What looks like a big corporation is often a privately held business in the form of a franchise. Franchises are all over. Restaurants, hotels, auto dealerships, gyms, real estate brokerages, home-services companies, and so many other businesses operate under franchise systems. These franchisees own the franchised business (under a lot of conditions) and that business has value that must be determined in an Illinois divorce.
How Are Franchises Valued And Divided In An Illinois Divorce?
When a spouse owns a franchise, putting a value on the business for an Illinois divorce is not as easy as valuing an independently owned store, restaurant, or service company.
A franchisee is an independent business owner, but the franchisee operates under rights granted by somebody else. The Illinois Franchise Disclosure Act defines a “franchise” as a contract or agreement, “either expressed or implied, whether oral or written,” that satisfies three requirements. 815 ILCS 705/3(1). The franchisee first must be granted the right to offer, sell, or distribute goods or services “under a marketing plan or system prescribed or suggested in substantial part by a franchisor.” 815 ILCS 705/3(1)(a).
Second, the operation of the franchisee’s business under that system must be “substantially associated with the franchisor’s trademark, service mark, trade name, logotype, advertising, or other commercial symbol.” 815 ILCS 705/3(1)(b). Finally, the franchisee must be required to pay the franchisor or its affiliate, directly or indirectly, “a franchise fee of $500 or more.” 815 ILCS 705/3(1)(c).
These contractual rights can be valuable. They can also be temporary, limited, expensive to maintain, and hard to transfer.
Business Valuation Resources summarizes this distinction: “Franchises are contract rights, not outright ownership.” Business Valuation Resources, Franchise Value: Valuation Methods and Benchmarking Data 23 (2016). The franchisee does not own the franchisor’s trade names, logos, production rights, or production systems. Id. Instead, “[w]hatever benefits exist to the franchisee are found in the franchise agreement.” Id.
That is an important distinction in an Illinois divorce. Under the Illinois Marriage and Dissolution of Marriage Act, when valuing property for purposes of division, “the court shall employ a fair market value standard.” 750 ILCS 5/503(k). For a franchise, determining fair market value requires more than looking at the franchisee’s revenue or applying a generic industry multiple.
The valuation must determine what the spouse owns, what economic benefits those rights produce, how long those rights are expected to continue, and what a hypothetical buyer could truly acquire.
What Is Actually Being Valued?
The appraiser has to identify the property being valued before choosing a valuation method.
A franchisee may own one operating location. The franchisee may own multiple locations, each governed by a separate agreement. The franchisee may own an interest in an entity that owns multiple franchises with another investor.
Business Valuation Resources distinguishes among several franchise structures. Franchise Value: Valuation Methods and Benchmarking Data at 7. Under a single-unit arrangement, the franchisee invests in one unit and usually operates within a defined territory. Id. A successful franchisee may later acquire more units, with an individual franchise agreement typically governing each unit. Id. Under an area-development arrangement, the franchisee may obtain the right to open multiple units within a designated territory over an agreed-upon period. Id.
These are important distinctions because the marital asset may not just be “the franchise.”
Imagine a franchisee who owns six restaurant locations through four limited liability companies, owns the real estate beneath two restaurants through another entity, leases the other locations, and possesses development rights for three additional restaurants that have not yet opened. A valuation that merely capitalizes the combined earnings of the six existing restaurants may miss essential assets and liabilities.
The appraiser should identify the ownership interest held by the spouse, the franchise agreements and locations covered by the interest, and any expansion or area-development rights. The appraisal should further account for the ownership structure of each operating entity, any minority or noncontrolling interests, separately owned real estate or leasehold interests, equipment and inventory, existing debt and personal guarantees, and any related entities that provide management, real estate, or other services to the franchise business.
This aligns with the broader principle that intangible assets may arise from contractual legal rights and may exist separately from general goodwill.
So, the first question in valuing a franchise in divorce is: What property interest does the spouse actually own?
The Franchisee Does Not Own The Brand
The value of the franchisor’s brand is different from the value of the individual franchisee’s business. BVR explains that “[f]ranchises are contract rights, not outright ownership” and that the franchisee does not have the full bundle of rights associated with the franchisor’s trade names, logos, systems, or production rights. Franchise Value: Valuation Methods and Benchmarking Data at 23. Instead, “[w]hatever benefits exist to the franchisee are found in the franchise agreement.” Id.
Thus, a profitable franchise location may benefit greatly from a nationally recognized brand without owning the brand. Understanding Business Valuation also distinguishes trademarks and trade names as marketing-related intangible assets while identifying franchise agreements as contract-based intangible assets. Gary R. Trugman, Understanding Business Valuation 742 (6th ed. 2022). A hypothetical buyer may be paying for the contractual right to keep operating under the brand, together with the franchisee’s other tangible and intangible assets, rather than buying any ownership interest in the franchisor’s trademark.
When goodwill is analyzed, this distinction also matters. The franchisor’s national trademark should not just be treated as goodwill owned by the individual franchisee, even though the franchise business may possess value above its tangible assets. Accordingly, the appraisal should distinguish the franchisor’s brand from the contractual and enterprise value that truly belongs to the franchisee.
The Franchise Agreement May Be The Most Important Valuation Document
The franchise agreement is “the most important document you will meet in valuing a franchise business.” Franchise Value: Valuation Methods and Benchmarking Data at 11. The agreement establishes the parties’ rights and obligations and often addresses territory, duration and renewal, fees, royalties, advertising, and training. Id. at 11-12. So, the agreement can be vital in determining what economic rights a hypothetical buyer could acquire.
The Remaining Franchise Term Matters
Franchise agreements are “not granted into perpetuity,” so the appraiser should consider the remaining term, renewal rights, renewal costs, and any conditions imposed on renewal Id.at 12. A franchise with lots of years remaining on favorable terms can present a different risk than one nearing expiration or needing a new agreement to continue operating.
