Buying a restaurant may be a lifelong dream, whether you are currently in the business, buying a second or third location, or coming back to the industry after a break. It is also a significant financial decision that should be carefully considered based on the restaurant's current value and future potential.
Whether you’re a first-time buyer or a seasoned investor, knowing how to accurately value a restaurant is essential to avoid overpaying and to set yourself up for long-term success. A thorough understanding of valuation methods, financial analysis, and due diligence can help you assess a rest
aurant’s worth and negotiate from a position of strength.
At We Sell Restaurants, we recognize that no two restaurants are alike but the treatment of earnings should be. While locations can sometimes have unique factors that influence the value, there are financial parameters that set the value of the business, Less defined items, like customer base, location, or reputation can impact the future potential but don't weigh into the current value.
By understanding the reality of restaurant valuation, you’ll not only protect your investment but also position yourself for future growth and profitability. This guide will walk you through the essential steps to evaluate a restaurant’s value, ensuring you have the knowledge needed to avoid common pitfalls and costly mistakes.
Understanding Restaurant Valuation Methods: There are several methods to determine the value of a restaurant, each suited to different business models and situations. Let’s break down the most common approaches:
Asset-Based Valuation
This approach values a restaurant based on its actual assets, which are primarily the equipment, furniture, and leasehold improvements. Inventory is generally not taken into consideration because asset-based valuation is applied to turnaround situations where a change of concept is necessary. This valuation method for those buying a restaurant is used to restaurants that may even be closed though most are open. It provides an indication of the replacement cost but doesn’t consider income generation.
When this method is applied to a franchise restaurant for sale, it may undervalue the business since it may have a strong brand and loyal customer base but just be suffering from a lack of commitment for the current owners. It is an effective tool for valuing distressed or non-operational restaurants.
Income-Based Valuation
Used primarily for profitable restaurants, this method focuses on the restaurant's income-generating potential. Seller’s Discretionary Earnings or (SDE) is the method that calculates the total financial benefit received by the owner, including salary, bonuses, and other perks. It is most often used to value small to medium-sized opportunities for those buying a restaurant. It gives the clearest picture of the owner’s compensation and is most valid since it is used by lenders to establish values for Small Business Association (SBA) backed loans, the principle source of financing for buying a restaurant.
In establishing the SDE for the business, a Certified Restaurant Broker should also evaluate key financial metrics that offer insight into a restaurant’s health and performance. These indicators will help you determine if the asking price is justified. In particular, a review of prime costs for the business, which are labor, occupancy and food costs, identify opportunity above the current performance of the business.
Market-Based Valuation
This method compares the restaurant with similar businesses that have recently been sold in the area. This method demonstrates why it is critical to work with an expert for buying a restaurant such as We Sell Restaurants. A specialized brand will have access to the most data for market-based valuation or comparable sales (comps) in the marketplace. The more data for this type of modeling, the more reliable the results. In addition, brands specializing in restaurant sales will have knowledge of the latest lending conditions and banks working with restaurant transactions.
Other Variables to Review When Buying a Restaurant
Trending on revenue, staffing and location and lease terms can all affect valuation. These factors provide insight into future operational costs and growth potential.
Revenue and Profit Trends
Examining revenue and profit trends over the past three to five years helps you assess whether the restaurant is growing, stable, or in decline. Consistent growth indicates strong viability, while declines may indicate opportunity for growth or operational issues.
Staffing and Turnover Rates
As the industry continues to grapple with staffing models, a complete understanding of the employee base, recruitment process, longevity of staff and payroll rates is also important in evaluating across different businesses when buying a restaurant. High turnover or excessive payroll may strain profitability. Also, assess whether there’s an established management team or if new hires will be needed.
Location and Lease Terms
A prime location impacts value when the lease rate is at or below market rate or significantly above market rate. Both must be considerations for the future. Any restaurant buyer should understand the lease and future costs. Unfavorable lease terms or frequent rent escalations could diminish the restaurant’s attractiveness. SBA lenders require a minimum of 10 years of lease term which can include option years so the lease can also impact lending.
