What’s it worth? What am I willing to pay? How much do I think I can get?? These are the age-old questions that revolve around almost everything we do. In most cases the value of something is based upon a comparative analysis. It’s easy to compare the price of a case of tomatoes or 10 lbs. of ground round between vendors as they are basic commodities. You have a preconceived notion of their value and use that as your starting point before looking at additional value propositions.
The value of business is a blend of numbers and qualitative influences. There needs to be a meeting of the minds on the measurable benefits giving value for the buyer and seller. The best description I have ever heard is that “value is a mutually agreed upon hallucination”. Two parties need to come to a mutually agreed upon position in order to make a transaction work.
Is a one bedroom apartment on the Upper West Side worth $1.1MM?? Not for me, but there are hundreds of them sold yearly. Does a $20,000 diamond – just a rock make any sense? If you really think about it, these are both totally illogical aren’t they? So why do they sell? Why will someone buy?
To break the spell on the restaurant value mystique you need a logical starting point for value – buyers and sellers need to craft a “win / win” transaction or it will never happen.
“Fair market value” is often based upon a multiple of annual earnings often measured before taxes, interest depreciation and amortization or “EBITDA”. In the restaurant business it is VERY rare for an individual owner to report their earnings accurately so this number is often illusive. The owners job is to find ways NOT to show earnings and lower their tax exposure.
Over all the years that I bought, sold and brokered over a hundred restaurants and I came up with a simplified way to place a value on a restaurant. Others have their own formulas, but this has worked for me.
To determine that starting point, I use the average annual reported sales then calculate a purchase price between 20 and 40% of that number. This valuation adjusts depending on a number of important variables. Among them are:
- Quality of location, visibility, parking, facility, equipment.
- Favorability of lease – you will be stuck with this for a long time!
- Sellers willingness to finance – “hold paper”.
- Sellers eagerness to sell.
- Brand Equity – a good reputation that can be continued – or not.
- Existence of external influences that could add or detract from the restaurant’s value like being downwind of a sewage treatment plant!
Dave’s Quickie Restaurant Valuation:
- Get the last three years of sales from tax returns. Don’t accept claims of cash “under the table”. If it isn’t reported – it doesn’t count. Calculate the average annual revenue and then calculate 30% of that number. Your starting point.
- Dig into the lease which is your primary fixed cost:
- Is rent below the current per square foot cost for restaurants in the area? Add 2 – 3% if yes, or subtract 2 – 3% if not.
- Are there 10 years or more remaining on the lease with favorable increases – if so add 5%. If escalations are high subtract 5%.
- Are there less then 5 years remaining on the lease? If so subtract 10% or just walk away.
- Are renewal options at “fair market value” or “current market value” at time of renewal? If so add 0%, as they are worthless.
- Is “Assignment of the lease not to be unreasonably withheld”stated? If so add 2 – 3%. But if not you might not be able to sell the restaurant without the landlord owning you. If no favorable assignment clause- RUN away!
- Is total occupancy cost (rent, taxes, common charges and insurance) below 7% of the average annual sales? If so, add 2 – 3%. If not subtract 2 – 3%. Over 15% walk away.
- Realistically rate the condition of the facility, equipment, furniture and fixtures. If you can use FF&E in good condition add 5%. If there is little or no value subtract 5 – 10%
- Keeping the name, goodwill and reputation? Add 5 – 10%. If not, add 0%.
- Keeping the existing staff and this adds value? Add 2 – 3%. If not – 0%
- Location quality, visibility, traffic, parking etc? This is subjective… add or subtract 2% – 5%.
- You find a neat 2,000 sq ft restaurant that has been in business for 3 years with average annual sales / revenues of $1 million. Sales have been declining since opening from $1.1MM year 1, to $1.0MM year 2 and $900,000 year 3. The asking price is $475,000 with no owner financing or holding paper.
- 30% of the $1MM average revenue is $300,000 – your base number.
- 7 years remain on lease with no written renewal options . Sorry 0%
- The lease assignment says, “Not to be unreasonably withheld” – add 2% or $6,000.
- Total annual occupancy cost $55,200 with average sales of $1MM is ~5.5% – BUT – declining sales and a 3 – 4% increase in rent, taxes etc., per year gets you over 7% fast and climbing if YOU can’t drive sales quickly enough. Therefore I would subtract a minimum of 2% or $6,000 from the value.
- The base rent is $25.00 per sq ft with other local restaurants paying $23 and $27 per sq ft. Nothing special – add 0%
- The place is nice but you are going to have to remodel the dining room. The kitchen equipment and infrastructure will all be used giving you added value – add 3% or $9,000.
- You are not going to keep the name or goodwill. No value so add 0%
- You are going to keep the staff that all seem competent and eager to stay on – a time and money savings. Add 2% or $6,000
- This is a decently trafficked downtown location with dedicated parking, however there is a public lot for guests across the street. They cancel each other out – add 0%
My Valuation –
Base Value – $300,000
Lease Benefits $ 0
Assignment Value+ $6,000
Occupancy Costs – $6,000
Market value rent $ 0
Equipment, Facility + $9,000
Name & Concept $0
Staff + $6,000
Parking & Location $ 0
Estimated Value $327,000
Now assume that a well run restaurant will make 10 – 20% EBITDA, however a restaurant with marginal sales below $1MM can struggle and will earn less because fixed costs have greater impact with lower sales. This restaurant is currently unprofitable at $900,000 with declining annual sales – a risky negative. Forget your ego – what’s it really worth??
Pay this price and if you can hit these profit numbers it will take you approximately 3 and a half years to recapture your investment. Over the remaining 4 years of the lease you might get a return on your investment of $400k to $600k. Is that worth it to you?