The process of buying a restaurant begins with an examination of your own motivation for entering the industry. This critical first step allows you to set initial parameters for your search and keeps you from going down a path that can be overwhelming, intimidating, and time consuming.
If you see yourself buying a restaurant and entering this industry for the long term, then we challenge you to put some initial effort up front in determining a strategy that will align with your needs and those of your family.
That's why the first step in buying a restaurant isn't about the search, the numbers, or the process. The first step is to determine some due diligence on yourself and separate your wants and needs.
Want to understand if buying a restaurant is the right choice for you? We recommend all restaurant buyers conduct due diligence on themselves at the outset. Take a good hard look at all parts of your lifestyle before taking the plunge to buy a restaurant. Many years ago, we created a one-page Restaurant Assessment Tool to help those in the process of buying a restaurant determine their real needs.
The needs of a Thirty-Year-Old Millennial looking to buy a restaurant are very different than those of a baby boomer with early retirement seeking to supplement income or keep boredom at bay. Working with restaurant buyers every day tell us everything we need to know about the demographics of those buying a restaurant , and national data supports those findings.
Do you know that business ownership runs in families? If you are the son or daughter of an entrepreneur, this could be why that cubicle or corner office is less than fulfilling. 55 percent of restaurant buyers have a parent or grandparent that owned a small business. We also know that the number one motivation for purchasing a small business is the chance to be your own boss, according to 63 percent of all respondents to a recent survey.
What's your motivation? Take our Restaurant Assessment Tool to understand if buying a restaurant is something you have thoughtfully considered from top to bottom, before making the plunge. The Restaurant Assessment Tool available at this link, Restaurant Assessment Tool, helps you uncover what your needs are before you begin shopping for the perfect location. We Sell Restaurants helps those achieve the American dream, but don't let that dream turn into a nightmare if the business is really not for you.
For some, the journey should end at this point. In fact, we have actually developed five signs that you're not ready to buy a restaurant. Just because your brother's a successful multi-unit owner or your cousin just made it onto Top Chef, doesn't mean the industry is for everyone. We interviewed a number of contestants on hit TV shows like Hell's Kitchen and Top Chef. For some, the desire for prime time is a greater motivation than their culinary skills. The process of buying a restaurant begins with an examination of your own motivation for entering the industry. This critical first step allows you to set initial parameters for your search and keeps you from going down a path that can be overwhelming, intimidating, and time consuming.
Once you are solid on your motivation for buying, it's time to dig into the numbers and determine if the business will support the needs of yourself and your family. How do you do that? Begin to study basic elements of the restaurant industry, like food costs and labor costs, laid out in this post.
Key Points on Valuation:
Study the basics of restaurant valuation and understand the definitions of terms like Discretionary Earnings or Owner Benefit covered in articles like this one. Why are those terms critical? They are the basis for lending, a key element of buying a restaurant. While there is the option to buy restaurants with no money down or limited resources, a business with good books and records that qualifies for lending will allow for the most leverage (least invested) and best return.
Here's a quick primer on key restaurant math terms and how they are calculated, that every restaurant buyer should know. Calculations for Food Cost, Occupancy Cost, Gross Profit, and Net Profit are based on the Uniform System of Accounts for Restaurants (a handbook available from the National Restaurant Association).
Gross Sales - Gross sales are the top-line sales of the restaurant business that may include sales tax, comps, and promotional discounts. In some cases, local sales tax will be included. Gross sales should not be relied upon as a description of revenue.
Net Sales - Net sales are top-line sales of the restaurant business minus any comps, promotional discounts, sales taxes, or other items. Net Sales is the true revenue of the restaurant and the amount upon which royalties would be paid, if the restaurant business for sale is a franchise.
Food Cost - Food cost is calculated by taking the total food costs and dividing it by revenue. (See above -- this is the Net sales number). Food costs may sometimes include paper products but should not include labor costs, though some accountants do approach in this manner. Different restaurant concepts will have a higher or lower food cost depending on the concept. For example, taco concepts have low meat amounts while fine dining or full-service restaurants may source only organic or farm to table items, which increase food costs. A rule of thumb is that you will see Fine Dining at or around 35% food cost, Pizza/Italian around 32% food costs, and American Casual around 29% food cost.
Occupancy Cost - Occupancy costs are the total cost of all fees to occupy a space including the base rent amount plus CAMS (Common Area Maintenance Charges), along with any Taxes and Insurance costs reimbursed to the landlord for the pro rata portion of the space.