Quality and Condition of Equipment
Assessing the restaurant’s equipment helps estimate future investment needs. Older, worn-out equipment may require immediate replacement, adding to your initial costs. Conversely, newer equipment offers a smoother transition and lower upfront costs.
Menu and Customer Base
Confirm that the recipes and menu will transfer since you will be at risk if you can't duplicate the existing menu for the location. Review online reviews and social media presence to assess customer loyalty and brand reputation. Positive reviews and a strong social following indicate a strong brand.
Conducting Due Diligence When Buying a Restaurant
Due diligence ensures that the restaurant’s financial and operational information is accurate and that no hidden liabilities exist. The following steps are critical:
Financial Statements
Request income statements for the past three years which is the same basis that SBA lenders use for establishing value. Due to the impact of COVID, a range beyond this is not meaningful to establish value. The lender will want the last two years plus the most current year to date profit and loss statement plus the balance sheet. These documents offer a comprehensive picture of the restaurant’s financial performance and may reveal inconsistencies in revenue or expenses.
Tax Returns
The lender will require tax returns and do their own comparison to the filings with the Internal Revenue Service. Buyers should also compare tax returns with financial statements to ensure accuracy. There will also be some differences since depreciation is always shown on a tax return and rarely shown on a P&L for example. Confirm any discrepancies with the seller during the due diligence period.
Legal and Regulatory Compliance
Investigate any outstanding legal issues, such as pending lawsuits or health code violations, and ensure the restaurant complies with local regulations. These issues can become costly liabilities if not addressed prior to the sale.
Inventory and Equipment Valuation
Conduct an on-site inspection to confirm the condition of inventory and equipment. Match the equipment in the store with the assets provided in the schedule on the asset purchase agreement.
Working with a Certified Restaurant Broker for Buying a Restaurant
A Certified Restaurant Broker offers specialized expertise, ensuring you receive an accurate valuation and guidance throughout the purchase process. Brokers have access to market data and recent sales comparisons, which can help you determine whether you’re getting a fair deal.
Additionally, brokers can provide valuable negotiation support, ensuring the final price reflects the restaurant’s true value after considering its condition and financials.
Common Pitfalls to Avoid When Buying a Restaurant
Some common mistakes buyers make during the valuation process include:
Over-Reliance on Seller’s Numbers
It is a simple process to verify the seller’s financial information. Revenue on the P&L can be verified against sales tax filings and POS systems, along with tax returns. Expenses can be validated through invoicing and tax filings as well.
Ignoring Operational Costs
Fixed and variable expenses, such as rent, utilities, and labor, can impact profitability. Ensure you have a clear understanding of these costs before committing to a purchase.
Overestimating Growth Potential
While future growth is appealing, valuations should primarily reflect the restaurant’s current performance. Don’t pay for future potential that may not materialize.
Conclusion: Valuing a restaurant accurately is one of the most critical steps in the buying process. Understanding valuation methods, analyzing key financial metrics, and conducting thorough due diligence will put you in a strong position to make an informed decision. At We Sell Restaurants, we’re here to support you every step of the way, whether you’re just starting your search or ready to make an offer. A successful investment begins with the right valuation. Ensure you’re paying a fair price and starting your journey with confidence.
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Robin Gagnon, Certified Restaurant Broker®, MBA, CBI, CFE is the co-founder of We Sell Restaurants and industry expert in restaurant sales and valuation. Named by Nation’s Restaurant News as one of the “Most Influential Suppliers and Vendors” to the restaurant industry, her articles and expertise appear nationwide in QSR Magazine, Franchising World, Forbes, Yahoo Finance, and BizBuySell. She is the co-author of Appetite for Acquisition, an award-winning book on buying restaurants.