An Integrated Economic Model for the Evaluation of Franchise Systems: A Synthesis of Agency and Finance Theories

Abstract

The fundamental approach to measuring goodwill in franchisee-operated businesses is the same for any other business models. However, the difference lies in the methodology, more particularly in the calculation of a risk premium, the identification of cash-flows, and the evaluation of the franchise system. Franchisees are common law agents and are not free agents, unlike their counterparts that operate independent businesses. They are prescriptively created, governed, and terminated by contracts that are determined and controlled by their principal. As principals, franchisors rely on franchisees to do that which they cannot do themselves with equal efficiency. In order to facilitate this arrangement, they enter detailed contracts that express their reciprocal intentions and expectations. These include such things as performance standard, revenue sharing, risk allocation, operational protocol, and intellectual property rights. In fact, franchisors insist on retaining proprietary rights to all intellectual property and instead grants to the franchisee a contractual right to use it for a limited period. During that period, franchisees have to mobilise their financial and intellectual capital to leverage the intellectual property for cash-flow generation. This process often generates valuable goodwill. Arguably, goodwill exists, where the total value of cash-flows generated from the business exceeds the opportunity cost of net tangible assets employed in the business.