How Buyers Evaluate a Restaurant, Bar or Club
Business to Determine if it is the Right Opportunity
- Part 1
The three primary areas buyers focus on in doing
their analysis to determine if the restaurant, bar
or club opportunity is the right one for them is as
follows: a. Price Valuation, b. Location
Overview and c. Lease Terms. In this
article I will discuss Price Valuation and Location
Overview and in the next edition I will discuss
Lease Terms.
Price Valuation
A buyer evaluates the price of the business to
determine if it is reasonable based on a couple
different methods.
Assets in Place Method of Valuation - If the
business is not making money or is marginally
profitable this is called the Assets in Place
purchase. With these types of purchases the
buyer is usually interested in the fixtures and
equipment, lease, leasehold improvements and any
licenses that go with the business and they are not
normally interested in the name and menu of the
business. The buyers for this type of business have
their own menu and concept in mind. The criteria for
pricing the Assets in Place business is the ratio
between the sales price and sales.
For example if is a business is generating $500,000
in yearly sales and the sales price is $125,000 -the
sales price is approximately twenty five percent
(25%) of the yearly sales. ($500,000 yearly sales x
25% = $125,000 sales price), My experience in
selling these types of businesses, which is the
majority of the businesses I sell, is that
businesses doing $350,000 in yearly sales or less
sell on an average of thirty five percent (35%) of
yearly sales. For example if a business in doing
$300,000 in yearly sales the average sales price is
approximately $105,000 ($300,000 yearly sales x 35%
= $105,000 sales price). Businesses doing $350,000
to $1 Million in yearly sales sell at an average of
twenty five percent (25%) of yearly sales. For
example if a business is doing $750,000 in yearly
sales then the sales price will be approximately
$187,500 ($750,000 yearly sales x 25% = $187,500
sale price). Businesses doing $1 Million to $2
Million in yearly sales are selling at an average of
seventeen percent (17%) of yearly sales. For example
if a business is doing $1.5 Million in yearly sales
it will sell for approximately $255,000 sales price
($1.5 Million yearly sales x 17% = $255,000 sales
price). My experience in selling businesses doing $2
Million or more in yearly sales is that they sell
for approximately fifteen percent (15%) of yearly
sales. For example if a business is doing $2.5
Million in yearly sales it will sell for
approximately $375,000 ($2.5 Million yearly sales x
15% = $375,000 sales price).
When buyers are eyeballing buying opportunities they
are not necessarily familiar with the ratios
indicated above but if they have been in the market
long enough they develop an innate sense of value
based upon how the subject business they are
evaluating compares to other comparable businesses
for sale.
Going Concern Method of Valuation – The Going
Concern Method normally means that the business is
making money and when the buyer purchases a going
concern business they usually want to operate the
business the same way the seller did and maintain
the name, menu, operating systems and personnel in
place. With this method the lease, leasehold
improvements, fixtures and equipment, name, menu,
concept, goodwill and cash flow are all included as
part of the sale. The primary valuation method used
for a Going Concern Valuation is the yearly adjusted
cash flow method which is also referred to as
discretionary earnings. This means that the net
profit on the tax return or on the year-to-date
income and expense statement is adjusted by adding
back the following items to the net income: one
working owners salary and payroll taxes, any
personal expenses the owner is charging the business
(food for consumption at home, life, health and
disability insurance premiums, auto expense,
entertainment and vacation expense, etc.),
depreciation, interest and amortization expense on
any loans the buyer will not be assuming and net
operating loss carry forward charges if any.
Additionally any extraordinary expense and or
non-reoccurring expenses such as extra legal or
accounting bills related to a particular lawsuit or
unusual situation would be added back to the net
income too.
Once the yearly adjusted cash flow is determined a
sales price multiplier will be used to determine the
value of the business. The sales price multiplier
for independently owned, non-chain, non franchised
food service operations will vary from one to three
times yearly adjusted cash flow depending on the
risk factors and other factors listed below.
The risk factor is determined by the following
criteria: 1) the degree of difficulty in operating
the business, i.e. an espresso operation has a low
degree of difficulty as it is an easy operation to
run but an upscale dinner house operation has a high
degree of difficulty because it requires a high
degree of expertise and sophistication to run this
type of business successfully and 2) how long the
business has been in operation and the past history
of the business in terms of profitability and sales
growth. A business with an easy to operate format
coupled with a well-seasoned profitable earnings
history will utilize a higher sales price multiplier
versus a business with a high degree of difficulty
without a track record.
The other factors which determine the sale price
multiplier are as follows: 1) the lease value,
(whether the lease is at market, below market or
above market and the length of the lease),
2) the potential upside of the business (i.e. a
business currently serves dinner only and has only a
beer and wine license and there is potential for a
strong lunch and/or brunch business and hard liquor
sales) and 3) the future growth opportunities of a
particular location (i.e. if there are some major
new development(s) that will add new potential
customers to the area without a lot of extraordinary
new competition).
An example of a Going Concern Valuation is indicated
as follows. If the yearly adjusted cash flow of the
business is $75,000 and the multiple to be used is
2.5, the value of the business would be calculated
as indicated : $75,000 (yearly adjusted cash flow)
multiplied by 2.5 (the appropriate multiplier to be
used based on the facts discussed above) which
equals $187,500 ($75,000 adjusted cash flow times
2.5 = $187,500 sales price).