Illinois law also impacts this analysis. Section 19 of the Illinois Franchise Disclosure Act provides that it is a violation to terminate an Illinois franchise before expiration of its term except for “good cause,” which includes failure to comply with lawful provisions of the agreement after notice and a reasonable opportunity to cure. 815 ILCS 705/19(a)-(b).
Section 20 provides that, under specified circumstances, a franchisor may not refuse renewal without compensating the franchisee for the “diminution in the value of the franchised business” caused by expiration. 815 ILCS 705/20. These protections do not make a franchise perpetual. However, they do reinforce why current earnings should not just be assumed to continue indefinitely.
Transfer Restrictions Matter
A franchise agreement may limit who can purchase the business. Illinois law recognizes a franchisor’s right to “approve or disapprove a different franchisee,” require a reasonable transfer fee, and require the purchaser to execute a franchise agreement on terms not materially different from the existing agreement. 815 ILCS 705/7. These restrictions can narrow the available buyer pool, as well as affect marketability and value.
Territory And Expansion Rights Matter
The agreement may establish whether the franchisee receives an exclusive or protected territory and whether additional locations may be opened nearby. Franchise Value: Valuation Methods and Benchmarking Data at 12. BVR warns valuators about the potential for new locations to “cannibalize existing franchisee territory.” Id. Development rights, territorial protection, and the franchisor’s ability to add competing locations can therefore impact the sustainability and growth of the franchise’s earnings.
The Franchisor Can Control Important Business Decisions
A franchisee may lack control over decisions that affect future profitability. Franchisors may dictate appearance, hours, site selection, available goods or services, pricing practices, accounting procedures, and approved suppliers. Id. at 9-10. A franchisee may even be necessary to purchase from an approved supplier “even if similar goods can be bought elsewhere for less.” Id. at 9.
These restrictions can impose costs the franchisee cannot avoid. Franchise agreements may need facility updates as branding changes and that the resulting capital investment should be incorporated into projected net cash flow. Understanding Business Valuation at 143. So, required technology upgrades, remodels, supplier restrictions, or other franchisor mandates may affect the future economic benefit being valued.
The Franchise Disclosure Document Can Provide Important Valuation Evidence
Importantly, the franchise agreement is not the only franchise document an appraiser should review. The Franchise Disclosure Document (FDD) can provide essential information about the actual franchise system.
Under Section 16 of the Illinois Franchise Disclosure Act, the disclosure statement “shall be prepared in accordance with” the FTC Franchise Rule. 16 C.F.R, Part 436. 815 ILCS 705/16. For a franchise required to be registered under the Act, Section 5(2) makes it unlawful to offer or sell the franchise without providing the prospective franchisee the disclosure statement and proposed agreements “at least 14 days prior” to execution of a binding agreement or payment of consideration, whichever occurs first. 815 ILCS 705/5(2).
To be clear, the FDD is not a valuation report; however, it contains information that may help explain the contractual rights, risks, and economics underlying the franchise. BVR explains that “[t]wo legal documents governing franchise relationships have a significant impact on company value”: the FDD and the franchise agreement. Franchise Value: Valuation Methods and Benchmarking Data at 10. Several FDD items may be particularly helpful.
Item 17: Renewal, Termination, And Transfer
Item 17 addresses renewal, termination, transfer, and dispute resolution. 16 C.F.R. § 436.5(q). Item 17 identifies whether the franchise can be renewed, what the franchisee must do to qualify, whether fees or other terms may change, the franchisee’s post-termination obligations, and what is required to receive franchisor approval of a sale. Federal Trade Commission, A Consumer’s Guide to Buying a Franchise, “Renewal, Termination, Transfer and Dispute Resolution (FDD Item 17).”
These disclosures may bear directly on the duration and transferability of the rights being valued. If a franchise is approaching renewal or a transfer must have franchisor approval, Item 17 and the underlying agreement may help establish what a hypothetical buyer would need to do to keep operating the business.
Item 19: Financial Performance Representations
Item 19 regards financial performance representations about franchise sales or earnings. 16 C.F.R. § 436.5(s). The Franchise Rule does not require a franchisor to give a financial performance representation, yet most franchisors do. Claims regarding sales or earnings usually must appear in Item 19. Federal Trade Commission, A Consumer’s Guide to Buying a Franchise, “Financial Performance Representations (FDD Item 19).” Any such representation must also have a “reasonable factual basis.” Id.
Item 19 can give helpful context for comparing the subject franchise with system-level performance. If the subject location substantially outperforms or underperforms the disclosed results, the appraiser can investigate whether management, owner involvement, competition, location, territory, or another factor explains the difference.
Item 19 should not replace the subject franchisee’s actual financial records. Some valuation experts consider the performance information susceptible to manipulation, so BVR explains that missing or inadequate information may require “more primary research.” Franchise Value: Valuation Methods and Benchmarking Data at 11.
Item 20: Outlet Growth And Turnover
Item 20 provides information about the franchisor’s outlets and franchisees. 16 C.F.R. § 436.5(t). It provides “charts showing growth and owner turnover in the franchisor’s system”; the FTC recommends investigating why franchised outlets have closed. Federal Trade Commission, Franchise Fundamentals: Taking a Deep Dive Into the Franchise Disclosure Document, “Franchisee and Franchise System Information (FDD Item 20)” (2023).
Additionally, Item 20 provides contact information for current and former franchisees, which may offer more evidence regarding costs, profitability, franchisor support, and reasons owners left the system. Id.
Transfers, closures, system-level growth, and owner turnover may provide context for assessing whether the subject franchise’s historical earnings are likely to carry on. The FDD should thus be reviewed with the franchise agreement, the subject franchisee’s actual financial records, and other available evidence.
