Did you know that approximately 60% of restaurants change ownership within the first five years? Whether you’ve owned your restaurant one, two or ten years, knowing your restaurant's value is crucial for making informed business decisions about when and how much it might sell for.
This article aims to simplify the restaurant valuation process, offering expert tips and strategies to help restaurant owners understand what their business is worth.
As a restaurant owner, you should know what restaurant valuation is, why it’s important, how to prepare for valuation, key factors influencing value, different valuation methods, expert tips for getting an accurate valuation, how much you should expect to pay for a restaurant valuation and common pitfalls to avoid.
Section1: Understanding Restaurant Valuation:
Restaurant valuation is the process of determining the economic value of a restaurant business. The Internal Revenue Service defines the term as, “the price that would be agreed on between a willing buyer and willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.” There are a lot of things to unpack in this definition.
A willing buyer or seller must be agreeable to the transaction in this definition. The language, “neither being required to act” precludes that the would-be buyer or seller is under some requirement or pressure to sell. What are circumstances that would “require” a seller to act? One example might be a buy/sell agreement put in place in a partnership where one party is required to buy out the other based on certain circumstances. A seller under pressure to sell to pay off a note coming due is another example. A buyer obtaining a U.S. visa contingent on a closing, may feel he is “required” to close on a deal.
The last element of the IRS definition is that “both having reasonable knowledge of the relevant facts.” This is a critical element of any transaction and confirms why performing due diligence as a buyer is critical.
- Third Party Valuations
All deals subject to an SBA loan will be required to have a third-party valuation performed. This independent firm is never chosen by the bank, the broker, buyer, or seller. A third-party valuation is ordered blindly by the bank much as a home purchase requires an appraisal. The valuation must establish that the purchase price is in line with the lending parameters including the debt service required.
- Importance of Restaurant Valuations
Knowing the value of your restaurant is crucial for several reasons. If your restaurant goes on the market for sale at the wrong price, the seller is damaged. If it is priced too low, he fails to get fair pricing on the business. If it is priced too high, the business will linger on the market, unsold, without interest.
Other important reasons to know the value of your restaurant is in the event you need an obtain lending for expansion or growth. An accurate valuation of your existing business can help you secure the funding you need for a remodel, purchase of extra space for parking, or updated equipment.
Another reason to understand the value of your restaurant is for financial planning purposes. A 2021 Price Waterhouse Coopers survey found succession planning is not a priority among small businesses They found that “Only 34% have a robust, documented and communicated succession plan in place.” Understanding the fundamental value of an asset, like your restaurant business, helps you make informed business decisions as you plan for those that may eventually inherit these assets.
Common Methods: There are three common ways to value a restaurant:
- Asset-Based: Focuses on the value of the restaurant's assets.
- Income-Based: Based on the restaurant’s revenue and profit.
- Revenue-Based: A generic estimate based on sales only.
The most reliable, used by SBA lenders to establish valuation, is the income-based valuation model. Certified Restaurant Brokers are trained in this model of valuation for their clients.
Section 2: Preparing for Valuation:
- Financial Records: Accurate and comprehensive financial records are essential to getting an accurate valuation of your business. You will need your profit and loss statements which show your revenue and expenses for the most current year. You also need last year’s tax filings for your company since profit and loss statements don’t always include year end adjustments.
- Lease Information: If you rent the property, the current lease is critical since, without a lease, the buyer will have no means to operate the business. If SBA lending is part of any sale, you will need a minimum of a full ten years of lease term to close on a deal. This can be broken into existing lease term plus option years but must add to the full term that the loan is amortized over. That means a 10-year loan term needs a 10-year lease term.
If you own the building and are seeking a restaurant valuation, a recent appraisal is important. If your appraisal is out of date, requesting a quick update may be a less expensive route than obtaining a new appraisal. The value of your business and the cash flow it generates can affect the value of your real estate since the business must be able to generate enough cash flow to service the debt based on the value of the real estate.
Section 3: Key Factors in Restaurant Valuation
While location, brand reputation, and other items are important, the most critical elements of the restaurant valuation are the profitability numbers. A business in a prime location that is losing money, despite whatever “opportunity” the seller believes is ahead of it, will never be as valuable as a business making money.
A business losing money is sometimes referred to in the industry as an “asset sale” or turnaround opportunity. This type of business will be worth only a fraction of the cost of the original assets though this may be influenced by a prime location, favorable lease terms, or other, non-financial aspects.