Location Overview
You may have heard the saying that the three most
important ingredients for a successful business are
location, location and location. Obviously there are
other factors which are very important as well which
are discussed in this article and elsewhere but you
cannot compromise on location. Choosing the right
restaurant location is one of the most important
factors in contributing to ones success in the
business. The restaurant business is very
challenging to be successful in and having a strong
location will enhance your chances for success. The
key factors to consider in choosing the proper
location which are discussed in detail below are as
follows: 1. built out market, 2. stable
demographics, 3. growth potential, 4. diversified
clientele, 5. strong visibility and easy access, 6.
heavy pedestrian and vehicular traffic, 7. major
market generators in the area, 8. rent affordability
and 9. trade area draw.
1.
Built out market – You want to locate
in an area that has combination of commercial
businesses and residential population built out. If
you locate to an area with a lot of open space you
will be vulnerable to have new head on competition
versus being in an area that is already is built
out.
2. Stable demographics – Having a
solid demographic base of long term well educated
residents grounded with a strong commercial base of
businesses and office tenants in the area is
important.
3. Growth potential – Although you want to be
in a well built out area it is always helpful to be
in an area where there is opportunity for existing
commercial businesses to expand.
4. Diversified clientele – It is helpful to
have a mix of residents, commercial activity
including retail businesses and offices buildings as
well as hospitals, schools and religious
institutions in the area.
5. Strong visibility and easy access – Strong
visibility means that the business is easily visible
to pedestrian and vehicular traffic and easy access
means it is easy to get to the location by either
foot traffic or vehicular traffic.
6. Heavy pedestrian and vehicular traffic
– With these two qualities the business will have
more exposure and have a greater opportunity to
increase sales.
7. Major market generators - Strong
traffic generators include hospitals, theaters,
colleges, shopping centers and tourist attractions.
8. Rent Affordability - This means
that you can afford the rent you will be paying.
Frequently operators pay more rent then they should
and this can contribute to them going out of
business. Restaurant operators should not pay more
than 6% to 8% of their sales in rent. This 6% to 8%
factor also includes any additional costs you may be
paying the landlord which may include real estate
taxes, fire insurance and CAM charges (common area
maintenance costs) which include security,
gardening, common area utilities and maintenance
costs, etc. This means that if you are doing
$600,000 in yearly sales your rent should be no more
than $48,000 ($600,000 sales x 8% = $48,000) in
yearly rent.
9. Trade Area Draw - This is the
distance an average customer will travel to come to
your restaurant. Most neighborhood restaurants draw
customers from a one mile radius of the site.
Outstanding planned dining restaurants such as the
French Laundry in Yountville, Michael Mina and Gary
Danko restaurants in San Francisco may draw
customers from hundreds of miles away.
The price of the business, location of the business
and the lease terms (which will be discussed in the
next edition) are the three most important variables
a buyer will evaluate to determine if the business
is right for them. If you are considering selling
your business it is important to consider these
items in determining how marketable your business
will be and consult with a professional like
Restaurant Realty Company to give you an unbiased
assessment.
Lease Terms
The lease terms will be discussed in the first
issue of 2012 .
Peter Osborne
-
Momo's, Pete's Tavern, Pedro's Cantina & more!
Peter Osborne is a native restaurateur who has been
in the business in the Bay Area since he was 15.
Starting out as a dishwasher at Sid & Jims in Mill
Valley, he then worked at Victoria Station in
Larkspur as a busboy; then on to Sam’s Anchor Café
in Tiburon as a busboy and waiter while attending
San Francisco‘s City College Hotel and Restaurant
School from which he graduated; He then worked for
Rusty Scuppers for 6 years as a bar manager, kitchen
manager and general manager. His next few years
included working for Borel’s in San Mateo as General
Manager; Kimpton Group for 1 year; Fior D’Italia for
5 years as Maitre’d and Manager.
In 1991 he bought Mulhern’s in the Marina district
out of bankruptcy and changed it into Buchannan
Grill. In 1995 he bought the fabled Washington
Square Bar & Grill. In 1996 he had the vision to
realize that with the SF Giants Ball Park opening
that there was a need for restaurants in that area.
He and his investors built Momo’s which opened in
1997 and sold Buchannan Grill and Washington Square
Bar and Grill shortly thereafter. He opened Pete’s
Tavern in 2007 and Pedro’s Cantina in 2010. All of
these restaurants are on the King Street corridor
across from AT&T Park. He is often called the king
of King Street because of his ownership of these 3
businesses. He purchased Kelly’s Mission Rock in
December of 2011 in the bankruptcy court and will be
opening it sometime in 2012 as a seafood restaurant.
Three of his restaurants are on the same block and
the newest restaurant is on the other south side of
the ballpark and a 25 minute walk from his other
restaurants.
Pete’s operating philosophy is hospitality,
hospitality, hospitality, great food, great service
with a solid entertainment component. It’s important
to have strong interaction with décor, music, and
lighting. Pete thinks that it is an exciting time in
San Francisco with the development of Mission Bay,
the upcoming America’s Cup and he says the wind is
blowing towards Mission Bay-a strong component in
the new development of San Francisco. Restaurant
Realty is pleased to have assisted Peter in the
purchase of Kelley’s Mission Rock and wishes Peter
continued success in all of his endeavors.
