Do you want to sell your restaurant? If YES, here are 5 smart ways to value your restaurant business for sale and 5 factors to consider before selling.
Valuing a restaurant business involves understanding and finding a crucial balance between the needs of the owner and seller based on the restaurant’s assets and track record. The assigned value should incorporate the amount of money the restaurant earns as well as how much it owns.
It is also expected to reflect on other factors that grow or reduce value such as whether it has established name recognition, a beneficial lease, or effective systems that allow the owner to make profit without working too hard. It’s very important to note that the more money a restaurant earns, the more it is worth.
Preliminary Check for Selling your Restaurant
Buyers always want to know that they can earn a living and receive a substantial return on their investment. That is why to calculate a business value based on your bottom line, start with your net income on your most recent profit and loss statement.
Add the amount of any expenditures that are specifically linked to your personal ownership of the business, such as interest payments on business loans. The typical restaurant will be valued at one to three times this adjusted net income, depending on other factors such as the likelihood of a new owner being able to sustain the current level of sales and profit.
Restaurant businesses also tend to own equipment and furnishings that add to their value. It’s very crucial also to list everything that the business owns, such as kitchen fixtures, plate ware, and tables and chairs. Assign a value to each item, and adjust this value based on how long it has been owned and how you have chosen to depreciate it on your tax returns.
Lease value is also a very necessary ingredient in a restaurant sale price. The success of many restaurants depend on their locations, and restaurateurs often invest hefty sums in leasehold upgrades such as expensive kitchen ventilation systems.
Restaurants succeed and fail because of many intangible factors such as the personal connection an owner makes with the clientele and the consistent quality of the food and service. Note that it can be tricky to place a monetary value on these considerations, but they certainly affect the value of the restaurant.
If the success of the restaurant depends on the personality and talent of a specific individual, then it will be worth less once this individual no longer owns it. If, however, the restaurant’s success depends on systems that will survive a change of hands, then it is worth more.
5 Factors to Consider When Valuing a Restaurant Business
Once you do choose to sell your restaurant, give up a share of ownership (or equity) to an investor, or are approached by someone who wants to make you an offer for your business, it’s very critical you understand just what your restaurant is worth – and that’s why you should value your restaurant. Have it in mind there are so many things potential buyers and investors will look into before they put out a check. Here are just a few of them.
- Cost of Assets/Equipment
Restaurants are known to carry different types of equipment. If someone buys your business, are they also buying this equipment or just the name? If they are buying the equipment, is it all paid for, or are some of the larger equipment being leased or rented?
Note that these also ties in to liquidation valuation, since when it comes down to it, the assets is the only guaranteed worth of the business. After all, you can buy a pizzeria with the world’s best oven included, but if you don’t have a good pizza cook on your team, that oven will only generate its market worth when you sell it after you go out of business.
- Customer Loyalty
A lot of restaurant owners make a point to know their customers. Some restaurants also have well-known chefs behind the scenes. When a restaurant is acquired, one or both of these individuals may be out the door – as could be the customers they bring in.
That is why before determining a restaurant’s worth, find out if the customers are loyal to the brand or the people behind it. If all the business’ regulars disappear when the ownership papers are transferred, the initial valuation goes out the window.
Have it in mind that the state of the economy and the market can have a very huge impact on the valuation of your business. If the economy is down and the deal is over a high-end restaurant, chances are the sales aren’t going to skyrocket overnight, meaning the restaurant could be worth less than it once was or could be. As always, this is a risk one would face when buying or selling any business, and this can be frustrating since this is mostly out of your control.
- Age of the Business
Note that if the business is a relatively new business but has been performing well, this could entice an investor or a business buyer into getting in on the ground floor. But, it can be just as scary to other investors who may see your restaurant as a fad instead. Ultimately, when it comes to the age of the business, investors want to know how much your business will grow, whether or not it will stay consistent, and if it’s doomed for failure.
- Experience/Expertise of the Investor
Let’s imagine that one investor offers you an equity deal of $200,000 for 20% – a $1 million valuation. Another potential investor offers you $200,000 for 25% – only an $800,000 valuation. At a first glance, you may want to side with the first investor.
