Latest / Franchise Conversations with Fexingo: Buying, Running, and Scaling Franchise Businesses / Franchisees Use Leasehold Improvements to Boost Valuation
Transcript
- Lucas: You know, there's a moment every franchisee faces — usually about two years before they want to sell — when they look around at their units and think, should I put money into this place, or just let the next guy deal with it? Luna: Right, and the instinct is often to coast. Why spend your own cash on improvements you won't enjoy? Lucas: Exactly. But I've been looking at data from a recent franchise resale in Florida — a multi-unit Subway operator who went the other direction. He invested about $150,000 across three stores in energy-efficient HVAC, LED lighting, and a modernized kitchen layout. Luna: And what happened? Did he get it back? Lucas: He got it back and then some. The units sold for a 22% higher EBITDA multiple than comparable Subway stores in the same market. We're talking about an extra $300,000 in sale price on a $1.3 million deal. Luna: So that's a 2-to-1 return just on the improvements alone. But I imagine the math isn't always that clean. Lucas: It's not. And that's what I want to dig into today — when do leasehold improvements actually boost valuation, and when are they just flushing money down the drain? Luna: Let's start with the basics. What counts as a 'leasehold improvement' in franchise context? Lucas: Broadly, it's any physical change to the leased space that stays when you leave — new flooring, HVAC, kitchen equipment that's bolted down, updated signage, reconfigured counters. The franchisor often mandates some of these through remodel cycles, but the smart money is on voluntary upgrades that improve efficiency or customer experience. Luna: And those are the ones that can move the valuation needle, because a buyer looks at a store and sees either a capital expenditure they'll have to make, or one that's already done. Lucas: Precisely. The Florida Subway operator targeted exactly three categories: energy costs, labor efficiency, and brand freshness. The HVAC and LED lighting cut his utility bills by 18% across the three stores. That flows straight to the bottom line, and since valuation is based on EBITDA, a $15,000 annual savings capitalized at a 6x multiple is worth $90,000 in enterprise value. Luna: But that's still less than the $150,000 he spent. So the big driver must have been the multiple expansion. Lucas: Exactly. The market for franchise resales is not purely rational. Buyers pay a premium for turnkey operations. They don't want to deal with a 15-year-old HVAC that could fail next summer. By modernizing, he signaled low risk. The multiple went from 5.2x to 6.4x — that's 22%. Luna: So the key is to pick improvements that a buyer would otherwise discount the price for. But how do you know what those are? Lucas: Talk to a broker who specializes in franchise resales in your segment. They'll tell you the common deal-breakers. In quick-service restaurants, it's often the exhaust hood, the walk-in cooler, and the point of sale system. In retail, it's flooring, lighting, and the bathroom condition. Luna: And timing matters too. If you're planning to sell in three years, you want to do improvements in year one or two so you capture the savings and the buyer sees a track record. Lucas: That's exactly what this Subway operator did. He made the improvements 18 months before listing. That gave him time to show 12 months of lower utility costs and higher customer satisfaction scores on the franchisor's satisfaction survey. Luna: Were there any improvements he did that didn't pay off? Lucas: He told me he upgraded the seating area with nicer tables and chairs — cost about $12,000. Buyers didn't care. They said it was nice but not a factor in their offer. So that was wasted money from a valuation standpoint. Luna: That's a great lesson. Not all improvements are created equal. The ones that boost efficiency or reduce risk matter more than cosmetic upgrades. Lucas: And there's a bigger strategic question: should you even do improvements if your lease is expiring in five years? Because if you can't get a renewal, you're essentially donating the improvements to the landlord. Luna: That's the dark side of leasehold improvements. You're adding value to a space you don't own. Lucas: Right. So before you spend a dime, you need to negotiate a lease extension that aligns with your exit timeline. Ideally, you want at least 10 years remaining on the lease at the time of sale. That gives the buyer confidence they'll recoup the investment. Luna: So the sequence is: first secure the lease, then make the improvements, then sell. Not the other way around. Lucas: Exactly. And there's another layer: some franchisors have co-op marketing funds or rebate programs for approved vendors. This Subway operator used the franchisor's approved HVAC vendor and got a $5,000 rebate per store. That brought his net cost down to $135,000. Luna: So he effectively got a 3.3x return on his net investment if you include both the utility savings and the multiple expansion. Lucas: