While everyone has some idea how much they want to pay or price a restaurant for sale, the truth is, selling a restaurant is a math problem with a right and wrong answer
What is the methodology for restaurant valuation? For lenders and sophisticated restaurant brokers familiar with the process it’s the Income Valuation Method. This is the most favorable and trusted method used to value restaurants for sale. In today’s lending environment, this is how we establish value and secure financing on a business. A restaurant for sale with solid profits that fits the SBA criteria to both satisfy the buyer’s lifestyle needs and satisfy the debt payments with a 25% cushion will qualify for lending.
For that reason, the Income Valuation Method provides the most acceptable method of valuation for banks, lenders and individuals in assessing how much to pay for a restaurant. In a situation where a restaurant buyer is paying cash, this helps to reduce fear of the transaction as the business has a proven track record.
A restaurant for sale with strong books and records, assessed under the Income Valuation Method has the highest number of potential buyers and hence commands the highest possible price. An expert restaurant broker can go through the Profit and Loss statement along with tax returns to find the Seller’s Discretionary Earnings (SDE) or owner benefit that is customarily accepted by lenders to value the business. This includes net income PLUS reasonable and customary add-backs.
Add Backs are the benefits realized by a seller today that go away when he or she leaves the business. For example, owner’s 1099 or W2 earnings are calculated as Add Backs. Any personal expenses such as a cell phone or auto expense for the benefit of the seller are also “added-back” to the bottom line to calculate the earnings.
What is not allowable for “add-back” purposes are efficiencies a new owner could potentially achieve that the current operator hasn’t. It should factor in your decision to buy but should not be calculated in the pricing of any restaurant for sale. The entire purpose of the add backs is to calculate owner benefit and ultimately pricing of the business. If you can identify strategies to be more successful in the future than the current owner, that benefit belongs to you as a buyer, not to the seller in the pricing of the business.
Once the Seller’s Discretionary Earnings is appropriately determined, then it becomes the basis for a “multiple” for pricing restaurants for sale. Every buyer wants the answer to the question, “What’s the multiple for restaurant pricing?” and the response rarely satisfies anyone. In general, restaurants for sale can be offered and sold somewhere between 2.5 and 3 times times earnings, with market factors adjusting this up or down. For purposes of this article, we are limiting our discussion to single restaurant units. Multi-unit sales (anything above two, especially franchise) changes the multiple significantly and requires a whole different analysis and pricing model.
“How much to pay for a restaurant for sale? ” can be affected by any of the following variables including: strength of books and records, saturation of concepts in the marketplace, seasonality, location, comparable Sales Information or “comps,” franchise or independent offering, geography and competition.
Strong restaurant brokers that know the market and should be able to share exactly where a restaurant is priced based on the multiple and why. Ask some questions of your broker to be certain they fully understand restaurant pricing. If you’re not satisfied with the response, find an expert restaurant broker to help you buy a restaurant.
Our restaurant for sale listings are all valued using the same methodology and can be found at this link.