That’s because you will keep more equity and control. However, while the second deal leaves you with less ownership of the restaurant, it does not necessarily devalue your company – at least not in the way that you think it will.
Maybe the second bidder has years of experience growing restaurant businesses. Would you be more likely to accept the offer then? Now you must decide if your 80% retained from partnering with the first investor will be more in the long run than 75% with the second investor.
But if the second investor has the potential to grow your business more than the first investor, your slice of the pie would be comparatively smaller – but you’d have a much larger pie. In other words, 75% of a billion dollar company is much more than 80% of a million dollar company.
5 Smart Ways to Quickly Value a Restaurant Business for Sale
Indeed, there are many methods to value a business or a restaurant. Although the factors briefly explained above play a role in any negotiation, there are several technical methods financial experts will leverage to come up with what they believe to be a fair deal. Below are the most common business valuation methods that restaurateurs should consider first.
- Income Valuation Method
This particular approach looks at how much income a business will generate for its owners. Needless to say – the higher the projected income, the higher valuation a business tends to be given. There are two ways to use the income valuation method to understand a restaurant’s worth. One is Multiple of Discretionary Earnings and the other is Discounted Cash Flow.
Of these two, most experts advice you stick with the multiple method, as it’s a better fit for smaller businesses. The multiple method is an accurate representation of a company’s worth at one time to make an educated estimate of its worth in the future. Because of that, it’s simple enough to find this number and apply it in the valuation process.
But note that due to this number being more of a simplified snapshot of what the restaurant’s worth will be, the multiple method can be less-than-reliable, especially when external forces like the economy come into play. The number is also the trajectory of a business based on it’s current performance, and so a change of hands in leadership could also change the valuation.
- Going Concern Method of Valuation
This valuation method normally means that the business is making money and when the buyer buys a going concern business, they usually want to operate the business the same way the seller did and maintain the name, menu, operating systems and personnel in place.
With this method, the lease, leasehold improvements, fixtures and equipment, name, menu, concept, goodwill and cash flow are all included as part of the sale. Have it in mind that the key valuation method used for a Going Concern Valuation is the yearly adjusted cash flow method which is also referred to as discretionary earnings.
Its simply means that the net profit on the tax return or on the year-to-date income and expense statement is adjusted by adding back the following items to the net income: one working owners salary and payroll taxes, any personal expenses the owner is charging the business (food for consumption at home, life, health and disability insurance premiums, auto expense, entertainment and vacation expense, etc.), depreciation, interest and amortization expense on any loans the buyer will not be assuming.
Also note that any extraordinary expense and or non-reoccurring expenses such as extra legal or accounting bills related to a particular lawsuit or unusual situation would be added back to the net income too. Meanwhile, once the yearly adjusted cash flow is determined, a sales price multiplier will be leveraged to ascertain the value of the business.
The sales price multiplier for independently owned, non-chain, non franchised food service operations will vary from one to three times yearly adjusted cash flow depending on the risk factors and other factors listed below. Your risk factor is determined by the following criteria:
- The degree of difficulty in operating the business, i.e. an espresso operation has a low degree of difficulty as it is an easy operation to run but an upscale dinner house operation has a high degree of difficulty because it needs a high degree of expertise and sophistication to run this type of business successfully
- How long the business has been in business and the past history of the business in terms of profitability and sales growth.
- The lease value, (whether the lease is at market, below market or above market and the length of the lease),
- The potential upside of the business (i.e. a business currently serves dinner only and has only a beer and wine license and there is potential for a strong lunch and/or brunch business and hard liquor sales)
- The future growth opportunities of a particular location (i.e. if there are some major new development(s) that will add new potential customers to the area without a lot of extraordinary new competition).
- Asset Valuation Method
We can all agree that sometimes it’s just time to call it quits. If a restaurant had a bad publicity scare it could not recover from or if years of poor service resulted in no loyal customers, a restaurant may be worth nothing. But the material in the restaurant could be worth more.