Is A Franchise Marital Or Nonmarital Property In Illinois?
Once the business interest is identified, the next question is classification.
Section 503(a) of the Illinois Marriage and Dissolution of Marriage Act states that “‘marital property’ means all property, including debts and other obligations, acquired by either spouse subsequent to the marriage,” except for the categories identified as nonmarital property. 750 ILCS 5/503(a).
Property acquired after the marriage and before a judgment of dissolution is “presumed marital property,” and that presumption may be overcome by clear and convincing evidence that the property was acquired by a method identified in Section 503(a) or otherwise qualifies under subsection (b)(1). 750 ILCS 5/503(b)(1).
So, a franchise interest acquired during the marriage typically will be presumed marital, even if only one spouse holds the ownership interest. Id.
In re Marriage of Roepenack is an example that involves franchise businesses. The court in this case noted that the parties’ corporations, “consisting of Jimmy John’s franchises, were formed during the marriage.” Roepenack, 2012 IL App (3d) 110198, ¶ 9. The parties purchased a Pekin franchise for $158,000 and a Lincoln franchise for $125,000, both with marital assets. Id.
Section 503(a) classifies as nonmarital property “property acquired before the marriage,” property acquired by “gift, legacy or descent,” and property acquired in exchange for qualifying nonmarital property. 750 ILCS 5/503(a)(1), (2), (6). Franchise ownership can complicate this analysis if the business expands during the marriage. For instance, one spouse may own one location before marriage but obtain more locations afterward.
Classification should therefore occur interest by interest. The attorney and valuation expert should determine when and how each interest was acquired, how the acquisition was funded, which entity owns it, whether separate franchise agreements govern different locations, and whether marital or traceable nonmarital funds were contributed.
The growth of a premarital franchise does not automatically convert that franchise into marital property. Section 503(a)(7) classifies “the increase in value of non-marital property” as nonmarital, “irrespective of whether the increase results from a contribution of marital property, non-marital property, the personal effort of a spouse, or otherwise,” subject to the statutory right of reimbursement. 750 ILCS 5/503(a)(7). This distinction can especially matter when a franchise begins with one premarital location but grows substantially during the marriage.
A Nonmarital Franchise Can Still Create A Reimbursement Claim
The analysis does not end with classification. A spouse may establish that a franchise is nonmarital property, but the marital estate may still have a reimbursement claim.
Under Section 503(c)(2)(A), when one estate contributes to another, “the contributing estate shall be reimbursed from the estate receiving the contribution.” 750 ILCS 5/503(c)(2)(A). Yet no reimbursement is available for a contribution that cannot be traced by clear and convincing evidence or that was a gift. Id.
For a franchise, marital contributions might include funds used to repay acquisition debt, equipment purchases or finance required remodels, fund expansion, or pay renewal or development fees.
The owner-spouse’s personal efforts can create a reimbursement issue as well. Section 503(c)(2)(B) provides that personal effort devoted to nonmarital property “shall be deemed a contribution from the marital estate” if the efforts are significant and result in substantial appreciation of the nonmarital property. 750 ILCS 5/503(c)(2)(B). However, if the marital estate “reasonably has been compensated” for those efforts, there is no reimbursement. Id.
That can particularly matter in an owner-operated franchise. A spouse may enter the marriage owning one location and spend years expanding the business, increasing sales, and managing employees. The resulting appreciation remains nonmarital under Section 503(a)(7), subject to the reimbursement provisions of Section 503(c). 750 ILCS 5/503(a)(7). Accordingly, whether the marital estate was reasonably compensated for the owner-spouse’s efforts may become an important aspect of the analysis.
This is also a reason why reasonable owner compensation is important later when the franchise’s financial results are normalized for valuation.
A Franchise Is Not Worth A Percentage Of Gross Sales
In many cases, franchises are discussed in terms of gross sales, EBITDA, seller’s discretionary earnings, or industry multiples. Those measures can provide useful information, yet none independently establishes the fair market value of a franchise.
Rules of thumb may be helpful as a double-check, but BVR’s authors say that “you will never catch us advocating or relying on them.” Franchise Value: Valuation Methods and Benchmarking Data at 25. This is because rules of thumb can miss changes in location, brand strength, the franchise relationship or agreement, and the quality of the franchisor’s management. Id.
Illinois case law demonstrates this problem. In In re Marriage of Cutler, the wife’s expert valued a captive GEICO insurance agency under the market approach by applying a 1.3 multiple to gross revenues, even though the rule of thumb he relied upon was based on multiline agencies instead of a captive agency like Cutler. 334 Ill. App. 3d 731, 734 (2002). The GEICO agreement further provided that the agency did not own its renewals and could transfer the agency agreement only with GEICO’s written permission. Id. at 736.
The appellate court held that the expert’s rule of thumb was “clearly inapplicable to this situation” since it failed to account for contractual restrictions that “clearly have a significant negative impact on the fair market value” of the agency. Id. at 737. So, the court concluded that the expert’s valuation “was not supported by proper evidence.” Id. at 737.
This principle also applies to a franchise. An EBITDA or revenue multiple may provide a starting point or reasonableness check; however, the appraiser still must determine whether the multiple reflects the specific brand, location, contractual rights, expenses, risks, and transfer restrictions of the franchise being valued.
Franchise Revenue Is Not The Same As Franchisee Profit
Gross sales can be especially misleading in a franchise, as the franchisee does not keep every dollar generated at the location.
Royalties are one example. Royalties are often paid weekly or monthly and may be calculated on top-line revenue or gross income, even when the franchisee is not profitable. Franchise Value: Valuation Methods and Benchmarking Data at 13.
Advertising expenses can also separate sales from economic profit. In many cases, franchisees must contribute a portion of sales to advertising funds, and parts of those funds may support administrative expenses, national advertising, or efforts to attract new franchisees rather than directly promote the individual location. Federal Trade Commission, A Consumer’s Guide to Buying a Franchise, “Franchisor’s Advertising and Training (FDD Item 11).”
