Selling a Restaurant and Guide to Valuation

Owners of too many restaurants for sale learn the hard way that listing at the wrong price is the single largest reason listings don’t sell.   What’s the downfall of listing something quickly just “to see” what the market response will be?  Here are just a few of the problems created by this strategy.

You only get one chance to make a first impression on the marketplace.  There’s a finite group of qualified buyers searching the market at any given time looking for a restaurant for sale.  When yours comes on too high or too low, it’s quickly evaluated and discarded without any further follow-up. Since the sales cycle for selling a restaurant is around six months, it may mean a re-launch a year later to re-engage a new pool of buyers and interest them in the listing.

Funding options are limited when the listing is overpriced.  A lender cannot approve the listing for a bank loan if the income on the books doesn’t justify the asking price.

Timing is everything when selling a restaurant.  Sports bars are “hot” in the fall when football season is heating up.  If you list too high during this time frame and “wait” for offers, by the time you’ve gauged the market reaction and lowered the price, you could be into a less desirable time period for selling (late spring or summer). The likely result? Nothing will happen.  A good restaurant broker should be able to offer some feedback for you on the best timing to list your restaurant.  

Your costs aren’t going away while you sit on the market.  Listing too high when you’re losing money means you’re accumulating more debt to deal with at the closing table.  If your lease is $4800 a month and it takes you four extra months to sell a business that’s losing money, you are ahead $19,200 if it’s priced to move quickly versus waiting it out.  That doesn’t include other expenses that may pile up while you’re trying to stick to your higher pricing.
With all the issues created by listing at the wrong price, getting an accurate value on your restaurant is not that difficult.  Pricing a listing for sale is a math problem with a right and wrong answer and an expert restaurant broker can get to the correct price accurately and efficiently.

Restaurant Valuation

There are three common methods of restaurant valuation.

• Income Valuation
• Replacement Value Method or Asset Value
• Annual Gross Sales Valuation Technique 

Income Valuation is the most favorable and trusted method used to value a restaurant by nearly all buyers. This is the method lenders will look at to value a business for lending.  In a situation where a buyer is paying cash, this helps to reduce fear of the transaction, as the business has a proven track record.  The methodology is shown below in the calculation which shows that Owner Benefit x Multiple = Restaurant Valuation.
 
Replacement Value Method or Asset Value technique assumes a buyer pays the seller some amount based on the opportunity to benefit from the existing investment in the restaurant facility, leasehold improvements, equipment, lease, and location of the restaurant. Generally, the replacement value method is used for a seriously devalued asset sale.  This is when second-generation restaurant space goes on the market because a concept is failing.  The seller ends up selling for pennies on the dollar-based on the cost of his or her original build-out.

Annual Gross Sales Valuation Technique is used by inexperienced agents who simply use a percentage of annual gross sales to determine a restaurant’s value.  It is the most unsophisticated form of pricing and is sometimes used by real estate agents that don’t sell businesses for a living or do not understand restaurant valuation

Off the Books Income

Lenders and professional valuation services take the position that any valuation method should ignore off-the-books income in the calculation of earnings for pricing purposes. The seller has already received the benefit of tax-free income that results in substantial savings on this money earned. It cannot be resold for a premium on the back end. For that reason, owner income cannot include cash under the table, tips, or other non-reported revenue. On the other hand, some businesses are so sexy to a buyer that they will ignore what it “should” be on the market for and pay a premium on unproven income to gain access to a club, pub, or bar type business where “off the books” is most common.

Frequently Asked Restaurant Valuation Questions

What’s the multiple?
Multiples vary by market, by concept, by geography and by a wide range of elements shown in the chart at the left.
 
Why are “Add-Backs” valid? They don’t show in the net income of a restaurant.

Add-backs are expenses that typically go away when the current owner leaves the business.  That means they would represent income on the P&L for a new buyer.  Usual and customary add-backs are accepted commonly by banks under SBA (Small Business Administration) lending criteria. These can include anything that is fully documented on the profit and loss statement and tax return that includes personal expenses paid for by the business.  Interest and Depreciation are always added back.

I know lenders don't accept “off the books” income in the valuation but I really did pocket a lot of cash in the last few years.  How do I prove this to a buyer?

It’s very difficult to get a buyer to accept off-the-books income.  He is going to know that you historically misrepresented the sales and earnings.   He will also want to verify the real numbers. The only way to validate the sales is to work in the business for a lengthy period of time to confirm the sales are really happening.  If you have benefited from this “off the books” activity, then count yourself lucky for all the savings you’ve had in state and federal taxes.  You’ve received the benefit of tax-free earnings.  List the business based on what’s on the books.

Should a Restaurant Seller do Owner Financing?

