The basic requirements for a good restaurant, bar or club business purchase are detailed below and include the following:
1) a long term lease with a strong tenant landlord relationship,
2) purchasing the business at a reasonable price and not overpaying for the business,
3) choosing a strong location, and
4) locating in a market where qualified employees are available and there is affordable housing.
A Long Term Lease with a Strong Tenant Landlord Relationship.
A tenant landlord relationship is a long-term partnership and it is important that you have a good relationship with your landlord as you will need the landlords support present and in the future.
The basic requirements for a good lease are as follows:
a. Lease Term -A five (5) year base term with a fair rent.
b. Yearly Rent Adjustments not to exceed three (3%) year.
c. Options -Several five (5) year assignable options with the future rent defined (the rent for first year of the option and subsequent yearly rent increases should be spelled out not to exceed three (3%) per year).
d. Use Clause – A flexible use clause should you need to change the concept in the future.
e. Additional Occupancy Costs such as real estate taxes, building insurance costs and common area charges (CAM) to be capped so you know what your future additional occupancy cost exposure will be.
f. Assignment and Subleasing -Reasonable lease transfer language including assignment and sublease language – giving you the right to sell your business and assign and/or sublet the space as well as to allow the buyer to negotiate a new lease.
g. Guarantor – Try to have an entity such as a corporation or limited liability company be the lease guarantor to minimize personal lease liability exposure.
h. Landlord Contributions – In a lease opportunity where the restaurant space is vacant or when the landlord wants to get rid of an undesirable tenant there may be a opportunity where the landlord is willing to provide the new tenant with a tenant improvement allowance and/or free rent.
Purchasing the Business at a Reasonable Price and not Overpaying for the Business.
There are two basic methods for determining the value and price of a business.
a. Going Concern Valuation Method -This is the first valuation method which is used for businesses that are reasonably profitable and the buyer is purchasing an ongoing business which includes the name of the business, its menu and all of its systems including its proprietary items (intellectual property, phone and fax numbers, logos, standard operative procedure manuals, recipes, etc.). Additionally, the lease, leasehold improvements, fixtures and equipment, licenses and goodwill are all included as part of the sale. The primary valuation method used for the Going Concern Valuation Method is the Sellers Discretionary Earnings (SDE) Method. These types of businesses usually sell for a multiple of Sellers Discretionary Earnings and multiples will range from 1 to 3 (for non-franchised and non chain restaurants) depending on the degree of difficulty in operating the business. Franchise and chain business multiples will vary pending their historical sales. Sellers Discretionary Earnings 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, 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 expense on any loans, net operating loss carry forward charges, if any, and any other expenses which are personal and will not be applicable to the buyer. Additionally, any extraordinary expenses and/or non-recurring expenses such as additional legal or accounting bills related to a particular lawsuit, audit or unusual situation would be added back to the net income as well as major equipment items purchased that have been expensed versus being capitalized should be added back too.
b. Assets in Place Valuation Method – This method is used for businesses that are not making money or are marginally profitable. In this type of sale, the buyer will change the business name, menu and possibly remodel the restaurant with an entire new concept. This method means that only the lease, leasehold improvements, licenses, fixtures and equipment are being sold. The name, menu, concept and goodwill are normally not included as part of the sale. With this method less emphasis is put on the financials of the business (however the buyer will want to know the sales history of the business as well as the history of costs such as insurance, utilities and occupancy costs that will still be applicable to the buyer’s new operation). There is no standard formula for determining value utilizing this method and valuation is somewhat subjective based on the broker’s knowledge of the market place. Restaurant Realty has sold over 1,000 restaurants, bars and clubs and completed over 4,000 valuations on restaurants, bars and clubs since 1996. A large number of these sales have been sold by the Assets in Place Method. The main criteria we use in this method is using the sales price of past businesses sold compared to the sales volumes on the past restaurants that we have sold. Assets in Place businesses sell from anywhere between 17% of yearly sales of the business being sold to 30% of yearly sales of the business being sold and, in some cases, adjustments are made to this formula.
c. A combination of the Going Concern Valuation Method and the Assets in Place Valuation Method. In some cases, we will use a combination of the above two methods discussed depending on the individual circumstances of the business.
Choosing a Strong Location
You want to make sure that the location you are choosing is not vulnerable to being occupied by too much new head on competition so you should pick a location whereby the surrounding area is developed and well-built out. You need to research with the local city planning and building departments in the area where you plan to open your business to learn what are the short term and long-term development plans in this area. Make sure the subject location is not vulnerable to an eminent domain / condemnation proceeding where the government has the right to take over the location and purchase it from the landlord at fair market value. If you are a tenant in this situation you will undoubtedly lose your space and get nothing for your investment. Choosing the right restaurant location is one of the most important factors in contributing to one’s 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 right location are as follows:
a. Rent Affordability– This means that you can afford the rent you will be paying based on your conservative sales projections.
b. Demographics to Match Your Concept Requirements– Demographics are the population statistics in the neighborhood of your proposed restaurant within a given radius of your site. In researching your concept, you want to make sure that the neighborhood population can financially support your restaurant.
c. The Demographics Include the Following Factors: 1) Per capita income – the yearly earnings per person. 2) Household income – the yearly earnings per family household. 3) Education levels – education levels broken down by persons holding a high school diploma, undergraduate degree and graduate degree. 4) Percent of income available for spending on food purchases away from home. 5) A breakdown of ethnic mix in the area. 6) Number of people living in the area.
d. Trade Area Draw– This is the distance a 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 may draw customers from hundreds of miles away.
e. Major Market Generators in the Neighborhood – Ideally you want to have a mix of the following in the immediate area of your restaurant: 1) A strong residential population. 2) A strong retail area with lots of foot traffic and vehicular traffic. 3) Strong traffic generators such as hospitals, theaters, colleges, shopping centers, large office complexes and tourist attractions.
Locating in a Market where Qualified Employees are Available and there is Affordable Housing.
This one is very important as you can’t staff your restaurant unless you have an adequate employee base. Qualified employees are one of the most important assets of the business and if there is a shortage of qualified employees in the area of your proposed business you may want to reconsider operating a business in this area. The primary items that will lead to a shortage of qualified employees in an area is the high cost of living which is largely a result of the high cost of housing in that area. In high cost of living areas restaurant employees can’t afford to pay the extravagant rents let alone own a home in these areas. In most of the San Francisco Bay Area counties including San Francisco, San Mateo, Santa Clara, Marin, Sonoma, Napa, Contra Costa and Alameda Counties as well as many counties throughout Southern California restaurant employees can’t afford the housing costs. Consequently, there is a shortage of employees in these areas and many employees travel long distances (1 to 2+ hours each way) to get to work which puts added stress on them which leads to burnout with these employees leaving their jobs and working in affordable areas closer to their home. Many restaurant operators in high cost of living areas have had to reduce their hours and/or days of operation (which would normally be profitable hours and/or days of operation) because they can’t find qualified employees to staff their businesses. Additionally, operators have to pay above the prevailing minimum wage in order to attract front of the house employees and substantially higher than the minimum wage for back of the house employees.