BVR similarly notes that a franchisee may have limited control over how advertising contributions are spent. Franchise Value: Valuation Methods and Benchmarking Data at 13.
Other necessary costs may include approved suppliers, leasehold improvements, equipment, technology, training, and operating requirements imposed by the franchisor. Federal Trade Commission, Franchise Fundamentals: Researching Franchise Opportunities (2023).
A buyer is therefore not obtaining the franchise’s gross sales. Rather, the buyer is obtaining the economic benefit expected to remain after the costs of operating within the franchise system.
What Factors Drive The Value Of A Franchise?
Franchise value is “the stream of expected profits from the current brand in the current market area.” Franchise Value: Valuation Methods and Benchmarking Data at 17. Put another way, the central valuation question is the expected future cash flow of the particular franchise business. Id.
This needs more than studying historical sales; BVR identifies factors like demand, seasonality, location, industry and local competition, the business’s life cycle, required capital, and the existing management team, together with franchise-specific considerations like royalties, marketing costs, expansion restrictions, contractual restrictions, and the franchisor’s stability. Id. at 17.
The Franchisor Creates Its Own Layer Of Risk
A franchisee can operate one location very well and nonetheless be impacted by decisions made outside the business.
BVR compares this exposure to key-customer risk since the franchisor is an outside entity with the ability to influence a major portion of the franchisee’s revenue and future growth. Id. at 18. So, changes in the franchise system, poor franchisor management, a decline in the brand, or financial instability at the franchisor level can impact an otherwise successful franchisee. Id.
On the other hand, the opposite can be true. A strong brand, advertising, training, established operating system, and market presence can reduce risks faced by a comparable independent business. Id. at 19-20. Thus, franchising alone is not necessarily a valuation discount or premium. The appraiser has to determine what risks and benefits the franchise system creates.
Location And Market Matter
The value of a franchise can depend massively on where it operates. Location, competition, market demand, and the business’s stage in its life cycle are all factors that impact expected cash flow. Id. at 17.
Brand recognition can vary by market, too. Established franchise systems may have existing multi-unit operators interested in acquiring additional locations, whereas a less established brand or a franchise entering a new territory may have a smaller ready market of buyers. Id. at 18-19.
Consequently, two locations operating under the same brand can have substantially different values because of demographics, traffic, lease economics, competition, local market acceptance, and the availability of qualified purchasers.
Required Capital Expenditures Can Reduce Value
Historical earnings also may not show the amount a purchaser will have to reinvest in the business.
Franchisors can require new layouts, remodels, equipment, technology, signage, or other improvements. BVR discusses a 25-location franchise transaction in which “deferred maintenance” became a significant valuation adjustment since some locations required substantial updates to meet the franchise system’s standards. Id. at 22.
Understanding Business Valuation likewise explains that a franchise agreement may require facility updates as branding changes, and the resulting capital investment should be incorporated into projected net cash flow. Understanding Business Valuation at 143.
So, a franchise earning $500,000 annually but facing a major mandatory remodel may not have the same value as an otherwise identical location that recently completed its necessary improvements.
Single-Unit And Multi-Unit Franchisees May Have Different Economics
The number of franchise locations can impact the economics of the business as well.
A single-unit franchise may depend on one location’s performance and the owner’s daily labor. A multi-unit franchisee may be able to spread administrative functions, management, and other costs across multiple locations. However, several locations also create additional leases, capital requirements, debt, and operating risk.
Some franchise operators reach a point where they must obtain multiple locations “just to have some economies of scale.” Franchise Value: Valuation Methods and Benchmarking Data at 23. Further, established operators with several locations can become natural purchasers when another location within the same system comes up for sale. Id. at 18.
Thus, the appraiser should not assume that four franchise locations are worth four times the value of one location. The valuation must consider the costs and benefits created by operating the units together.
A Franchise’s Financial Statements May Need To Be Normalized
Tax returns and financial statements report what happened historically. A business valuation tries to determine the economic performance that a hypothetical buyer could reasonably expect going forward.
Understanding Business Valuation discusses how normalization adjustments are meant to place financial information on an economic basis by taking away items that a willing buyer would not necessarily consider when evaluating future income or cash flow. Understanding Business Valuation at 198. The text groups common adjustments into comparability adjustments, nonoperating or nonrecurring adjustments, and discretionary adjustments. Id.
For a closely held franchise, discretionary adjustments may include “officer’s and owner’s compensation,” “owner’s perquisites,” “entertainment expenses,” “automobile expenses,” “compensation to family members,” and “rent expenses (if not an arm’s-length lease).” Id. at 202. Nonrecurring income or expenses may also require adjustment when they are not expected to affect the business going forward. Id.
Small-business records may need particular scrutiny in a divorce. Closely held businesses have a greater risk of personal and business expenses being commingled, so it is good practice to examine related-party remuneration, the business roles of family members, and expenses with a potential personal component. Tim Zimmerman & Antonina Wasowska, “Smaller, Not Simpler—Challenges with Litigation Engagements for Smaller Businesses,” Journal of Business Valuation 67, 70 (2021).
Normalization does not mean just adding back every expense the owner doesn’t want to pay. Staffing requirements, advertising contributions, required royalties, and other continuing obligations imposed by the franchise system usually impact the economics available to a hypothetical buyer and cannot be ignored simply because they reduce profit. Franchise Value: Valuation Methods and Benchmarking Data at 13.
Similarly, a one-time expense should not automatically be added back if it signals a recurring economic requirement. For instance, a remodel expense may seem unusual in one historical year; however, if periodic renovations are required by the franchise agreement, the appraiser nonetheless has to account for the expected future capital cost.
