay a premium to move forward with that.

15:42So if we were to back out the real estate component, which I'm still a little bit in the dark over, mainly because they don't share the validation with us. But if we were just to look at the operating business and how we think about that, I really like it overall. I mean, obviously it has to be the right buyer, but I mean, you're talking about really good revenue, strong margins. And anytime I think that you can drive seven figures of cashflow out of the same four walls, there's a lot to like about that overall. And I like the youth enrichment space. So curious, what do you think about just the business, irrespective of the real estate?

16:17The part thing about a business like this is your growth is extremely limited. Um, you know, this is obviously at a million three cashflow. I, did they say whether it was one location or two? I think it's just one. It seems like it's one large location. Yeah. So you're probably pretty close to full enrollment all the time on this one. Uh, it's matured, et cetera. Your only growth opportunity is to go build out another one. And, uh, you know, that is, that is expensive. Uh, you've got to build the building. Uh, you've got to find the location, just finding the right location in the feasibility study that you need to do to make sure that is a good place to put a new preschool.

16:56That's all very, very expensive. So if you're planning to grow this, you've got to have a lot of capital in reserve, basically, and a plan, a strategic plan. If you're buying this just for stable cash flow, yeah, I think it's a great business. But there is a difference, how much equity you have to put in for stable cash flow versus how much you might put in for growth. And I just think the growth opportunity here is expensive. No doubt. And one thing that's always kind of confused me about this kind of business is that you always hear about these places having really, really, really long wait lists.

17:30And so given that your growth is constrained by your four walls and really your only opportunity to drive more revenue is to increase prices, I don't know, maybe this is just me being a capitalist pig, But why is that market not correcting and they're just raising prices so that they don't have a 6 to 12 month wait list? Is there something that I'm missing there? Yeah, I think it's the real estate development piece, frankly. It's finding the next location, getting the approvals to build it out. I think it's that. I think that's the constraint. I'm talking about pricing. Oh, why can't you just keep pricing up?

18:05Yeah, yeah. Yeah, it probably hits a wall at some point of what people can pay. I think the, I mean, the last time I looked at the tuitions for a high-end preschool, it was very expensive. I mean, I like to the point, I don't know how a family with young children could afford to pay much more than that. So, you know, I think there's probably a point where they just, they lose enrollment if they go beyond that. And they probably all, every market's a little bit different in how they fill that out, but that's probably what it is. It's just, you reach a point where you can't raise prices anymore.

18:37It's very expensive already.

19:07friends of the podcast. They're passionate about helping entrepreneurs like you take the next big step. So don't wait to make your business ownership dream a reality. Visit acquisitionlab.com today to learn more and schedule your free consultation. And when you do, be sure to tell them the Acquisitions Anonymous podcast sent you. Circling back to the numbers, I know we talked about how like a lender would think about it valuation wise. How do you think about this as a buyer? Again, we're limited in what we know here. We don't know what the real estate is worth. But yeah, how do you think about between the real estate and the operating business going about how do I value this business?

19:43You know, kind of setting aside how the lender thinks about it. I don't know that you can. Yeah, I mean, I am a believer in, I value every business I see based on cash flow multiple. I don't care about the assets that are in the business other than real estate. In this case, we do have to kind of split that off and think about that differently. But I think about the cash flow and the stability of it. You know, so yes, they're telling us a million three SDE, but I'm going to break that down into, well, what's SDE? I have to have a salary, so I'm not going to pay for my salary. I'm not going to pay a four times multiple for my salary that I'm going to need to run it.

20:14I'm going to look at, again, the enrollment percentages. Am I at full capacity or not? Do I have growth opportunity? If I looked at the Primrose that was, for some reason, it was a newer one and it was only at 60 % enrollment and I believe I can take it to 80 % or whatever the maximum usually is, then I'm going to value it differently if I can grow it than if I can't. So to me, it's worth less if I can't grow it or if growth is very expensive. So I always kind of start with like a multiple range. It's usually somewhere between three and four. And then I start kind of thinking about the things that would make it worth more to me, like growth, and the things that would make it worth less to me, like maybe unstable margins, something like that.

20:55So if we were to try to, or I'm not even going to go there, because I guess where my head went is like, if we were to try to estimate what rent would be and try to back that out from SDE in addition to what your salary would be, my gut would be to put a multiple on that to value the operating entity and then kind of set the real estate aside separately. Yeah, that's what I would do too. Yep. Okay. But you can't overpay for the real estate, you know, because really you can only pay for the real estate, which you can afford to pay in rent in the business. So they are, to me, they're still connected.

21:28I can't overpay for this real estate if that means it costs me more than the market rent should be. So let's say, as an example, if they were paying 20K a month in rent, that's 240 a year total that we're backing out from SDE. What if we took another 100K off of SDE to pay for owner's comp or manager's comp, et cetera? So that leaves us approximately a million of SDE. So say, for example, if we were to put a four times multiple on that 4 million to get to that asking price, that would be almost 7 million that the real estate would have to be worth for that to make sense, which I'm sure it's not worth that.

22:07So yeah, I'm not sure I followed the math completely because I think you have to leave rent expense in the business when you're valuing the business. As long as the rent expense that you leave in the business is a market rent. Got it. That's the way I look at it. I adjust the market, I adjust the rent, the historical rent that's being paid to market. So a lot of times when a seller has owned the real estate, they have not been paying market rent. So you'll see this inflated EBITDA figure because it doesn't include market rent. Say the market rent is 240 ,000, they've been paying themselves 50 ,000.

22:38Now you have a negative that you've got to, and that's the cashflow that I would value the business on. And then I would go over and value the real estate kind of on that rent, what the market rent is to some degree, because that's all I can afford to pay in the business that occupies it. So knowing what you know now, which isn't everything, how do you think about that, uh, that asking price? I think it's probably fair to be honest. I think it's, if it's a four times, you know, maybe it's a little high because the million three is not a million three. Let's say that if it, if the million three is really a million of cashflow, once we sort of come down to what we think is realistic, uh, then maybe it's a little bit high, maybe by a maximum of a million dollars high, but it's pretty close to in the ballpark, which is nice to see.

23:21What do you think? So, well, this may be more than my basic college education can handle as far as math is concerned. I'm not a real estate guy. It's just not my thing in general. And I think that, you know, you have to, you just have to, real estate has to fit your investment profile of what you're looking for if you were to buy a business like this, where so much of the value that you're paying for is in that real estate. And by the way, that can be awesome. I mean, it's the same thing that I say about the food business. Part of the reason I'm not in the food business is that if I'm going to be in the food business, the best place to be, in my opinion, is the landlord.

23:54And I'm not in the real estate game. So yeah, it's just hard for me to think of, despite the fact that I like this industry, it's hard for me to think about this deal in a way that would make sense from my perspective. But let's talk about who this could make sense for. And I think we kind of did. But I mean, to me, this makes sense for obviously somebody that's well-capitalized, lives in DFW, kind of profiling here. Maybe it's one spouse, you know, works, works a job, makes a lot of money. They're well-known in the community. The other spouse is going to run this business full-time. They have kids.

24:23That's kind of who I have in my mind as to who this makes sense. What do you think? I think that's what I've seen too in different markets, as far as people who have already own these higher-end preschools. That's exactly what they look like. And, you know, yeah, someone has to be operating at full time. This is not a passive investment. This is very hands-on. And again, you're very visible to the other families in the community that might be your customers. And so I think that's very important. But yeah, I think a really good solid person, a couple where one works full time, I think would be perfect for this.