Profit Margin - The net profit margin refers to the percentage an owner/operator would have available to his or her benefit, after all expenses are paid. It is calculated by taking the net income divided by the revenue.
Labor Costs - The total cost of payroll divided by revenue, is the cost of labor. Typically, this would include payroll taxes and costs to prepare payroll but anyone buying a restaurant should confirm this for each business they are researching.
Discretionary Earnings - Discretionary Earnings (DE), also known as Seller’s Discretionary Cash Flow, Seller’s Discretionary Earnings or Owner’s Benefit, is the adjusted earnings before taxes, interest income or expense, non-operating and non-recurring income/expenses, depreciation, and other non-cash charges. It includes a single owner/operator or officer’s compensation and is typically used as the the basis for SBA lending.
EBITDA - EBITDA is an accounting term that stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
The difference between Discretionary Earnings and EBITDA, is the addition of a single owner operator salary added back to Discretionary Earnings. That is the standard nationwide for lending, by SBA lenders. With the wealth of knowledge and information at your fingertips, it's no wonder we tell sellers that finding a restaurant buyer willing to overpay is as common as a unicorn.
Once you have begun to understand the financial variables for buying a restaurant, the search is on, the next step in your journey.
Now that you have successfully navigated the first two steps in buying a restaurant, the search is on. How do you find restaurants for sale near you? The problem won't be finding the restaurant business for sale opportunities, it will be getting the follow up and support you need to move to the next step.
Find Restaurants for Sale through:
The internet and online listing sites have made the process of finding restaurant businesses for sale a relatively simple one. Study the listings and use our guide to restaurant for sale listing language to separate out the type of business you are looking at. Is it cash flow positive? If so, you'll see terms like profitable, earnings, and net income. Is it the sale of used equipment? If so, you'll see terms like asset sale.
The subsequent step; however, is where the best restaurants for sale for you are easily separated from the worst. Inquire online through a number of resources and measure the response.
For most businesses, the listing is confidential. That means, that the general public and the employees are not aware the business is for sale. Owners are concerned that the staff or customers may leave if they know this restaurant is for sale. Be prepared to sign a confidentiality agreement before learning any information on the business, for the reasons listed below and expanded upon in this article.
For many restaurants for sale listings, brokers still operate with a faxed or document form of a confidentiality agreement. We Sell Restaurants uses an online confidentiality agreement in order to provide better and faster access to information for our buyers. No matter which way the non-disclosure or confidentiality is covered, read it carefully and be sure to adhere to the legal requirements set forth.
Before signing anything, be sure that you speak with the restaurant broker and are comfortable with his or her services. If not, the confidentiality agreement you sign may commit you to working with them on the deal. You can hire the services of a restaurant broker to represent you on any parties’ listing. Here's a list of questions you should ask any restaurant broker before engaging their services.
You may also be required to provide a certain level of funds or "proof of funds" to qualify for a package on the restaurant for sale. This is not meant to be intrusive. It’s to protect the seller or broker and be sure you will qualify for the purchase, before providing highly sensitive financial information.
Request and evaluate the package provided on the listing to continue gauging your interest in the business. If a broker does not follow up or engage with you at the outset, you can be assured that the relationship will continue in that vein so it's best to move on from that listing and that broker.
The next step in buying a restaurant is to visit undercover as a secret shopper. There is so much that can be gained by this simple step. By visiting the restaurant for sale during busy and slow times, you can observe service, review staffing, and look for areas to improve the business if and when you take over.
On the other hand, you can also eliminate a restaurant for sale near you if you find the overall area is in decline, too close to schools for liquor service, or otherwise undesirable. While internet research to find restaurant businesses for sale has never been easier; nothing beats an in-person view of the business. There are some key items to remember when visiting the business. It might also be worth your time to consider ten things you should never do when buying a restaurant.
The once caveat to the site visit we would put forward is the danger in becoming a restaurant critic versus a restaurant buyer. The site visit is to confirm this is a good location with opportunity to grow. If you go in and decide it all has to be thrown out and you're starting over, you'll likely kick off negotiations with the seller in the worst possible way.
If you find so much wrong with the business that you feel is irretrievable, you may be in a situation where you need to build, rather than buy a restaurant. While both are good options, our infographic on building versus buying a restaurant might be helpful in viewing the pros and cons. Building a restaurant from the ground up can be more costly and less efficient than buying an existing restaurant.
There are key elements to focus on when looking at the restaurant for sale opportunity. Where can you grow the business? Are the current owners focused on building up the business, or are they absentee or unengaged? Our article on the top ten reasons restaurants fail, can be viewed inversely as the top ten reasons you can take over a business and make it better.