The point is not to make the franchise look more profitable. The point is to determine the sustainable economic earnings of the business.
Reasonable Owner Compensation Separates Labor From Ownership
Owner compensation particularly matters when the franchisee works in the business full time.
A closely held business owner can obtain money in two different capacities: compensation for working in the business and an economic return from owning the business. Understanding Business Valuation at 202.
Imagine that a franchise reports $350,000 of annual earnings before paying its owner. If the owner also works 50 hours per week as the location’s general manager, a hypothetical buyer may not necessarily receive a $350,000 return on investment. If replacing the owner’s managerial labor would require a $100,000 salary, that cost needs to be considered in determining the economic earnings attributable to ownership.
The owner-compensation adjustment attempts to restate earnings using the amount that would be required to hire someone qualified to perform the owner’s duties. Id. Considerations include education and experience, duties performed, hours worked, and geographic market. Id.
In Illinois, the distinction between future labor and existing business value is especially important. In In re Marriage of Frazier, the trial court valued a State Farm agency by reducing the owner’s projected future earnings to present value. 125 Ill. App. 3d 473, 476 (1984). The appellate court found a “fallacy” in using that method because, given the nature of the agency, the calculation “include[d] as marital property labor which will be performed after dissolution.” Id. at 476. The court reasoned that the owner could not “rest on his laurels and receive the future stream of commissions” because he would have to keep processing claims, servicing policies, advertising, and performing related work to retain the accounts. Id. at 476. The valuation did not reduce the agency’s value to account for that future activity, so it “effectively classified as marital property the results of the respondent’s future efforts” and produced a “grossly excessive valuation.” Id. at 477.
A franchise valuation should therefore distinguish the return generated by the existing business from compensation for labor that the owner, or a replacement manager, must keep performing.
How Is A Franchise Valued?
In Illinois, a fair-market-value standard is required when property is valued for division in divorce. 750 ILCS 5/503(k). The valuation date is the date of trial unless the parties agree to another date or the court selects another date within its discretion. Id.
There is not one valuation method that works for every franchise. In Cutler, the husband’s valuation expert testified that there were “three commonly accepted methods” for valuing a closely held business: the market approach, the income approach, and the asset approach. 334 Ill. App. 3d at 735. Cutler also demonstrates why the method must fit the particular business: the appellate court rejected a valuation that relied on a rule of thumb that was “clearly inapplicable to this situation” and failed to account for contractual restrictions that would substantially impact a hypothetical sale. Id. at 737.
The Asset Approach
Under the asset approach, the appraiser determines what the business owns, subtracts what it owes, and uses the resulting net asset value as the basis for valuation.
For a franchise, relevant assets may include cash, equipment, furniture and fixtures, inventory, receivables, leasehold interests, and other identifiable assets owned by the franchisee. Debt and other liabilities must be considered as well.
The asset approach can be particularly relevant when important earnings-producing rights are restricted or cannot be transferred. Cutler is an Illinois example. Using the asset approach, the husband’s expert valued the captive GEICO agency at $32,000, which he described as determining value by subtracting the business’s liabilities from its assets. Id. at 735. The agency did not own its renewals, and the GEICO agreement could be transferred only with GEICO’s written permission. Id. at 736. After the appellate court rejected the competing market and capitalized-returns valuations, it concluded that the $32,000 asset valuation was “the only properly proven value of the business” and directed that it be used in distributing the marital property. Id. at 738.
However, an asset approach can understate the value of a profitable franchise that is expected to continue as a going concern. A buyer may be willing to pay more than the value of the equipment and inventory because the buyer expects to obtain a continuing stream of economic benefits from the existing operation.
The Income Approach
The income approach focuses on the economic benefits the business is expected to produce.
BVR explains that franchise value reflects expected future cash flow from the current brand in the current market. Franchise Value: Valuation Methods and Benchmarking Data at 17.
For an older franchise with stable earnings, an appraiser may capitalize a representative level of normalized earnings or cash flow, whereas a discounted cash flow analysis may be more helpful when future results are expected to change due to identifiable events such as growth, remodels, or contract expiration. Franchise-specific risks must also be reflected in the analysis. Uncertainty from a franchise dispute may be incorporated through probability-weighted cash flows or an adjustment to the capitalization or discount rate. Id. at 22.
However, an income approach cannot merely capitalize the owner’s future labor. In Frazier, the appellate court rejected a valuation that included “as marital property labor which will be performed after dissolution.” 125 Ill. App. 3d at 476. The valuation didn’t account for the owner’s continuing post-divorce efforts; accordingly, the court held that it “effectively classified as marital property the results of the respondent’s future efforts” and produced a “grossly excessive valuation.” Id. at 477. Thus, normalized owner compensation and the distinction between labor and ownership particularly matter when valuing an actively managed franchise.
The Market Approach
The market approach estimates value by comparing the subject franchise to actual transactions that involve comparable businesses.
For franchises, identifying a genuinely comparable transaction can prove difficult. The best comparable transactions are sales involving the same franchisor, but franchisors may possess that information without making it readily available. Franchise Value: Valuation Methods and Benchmarking Data at 25-26.
Even a transaction involving the same kind of business may require major adjustment, as different franchises can have different territories, locations, profitability, franchisor relationships, royalty structures, transfer restrictions, remaining contractual terms, and remodel requirements. Additionally, franchise and nonfranchise businesses part of the same industry can trade at substantially different multiples. Id. at 26.
So, the market approach should ask more than whether another restaurant, gym, or service business was sold. The appraiser must determine whether the comparable transaction reflects sufficiently comparable economic and contractual rights.
A Revenue Or EBITDA Multiple Is Not A Complete Franchise Valuation
Actual buyers and sellers frequently discuss businesses in terms of revenue, EBITDA, or seller’s discretionary earnings. So, multiples can be helpful. However, a multiple cannot explain why one franchise deserves a higher or lower value than another.