Assets: Both physical and intangible assets contribute to valuation.
- Equipment and Fixtures: Ensure all equipment is in good working order.
- Intellectual Property: Consider the value of trademarks, recipes, and brand identity.
Section 4: Valuation Methods Explained:
- Asset-Based Approach: This method calculates the value based on the sum of the restaurant's assets, minus liabilities. It’s useful for restaurants with significant physical assets. This method is generally applied to restaurants that are not making money or have been established for less than a year.
- Income-Based Approach: This approach values the business based on its ability to generate revenue and profit. A Certified Restaurant Broker will look at the net income of the business and recast any expenses that benefit the owner and then add back any salaries that would accrue to a new operator. This approach calculates Seller’s Discretionary Earnings or SDE. It is also sometimes referred to as SDCF or Seller’s Discretionary Cash Flow.
Strong restaurant brokers with access to comparable sales will also compare your restaurant with similar businesses recently sold in the market and consider sale prices of comparable restaurants to confirm valuations.
Section 5: Expert Tips for Accurate Restaurant Valuations:
- Engage with a Professional: Calculating the value of a restaurant is not an exercise to be undertaken after reading an article or two online. Consult with a Certified Restaurant Broker for an accurate, unbiased, and accurate valuation. They have the expertise to account for all factors impacting value.
- Avoid Paying Valuation Fees: Professional restaurant brokers will generally provide services to provide the valuation free of charge. That’s the practice of the Certified Restaurant Brokers at We Sell Restaurants. Avoid firms that want to charge you thousands of dollars upfront for an opinion of value.
- Improving Value: A strong broker that knows the industry can provide you with specific strategies to enhance your restaurant's value if the number you are given is not where you want it to be. Suggestions might include:
Controlling Prime Costs: Control over three main costs contribute the most to the earnings of a restaurant business. Those are food costs, labor costs and occupancy costs. Bringing these in line can contribute strongly to profitability.
Enhancing Operational Efficiency: Streamline processes to reduce costs and increase profitability.
Marketing and Branding Initiatives: Invest in marketing to boost top line sales, build brand awareness and customer loyalty.
Section 6: Common Pitfalls and How to Avoid Them:
- Overestimating Value: Setting unrealistic expectations can deter potential buyers and prolong the sale process.
- Ignoring Market Trends: Stay informed about industry trends and adjust your business strategies accordingly. Stay on top of new listings at website like We Sell Restaurants to understand where the market stands.
- Neglecting Maintenance: Ensure your restaurant is well-maintained. Deferred maintenance can lower the perceived value and discourage buyers.
Conclusion: Understanding your restaurant's value is crucial for selling, expanding, and financial planning. Preparing for valuation involves maintaining accurate financial records and operational data, considering key factors, and choosing the appropriate valuation method.
Additional Resources:
Links to Tools and Calculators: Utilize these tools to help you with the valuation process:
Further Reading: Explore these related articles and guides.
Contact Information: For professional valuation services, call or text (404) 800-6700 or contact us for a free evaluation.
Certified Restaurant Broker®, MBA, CBI, CFE, is the co-founder of We Sell Restaurants, a brand that has carved an unparalleled niche in the industry as the nation's leading and only business broker franchise focused on restaurants. Under Robin’s leadership, We Sell Restaurants has grown to 45 states where it dominates the restaurant for sale marketplace, including franchise resales, delivering on the founder’s vision to Sell More Restaurants Than Anyone Else. We Sell Restaurants was named one of the most influential suppliers and vendors in the country by Nation’s Restaurant News and has earned a position on INC 5000’s list of fastest growing privately held companies. Franchisees of We Sell Restaurants surveyed by Franchise Business Review placed it 25th in the nation in franchisee satisfaction.
Robin is the Chair of the Women’s Franchise Committee of IFA and is a member of the IFA Board of Directors. She is also an MBA and Certified Franchise Executive (CFE) and has her CBI (Certified Business Intermediary) designation from the International Business Brokers Association. She co-authored Appetite for Acquisition, a small business book award winner in 2012 and contributes frequently to industry press appearing in Forbes, QSR, Modern Restaurant Management, Franchise Update, and others. She has appeared on The TODAY Show as a restaurant expert and Entrepreneur Magazine has named her to their list of the “Top Influential Women in Franchising.”