This particular valuation method just looks at the worth of a restaurant based on its assets and minus its liabilities. If all the tangible assets a business owns equate to $70,000, that is the asset-based valuation for the business.
This valuation method is relatively straightforward and tends to be the lowest a business is worth. In the end, if an investor tries to revamp the restaurant, but to no avail, they could theoretically break even on their investment by selling the supplies one-off. It’s also an easy way for a new owner to enter the industry due to low acquisition cost of used materials.
For the seller, this is essentially throwing in the towel and acknowledging your business failed. And for the buyer, it’s an uphill battle for re-branding and rebuilding. Neither of these hindrances can be seen as “unfair,” but it’s very crucial to know both parties aren’t getting any extra benefit from this deal – just the bare bones.
- Location Overview Valuation Method
We all know that choosing the right restaurant location is one of the most important factors in contributing to one’s success in the business. The restaurant business is very daunting and hard to be successful in and having a strong location will surely boost your chances for success. The key factors to consider in choosing the proper location which are discussed in detail below are as follows:
- Strong visibility and easy access – Have it in mind that strong visibility means that the business is easily visible to pedestrian and vehicular traffic and easy access means it is easy to get to the location by either foot traffic or vehicular traffic.
- Heavy pedestrian and vehicular traffic – With these two qualities the business will have more exposure and have a greater opportunity to increase sales.
- Built out market – To succeed in this business, you will want to locate in an area that has combination of commercial businesses and residential population built out. If you locate in an area with a lot of open space, you will be vulnerable to have new head on competition versus being in an area that is already built out.
- Major market generators – Strong traffic generators include hospitals, theaters, colleges, shopping centers and tourist attractions.
- Rent Affordability – This means that you can afford the rent you will be paying. Frequent operators pay more rent than they should and this can contribute to them going out of business. Restaurant operators should not pay more than 6% to 8% of their sales in rent.
This 6% to 8% factor also includes any additional costs you may be paying the landlord which may include real estate taxes, fire insurance and CAM charges (common area maintenance costs) which include security, gardening, common area utilities and maintenance costs, etc. This means that if you are doing $600,000 in yearly sales your rent should be no more than $48,000 ($600,000 sales x 8% = $48,000) in yearly rent.
- Stable demographics – Note that having a solid demographic base of long term well educated residents grounded with a strong commercial base of businesses and office tenants in the area is important.
- Growth potential – Even though you want to be in a well built out area, it is always helpful to be in an area where there is opportunity for existing commercial businesses to expand.
- Diversified clientele – It is helpful to have a mix of residents, commercial activity, including retail businesses and offices buildings as well as hospitals, schools and religious institutions in the area.
- Trade Area Draw – This is the distance an average customer will travel to come to your restaurant. Most neighborhood restaurants draw customers from a one mile radius of the site.
- Market Valuation Method
Like its name alludes to, the market valuation method is a subjective approach where a company is valued based on what it would be worth in the open and competitive market. Note that for smaller restaurants, this number can be based on what other restaurants have recently sold for in the area or with the same concept.
Two fast casual restaurants might have all of the same assets, but if one is by an office complex and one is on a road inaccessible from the interstate, you can bet one will be worth more than the other. But for larger restaurants, the number can be based off stock performance of other enterprises and how the stock market is behaving.
Note that if both parties go into a negotiation with the same knowledge, this can result in a pretty fair and mutually beneficial deal for everyone. But if a larger investment firm or conglomerate company goes in with more experience in interpreting and/or manipulating these numbers, they can negotiate under the guise of the market-based approach and strike a better deal for themselves.
Whether you’re buying or selling a restaurant business, it’s very advisable to try out a few of these methods to understand the price floor and ceiling you should consider. Have it in mind that every restaurant is different, and therefore, the valuation will vary based on countless considerations.
Internal factors such as sales, profit margins, and customer loyalty, and external factors like the market and the economy impact the history and the future of sales performance. But before you start making financial commitments, go over all of these aspects and consider consulting a financial professional to make sure the sale is fair and the deal will be beneficial to both parties.