BVR treats franchise rules of thumb as corroborative and not as methods on which the appraiser should simply rely. Id. at 25. The appropriate analysis still must account for location, brand strength, marketability, profitability, management, contractual terms, required capital expenditures, and the franchise system itself. Id.
Saying that a franchise is worth “six times EBITDA” or “a percentage of annual sales” does not end the valuation. The appraiser still has to explain why that multiple fits the franchise, under the agreement, in the market, with the earnings and risks.
Personal And Enterprise Goodwill In A Franchise
A franchise can have goodwill, yet the appraiser must determine whether that goodwill belongs to the business or depends on the continued efforts of the owner-spouse.
In Illinois, there is a distinction between personal and enterprise goodwill even outside professional practices. In In re Marriage of Talty, a case involving an automobile dealership, the Illinois Supreme Court explained that, “[t]o the extent that goodwill inheres in the business, existing independently of William’s personal efforts, and will outlast his involvement with the enterprise, it should be considered an asset of the business, and hence of the marriage.” 166 Ill. 2d 232, 240 (1995). In comparison, “to the extent that goodwill of the business is personal to William, depends on his efforts, and will cease when his involvement with the dealership ends, it should not be considered property.” Id.
From a valuation perspective, Understanding Business Valuation likewise distinguishes personal goodwill associated primarily with an individual from enterprise goodwill associated primarily with the business. Understanding Business Valuation at 826-27. Personal goodwill may arise from the owner’s “skills, knowledge, reputation, personality, and other factors” that cause customers to seek out that individual instead of the business itself. Id. at 827.
Because the franchisee does not own the franchisor’s national brand, a franchise presents an extra complication. BVR explains that “[t]he trademark and all other marketing intangibles are held at the franchisor level,” so valuing an individual location does not include valuing those franchisor-owned marketing intangibles. Franchise Value: Valuation Methods and Benchmarking Data at 9.
This does not mean the franchisee cannot possess enterprise goodwill or other transferable intangible value. The appraiser must separate the franchisor’s brand from the value that truly remains with the franchise business. Talty explains that enterprise goodwill is value that inheres in the business independently of the owner’s personal efforts and is expected to outlast the owner’s involvement. 166 Ill. 2d at 240. At the franchisee level, that can include value associated with an established location, transferable customer relationships, trained management, and a business organization capable of continuing after the owner leaves, while other value may reside separately in the contractual rights granted by the franchise agreement.
Strong historical profits by themselves do not establish transferable goodwill. A history of profitability “does not necessarily translate to transferable commercial goodwill.” Journal of Business Valuation at 67, 71. The appraiser should examine the owner’s role in producing revenue, whether the business has recurring revenue or owner-generated sales, whether another manager could step into the owner’s role, and whether an established management team can continue operating without the owner. Id. at 71-72.
In all, an owner-operated service franchise may possess more personal goodwill if customers or referral sources deal mainly with the owner. A franchise run by a management team, however, may have more value that survives after the owner departs. The central question is what economic value will remain with the business after the owner-spouse is gone.
Real Estate And The Franchise Business May Be Separate Assets
A franchise location and the real estate underneath it are not automatically the same asset.
A franchisee may operate from leased property, own the real estate within the operating entity, or hold the property through a separate LLC that leases it to the franchise business. When the real estate is not required to own the operating business, it is common to treat the property as a nonoperating asset, normalize the business’s earnings using fair-market rent, and value the operating business as though it rented its location. Understanding Business Valuation at 201-02. In that situation, “the real estate is a separate asset that should be valued apart from the operating entity.” Id. at 202.
This can be important when the franchisee leases property from an entity owned by the same spouse. Rent may be above or below market, affecting the reported profitability of the franchise. Understanding Business Valuation notes that non-arm’s-length rent is an item that may need a normalization adjustment. Id. at 202.
Thus, the appraiser should determine who owns the real estate, whether the franchise must operate from that location, whether the rent reflects market terms, and whether the property is already being valued separately as part of the marital estate.
A Buy-Sell Agreement May Answer A Different Valuation Question
A franchisee may own the business through a corporation, LLC, or partnership governed by an operating or buy-sell agreement that sets a redemption price or valuation formula. Yet that contractual price does not necessarily establish fair market value.
In In re Marriage of Gunn, the appellate court held that “a buy/sell agreement is not necessarily an indication of fair market value.” 233 Ill. App. 3d 165, 184 (1992). The agreement in the case provided a valuation formula upon death, disability, retirement, or termination; however, it did not address divorce. Id. at 182.
By contrast, the operating agreement in In re Marriage of Schlichting explicitly provided a valuation and buyout procedure “[i]n the event of a Member’s divorce.” 2014 IL App (2d) 140158, ¶ 7. The appellate court held that the trial court abused its discretion because it entered a property-distribution order that conflicted with that agreement when the agreement already provided a way of addressing the divorce valuation without violating its transfer restrictions. Id. ¶¶ 68-69.
Franchise cases demonstrate the same point. In Inzer v. Inzer, a case regarding a 24% interest in a Sonic franchise, the operating agreement contained a strict buy-sell provision, and the nonowner spouse had signed an acknowledgment referencing the franchise’s repurchase rights. Business Valuation Resources, Business Valuation in Divorce Case Law Compendium 390-92 (5th ed. 2020). Inzer is not an Illinois authority, but it shows why the language of the agreement and who agreed to it can be important.
The attorney and appraiser should therefore determine what event the buy-sell provision covers, how the provision’s valuation formula works, and how the provision interacts with the franchise agreement’s transfer restrictions. A contractual redemption price may answer a different question from the fair market value required under Section 503(k).
What Records Are Needed To Value A Franchise?
A franchise valuation depends on more than tax returns.