Do your homework on the business. If your instincts are still saying this is the one, proceed to the next step and make the offer.
Once the initial steps are out of the way and you've homed in on a restaurant for sale near you that meets your criteria, it's time to draft the offer. Components of the offer are both tangible and psychological. You have the "how much “and the "how soon", along with the "how to" of buying the restaurant to consider. A strong offer will include all of the following elements that we will review in detail.
The purchase price is just the beginning point of the negotiation and there are psychological elements to this opening statement of the negotiation. If you come in at rock bottom, you may simple annoy the seller to the point that he will not counter, putting yourself in the situation of negotiating against yourself to buy a restaurant. You don't want that.
Negotiations to buy a restaurant can include all cash at closing, an 'earn-out' component where some amount is paid in the future based on sales, a measure of seller financing, bank lending, or a combination of all. Using each of these elements properly can aid you in getting the best deal when buying a restaurant.
One quick note. If a buyer is willing to pay cash for the purchase or goes for lending, it really is the same thing to the buyer. He or she gets cash at the closing table. The only time a cash deal is preferable to a seller, is when it speeds up the transaction. However, the restaurant brokers at We Sell Restaurants are finding that our lenders move very quickly on lending, so there's no real difference between funding something personally versus a bank loan.
Time to close; however, is a critical element of the purchase and this brings some psychological components with it as well. For sellers, we see two elements of the most interest - time and money. You can often offer less money if you close in a shorter period of time. On the other hand, offering less money and a longer period to close are sure fire deal killers.
Time to train and after-sale support are negotiable deal terms for any offer to buy a restaurant. If it's a complex operation, you may need or want more time. On the other hand, if it's a simple concept, a shorter training time can be very helpful to the seller as a tangible part of the deal as he sees his exit occurring more quickly.
All offers to purchase a restaurant business should include a due diligence period. This is the time frame when the buyer reviews anything and everything about the business and has the option to terminate, in his or her sole discretion. This is a critical time period and should not be confused with other contingencies that need to be met before buying the restaurant. This is a simple and straightforward period when all materials are made available to the buyer for review including but not limited to: POS reports, Sales Tax Filings, Tax Returns, Employee Lists and Payroll, Schedules, Leases, and more.
The deal terms for buying a restaurant are that any offer should always include a strategy for payment of inventory, any deposits with the landlord or vendors, along with cash on hand, and any transfer fees to be paid. A savvy restaurant broker will have deal templates that incorporate all of those elements. The last thing you want to do is get a deal 90% there, and have small items affect the ability to finalize the terms.
Lastly, above and beyond any due diligence period should be a number of contingencies which will depend on the deal and type of lending. Customary contingencies are:
A Letter of Intent drafted by an attorney, is often one-way buyers seek to memorialize a transaction. Is this a good method? In our opinion, no. We cover many of the reasons in this article on how attorneys kills deals to buy restaurants. Overall, we recommend that you work with a broker familiar with deal terms before engaging with an attorney who is billing by the hour.
Once the contract is inked (or more commonly today, DocuSigned), it's time for the due diligence process to begin. For a well-organized restaurant broker, buyer and seller, this is a straightforward process where information flow begins immediately through a Dropbox link and/or weekly meetings.
The purpose of due diligence is to substantiate all the information points provided to this point and get all parties 100% confident in moving forward. Due diligence can take many forms but often consists of three main elements.
The buyer and seller often wish to meet at the restaurant for a walk through and discussion as part of the due diligence process. Remember that up to this point for most locations, the buyer has only visited as a customer and seen the public spaces. This is the chance to see the kitchen and back of house. Here are ten common do's and don’ts for restaurant sellers during this type of meeting.
For the financial due diligence, it is very common today for all materials to simply be shared online through a secure Dropbox link or similar method. That way, large materials such as leases and confidential financial details are not weaving their way through a Gmail account somewhere.
Remember, as stated earlier, there may be deal contingencies over and beyond due diligence. That means due diligence may end, but lending may be turned down. That's a reason to terminate the contract and get return of escrow. Due diligence may end before the landlord approves the lease transfer. As long as the landlord approval and assumption of the existing lease is a contingency, this will be an element that can cause the contract to fail with a full and complete return of escrow.
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Ready to sell restaurants instead of buying a restaurant? Select markets nationwide are still available for those looking for a franchise business with solid perforamnce. Visit wsrfranchise.com online to learn more about selling restaurants with We Sell Restaurants with direct coaching from our founders.
Eric and Robin Gagnon Founders -- We Sell Restaurants
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