Roughly. And that's the kind of math that makes franchisees take notice. But I want to be clear: this strategy only works if you're planning to sell. If you're in it for the long haul, the calculus is different. Luna: We've talked about the win. What are the biggest mistakes you see franchisees make? Lucas: Over-improving for the brand tier. If you're a Subway, you don't need a $50,000 custom millwork package. Buyers of quick-service franchises expect functional, clean, and efficient. They're not looking for a five-star dining experience. That's a mistake that can actually hurt valuation because the buyer thinks you overcapitalized. Luna: So there's a Goldilocks zone. Enough to signal low maintenance risk, but not so much that you're pricing yourself out of the market. Lucas: And one more thing: don't forget to document everything. Save invoices, before and after photos, utility bill comparisons. When you list the business, you want to present a narrative of a well-maintained, improved asset. Buyers love seeing that you took care of the place. Luna: That's also helpful for the broker. They can use those materials in the offering memorandum. Lucas: Exactly. So let's talk about a specific number. If you're a franchisee with three to five units and you're thinking of selling in the next three years, what should you budget for improvements? Luna: I'd say look at your unit-level economics. If your EBITDA margin is below 15%, improving efficiency should be priority one. If it's above 20%, you might focus more on risk reduction — HVAC, roof, parking lot. Lucas: Good rule of thumb. And a typical target is 5 to 10 percent of annual revenue per unit for a mid-cycle refresh. So if a store does $600,000 a year, that's $30,000 to $60,000. But you don't have to spend it all at once. Spread it over two years. Luna: And if you're a single-unit owner with a small budget, what's the highest-impact, lowest-cost improvement? Lucas: LED lighting. It's cheap, pays for itself in under a year through energy savings, and makes the space look brighter and cleaner. Plus it's a clear signal to buyers that you're on top of maintenance. Luna: And it's not disruptive to operations. You can do it overnight. Lucas: Right. So if you're a franchisee listening and you're thinking about an exit, start with the lighting audit. Then move to the HVAC. Then look at the lease. Luna: Before we wrap, I want to touch on one more thing: taxes. Are these improvements deductible or do they have to be capitalized? Lucas: Generally, leasehold improvements are capitalized and depreciated over 15 years under MACRS, but there are nuances. The Tax Cuts and Jobs Act allowed bonus depreciation for qualified improvement property, but that's been phasing out. As of 2026, I think it's at 40% bonus, but you need to check with your CPA. The point is, you can get a tax benefit that improves your cash flow in the years after the improvement. Luna: So the math gets even better when you factor in the tax shield. Lucas: Exactly. And if you time the improvements right, you can use the tax savings to fund part of the next project. Luna: This has been a really practical episode. I think a lot of franchisees overlook this strategy because they're focused on revenue growth rather than asset value. Lucas: And that's the shift we want people to make. You're not just running a business; you're building an asset. And assets need to be maintained and upgraded to hold their value. If today's episode helped you think about your own units a little differently, that's the goal. Luna: And if you found value in these conversations, they stay ad-free because of listener support. If you'd like to help keep it that way, you can find us at buy me a coffee dot com slash fexingo. No pressure, just a simple way to say this content matters to you. Lucas: Yeah, and it really does make a difference. Thanks to those who already have. Now, back to the numbers: let's talk about one more case study — a franchisee in the cleaning space who used leasehold improvements to flip a struggling unit into a top performer. Luna: I want to hear this. What did they do? Lucas: It was a Jan-Pro franchisee in Atlanta. He had a commercial cleaning contract that required him to store equipment on-site at the client's building. He invested $8,000 in a secure, organized storage room with proper shelving and ventilation. That improvement allowed him to win a larger contract worth $60,000 annually. The valuation impact? At a 5x multiple, that's $300,000 in added enterprise value from an $8,000 investment. Luna: So it's not always about the storefront. It's about improving the operational efficiency that the buyer sees as future cash flow. Lucas: Exactly. And that's the unifying principle. Every dollar you spend should be traceable to either higher revenue, lower costs, or lower risk. If it doesn't do one of those three, skip it. Luna: Great framework. I think our listeners can take that and apply it to their own situation today. Lucas: Thanks for listening. We'll be back next week with another angle on running your franchise better.