Understanding Business Valuation advises acquiring several years of financial statements and corresponding tax returns, together with interim financial statements and available forecasts or projections. Understanding Business Valuation at 127-28. Additionally, tax returns may reveal related subsidiaries, entities, or cost-sharing arrangements that require more investigation. Id.
A franchise requires additional records, as essential economic rights and obligations may not appear on the balance sheet. The franchise agreement and its amendments, current and historical FDDs, debt documents, transfer or renewal notices, leases, development or territory agreements, royalty and advertising records, required remodel or capital-expenditure notices, and any communications involving defaults or disputes with the franchisor may all impact value.
BVR identifies the FDD and franchise agreement as legal documents having a major impact on franchise value, while the franchise agreement and operating materials may govern royalties, marketing, accounting, recordkeeping, budgeting, and other operational requirements. Franchise Value: Valuation Methods and Benchmarking Data at 10-14.
The appraiser should further acquire records that allow the reported financial results to be tested, which includes payroll and owner-compensation records, general ledgers, bank or merchant records where appropriate, and related-party transaction documents. Closely held businesses may have inconsistent or incomplete records, such as tax returns that do not reconcile with financial statements or internal profit-and-loss reports. Journal of Business Valuation at 69. When records are missing, bank statements, receipts, invoices, third-party information, or other supporting documents may help reconstruct the financial picture. Id.
For a franchise, these records are useful for determining not only what the business earned, but also whether those earnings are sustainable and transferable to a potential buyer.
The Appraiser Must Avoid Double Counting
A franchise valuation should count each economic asset and benefit only once.
Illinois’s concern with double counting is particularly important when personal goodwill is involved. Talty held that the concern over duplication under Section 503(d) is limited to personal goodwill attributable to the owner; it does not extend to enterprise goodwill that exists independently of that individual. 166 Ill. 2d at 239-40.
In In re Marriage of Schneider, the Illinois Supreme Court similarly held that, where the owner’s personal goodwill had already been considered under the Section 503(d) factors in dividing the marital estate, “[a]ny further consideration of that goodwill in valuing Earl’s dental practice would amount to an impermissible double counting.” 214 Ill. 2d at 167.
A valuation can also duplicate value within the actual appraisal. Understanding Business Valuation describes a process where the whole enterprise is valued and then its value is allocated among tangible assets, identifiable intangible assets, and residual goodwill. Understanding Business Valuation at 826. This allocation matters for a franchise, as contractual rights under the franchise agreement should not be valued once as an identifiable intangible and then counted again as goodwill.
This problem may arise with real estate. If separately owned property is valued outside the operating franchise and the franchise’s earnings are normalized using fair-market rent, the value of that real estate should not also stay embedded in the franchise valuation. Understanding Business Valuation at 201-02. Similarly, cash, equipment, debt, or other assets and liabilities should not be added or subtracted a second time if the selected valuation method already accounts for them.
How Is A Franchise Actually Divided In An Illinois Divorce?
Valuing a franchise does not mean the business must be sold or actually divided between the spouses. Under Section 503(d), an Illinois court must divide marital property “in just proportions considering all relevant factors,” which includes the parties’ economic circumstances, future opportunities to acquire assets and income, and the tax consequences of the division. 750 ILCS 5/503(d), (d)(5), (10)-(12).
It may prove impractical to have a continued joint ownership of a closely held business after divorce. In Schlichting, the appellate court underscored the need for “a high degree of finality” in dividing marital property and recognized that divorcing spouses “might be unable to work together in a continued business association.” 2014 IL App (2d) ¶ 61. When a business is not susceptible to division in kind, the court is able to award it to one spouse and compensate the other with cash or an offset of other marital property. Id. ¶ 73.
That approach can make a lot of sense for a franchise since the nonowner spouse may not be qualified to become the franchisee. In Illinois, the law recognizes that a franchisor may “approve or disapprove a different franchisee” and may impose a reasonable transfer fee or require a new franchise agreement. 815 ILCS 705/7.
So, a practical result may be for the operating spouse to keep the franchise while the other spouse obtains other property or an equalizing payment. Still, the court should consider the franchise’s debt, liquidity, required capital expenditures, contractual transfer restrictions, and tax consequences in structuring the award. 750 ILCS 5/503(d)(5), (12).
The Bottom Line When Valuing and Dividing A Franchise In An Illinois Divorce
What is a franchise worth in an Illinois divorce? This answer cannot be determined merely by multiplying annual sales, EBITDA, or seller’s discretionary earnings by an industry multiple. The analysis begins with identifying the spouse’s ownership interest, reviewing the franchise agreement and Franchise Disclosure Document, figuring out the remaining contractual term and renewal rights, evaluating transfer and territorial restrictions, and classifying the interest as marital or nonmarital property. In Illinois, courts use a fair-market-value standard; however, the proper valuation method depends on the economic and contractual characteristics of the particular franchise.
Next, the appraiser must determine the sustainable economic earnings of the business. The analysis may require normalizing owner compensation and other expenses, considering royalties and advertising obligations, evaluating required capital expenditures, examining the strength and stability of the franchisor, and determining whether the business depends on the owner’s continuing labor.
Additionally, the appraiser should distinguish the franchisor’s brand from value belonging to the franchisee, separate personal from enterprise goodwill, and account for real estate, buy-sell agreements, transfer restrictions, and other assets or liabilities. An asset, income, or market approach may be proper, yet the methodology must reflect what the franchisee truly owns and what a potential purchaser could realistically obtain.
Valuation is only one aspect of the divorce analysis. The court must translate the marital value of the franchise into an equitable division of property while considering debt, liquidity, required capital expenditures, contractual transfer restrictions, and tax consequences. The franchisor or an operating agreement may restrict who can own the business, so a solution may be for the operating spouse to keep the franchise while the other spouse obtains other marital property, cash, an equalizing payment, or another award reflecting the marital value of the business.