Owner financing is increasingly popular especially if the books won’t hold up to strong scrutiny.  It is often requested by buyers as protection or insurance against future earnings to make sure a seller retains some “skin in the game” and won’t simply dump the business and run.  With that being said, there are definite steps you can take to mitigate the risk of owner financing on your restaurant for sale.   

Before you agree to owner financing, remember that you’re extending credit to someone you don’t know.  Do your due diligence.  Request a credit check, interview the buyer, “Google” him or her and go over his resume to make sure you understand whom you’re dealing with.  You wouldn’t hire a chef without doing these basic things so don’t loan money without the same effort.

Secondly, protect yourself when offering owner financing by hiring an attorney to execute basic strategies.  It’s a low-cost investment to protect you in the long run. Here’s what your attorney should do to protect you in the deal. 

First and foremost, the attorney will make sure there is formal written documentation of the loan.  It should include a specific interest rate, payment term, amount due, and spell out specifically the repayment structure, penalties for late payment, and process for repossessing the business.  Without a formal document executed at the closing table, you have no standing to take your business back if the buyer fails to pay. If the broker tells you he has some forms you can use, find another broker.  He’s practicing law without a license and you’ll pay the price if his documents don’t hold up over time.

Secondly, have your attorney secure the note with a lien on the assets of the business. If the buyer attempts to sell the equipment before you’re paid off, the lien will put the purchasing party on notice that there is money owed that has to be paid off first. 

Thirdly, secure the lien with a personal guaranty of the buyers.  Don’t allow them to simply sign for their corporation which they can easily bankrupt without personal harm.  Get personal guarantees of multiple parties (spouses, partners, etc) and if they fail to pay, you can pursue them individually as well as corporately.

Lastly, never loan more than you can afford to lose.  This seems simple but you can’t be so desperate to sell that you take a minimal down payment and finance the rest and pray they pay.  If they only owe you 30% and you’ll end up with the business back with 70% of the sales price in your pocket, it’s easy enough to take it over for a short period of time and then re-list it for a lower price.  You can actually make money flipping the same restaurant multiple times.

How a Valuation Can Add to Your Asking Price

Sellers sometimes look at their profit and loss statement or tax return and fear that the business is not that valuable because it shows a loss.  That is rarely the case.  An expert restaurant broker that performs a valuation will help you find all the owner benefit that exists in the restaurant.  This includes items showing as expenses on your tax return or P&L but actually come to the new buyer as income.

Here are examples of common expenses that are “added back” to the loss to demonstrate owner benefit (sometimes called Seller’s Discretionary Earnings).  Your valuation can be dramatically affected by these numbers and your broker should be looking at any of these expenses including, owner’s compensation, health insurance, auto expense, cell phone expense, one-time expense that is extraordinary or non-recurring (major one-time repair), receipts that document owner purchases, non-cash items such as depreciation and amortization, travel and entertainment, and donations.
In the example below, the earnings went from –$13,681.74 + $49,273.26.  That is then applied to a multiple to get the exact pricing.

Should I Sell my Restaurant Now?

Whether there is strong buyer demand in the market or not, it bodes well for the seller to understand when it is the right time to sell. Owner-operators have the opportunity to prepare their restaurants for market by taking a close look at the financials and operations currently in place at the location. The restaurant brokers have identified three things a restaurant owner can do to increase the value of their food business before selling a restaurant:

Remove Uncertainties - prospective buyers will hesitate to place an offer if their questions cannot be confidently answered. Are the food costs between 28% and 30%? Is labor accurately booked? What does the chart of accounts look like? Uncertainties or doubt anywhere in the operational costs of the restaurant will decrease the restaurant's sale price. When selling a restaurant, take time beforehand to organize the books. This may also require a shift in operations in order to improve sales and provide more accurate tracking of all operational costs. 

Confirm Income - Avoid making the mistake of including the wrong items on the P&L sheet. Selling your restaurant for the highest sale price will require that the P&L matches the tax returns. Moreover, one-time incomes (such as PPP money or other grants) , do not belong on the P&L and should not be taken into account when evaluating the business. 

Use a Critical Eye - After the books are organized, income confirmed, and overall metrics reflect the business accurately, take a look at the physical appearance of the restaurant as though looking from the buyer's perspective. This is the step where the owner should take time on the visual details of the store. Does the restaurant need a facelift with some new paint or updated furniture? Do the employees reflect the restaurant well? When selling a restaurant, ensure the books look good and the restaurant itself will visually appeal to the inquiring buyer. This will help improve its value and sale price.

A Certified Restaurant Broker® is equipped to make recommendations to restaurant owners about selling their restaurants. In some cases, the restaurant may be ready to hit the market. However, sometimes the recommended course of action might be to not sell the restaurant. Instead, spend a year tackling areas in the restaurant that need improvements. 

If you are preparing to sell your restaurant, read our Guide to Selling a Restaurant to better prepare the food business for market, and to sell it for the most money in the shortest amount of time!