Russell D. Knight is a Chicago divorce and family law attorney who has practiced family law since 2006. His Chicago practice focuses on Illinois divorce and family law, including the business and financial issues that arise when dividing closely held businesses and other difficult-to-value marital assets.
CASES, STATUTES, AND OTHER SOURCES REFERENCED IN THE FRANCHISE VALUATION AND DIVORCE IN ILLINOIS ARTICLE
815 ILCS 705/3(1) — Definition Of A Franchise Under The Illinois Franchise Disclosure Act.
815 ILCS 705/5(2) — Delivery Of The Franchise Disclosure Statement And Proposed Agreements At Least 14 Days Before Execution Or Payment.
815 ILCS 705/7 — Franchise Transfers, Franchisor Approval, Reasonable Transfer Fees, And New Franchise Agreements.
815 ILCS 705/16 — Form And Contents Of The Franchise Disclosure Statement And Compliance With The FTC Franchise Rule.
815 ILCS 705/19 — Termination Of An Illinois Franchise And The “Good Cause” Requirement.
815 ILCS 705/20 — Franchise Nonrenewal And, In Specified Circumstances, Compensation For Diminution In The Value Of The Franchised Business.
750 ILCS 5/503(a), (b)(1) — Definition And Presumption Of Marital Property.
750 ILCS 5/503(a)(1), (2), (6), (7) — Gifts, Property Acquired In Exchange For Nonmarital Property, Premarital Property, And Appreciation Of Nonmarital Property.
750 ILCS 5/503(c)(2)(A)–(B) — Reimbursement For Contributions And Personal Effort Between Marital And Nonmarital Estates.
750 ILCS 5/503(d) — Factors Governing The Division Of Marital Property.
750 ILCS 5/503(k) — Fair-Market-Value Standard And Valuation Date.
16 C.F.R. Part 436 And § 436.5(q), (s), (t) — FTC Franchise Rule And FDD Items 17, 19, And 20.
In re Marriage of Roepenack, 2012 IL App (3d) 110198 — Illinois Divorce Involving Corporations Consisting Of Jimmy John’s Franchises Acquired During The Marriage.
In re Marriage of Cutler, 334 Ill. App. 3d 731 (5th Dist. 2002) — Fair Market Value, Contractual Restrictions, Transferability, Rules Of Thumb, And The Asset Approach.
In re Marriage of Frazier, 125 Ill. App. 3d 473 (5th Dist. 1984) — Capitalization Of Earnings And The Improper Inclusion Of The Owner’s Post-Divorce Labor In Marital Value.
In re Marriage of Talty, 166 Ill. 2d 232 (1995) — Personal Versus Enterprise Goodwill And The Treatment Of Goodwill In A Nonprofessional Business.
In re Marriage of Schlichting, 2014 IL App (2d) 140158 — Divorce-Specific Operating Agreements, Transfer Restrictions, Business Interests, And Cash Or Property Offsets.
In re Marriage of Schneider, 214 Ill. 2d 152 (2005) — Personal Goodwill And Impermissible Double Counting In Business Valuation.
Inzer v. Inzer, No. M2008-00222-COA-R3-CV, 2009 WL 2263818 (Tenn. Ct. App. July 28, 2009) — Sonic Franchise Interest And The Effect Of A Contractual Buy-Sell Provision.
Federal Trade Commission, A Consumer’s Guide to Buying a Franchise — Franchise Costs, Royalties, Advertising, Franchisor Controls, And FDD Disclosures.
Federal Trade Commission, Franchise Fundamentals: Taking a Deep Dive Into the Franchise Disclosure Document (2023)— FDD Items 17, 19, 20, And Other Franchise-System Information.
Federal Trade Commission, Franchise Fundamentals: Researching Franchise Opportunities (2023) — Franchise Costs, Leasehold Improvements, Equipment, Training, Royalties, And Other Economic Obligations.
Business Valuation Resources, Franchise Value: Valuation Methods and Benchmarking Data (2016).
Gary R. Trugman, Understanding Business Valuation (6th ed. 2022).
Business Valuation Resources, Business Valuation in Divorce Case Law Compendium (5th ed. 2020).
Tim Zimmerman & Antonina Wasowska, “Smaller, Not Simpler—Challenges with Litigation Engagements for Smaller Businesses,” Journal of Business Valuation 65 (2021).
FREQUENTLY ASKED QUESTIONS ABOUT FRANCHISE VALUATION AND DIVORCE IN ILLINOIS
Is A Franchise Interest Marital Property In An Illinois Divorce? An interest acquired during the marriage is typically presumed marital. A premarital franchise or an interest acquired by gift, inheritance, or other qualifying nonmarital property may remain nonmarital; however, reimbursement claims may arise.
How Is A Franchise Valued In An Illinois Divorce? Illinois courts apply a fair-market-value standard. An appraiser may use the asset, income, or market approach after considering the franchise agreement, transfer restrictions, required expenses, earnings, remaining term, and other franchise-specific risks.
Does The Franchise Agreement Affect The Value Of The Business? Yes; the agreement may control territory, royalties, renewal rights, transfer approval, required capital expenditures, operating restrictions, and other rights that affect what a hypothetical buyer could obtain.
Can A Revenue Or EBITDA Multiple Determine A Franchise’s Value? Not alone; multiples may provide helpful market evidence or a reasonableness check. However, the appraiser must determine whether the selected multiple reflects the particular franchise’s brand, location, profitability, contractual rights, risks, and marketability.
Is Goodwill Included In The Value Of A Franchise? Enterprise goodwill may be included if it belongs to the continuing business and survives the owner leaving the business. Personal goodwill tied to the owner-spouse’s reputation, relationships, skills, or future efforts is treated differently.
