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How Buyers Evaluate a Restaurant, Bar or Club Business to Determine if it is the Right Opportunity – Part 1

By in 2011 - Volume 13

(Revised 5/12/24 from the original article written 12/30/11)

I originally wrote this Restaurant Rap article in 2011 and since that time this article has been among our most popular articles read.  I thought it was appropriate to update it which I have done below.

Since 2011 we have completed an additional 850+ transactions and in total since 1996 when I founded Restaurant Realty Company, we have completed over $1,000,000,000 (billion) of business and real estate transactions.  This includes selling over 1,600 restaurants, bars, clubs, and related commercial buildings and leasing over 3 million square feet of commercial space.

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:

  1. Sales Price Valuation
  2. Location Overview
  3. Lease Terms.

In this article, I will discuss Sales Price Valuation and in the near future will update the Location Overview and Lease Terms articles.

SALES PRICE VALUATION

A buyer evaluates the price of the business to determine if it is reasonable based on three major different valuation methods.  The first valuation method is the Assets in Place Valuation Method, the second is the Going Concern Valuation Method and the third is the Earnings Before Interest, Taxes, Depreciation and Amortization Method (EBITDA) which are all discussed in detail below.

Assets in Place Method of Valuation 

If the business is not making money or is marginally profitable this is called an Assets in Place purchase. In cases where businesses are profitable and the seller does not want to include the name, menu, and other proprietary items we will us this valuation method as well.  With these types of purchases the buyer is purchasing the fixtures and equipment, lease, leasehold improvements, and any licenses that go with the business.  They are not normally interested in the name and menu and/or the proprietary items. The buyers for this type of business have their own menu and concept in mind. The criteria for pricing the Assets in Place business are the ratio between the sales price and the business sales from past completed Restaurant Realty transactions.  For example, if the business did $400,000 in recent annual sales and was marginally profitable and sold for $100,000 we divide the sales price of $100,000 divided by $400,000, the yearly sales which equal 25% ($100,000 sales price/ $400,000 business sales = 25%).  We then state that the business sold for 25% of sales.  

We have four categories for Assets in Place Valuations which are indicated below.  

Our first category for Assets in Place Valuations is for businesses doing $499,000 or less in yearly sales and our average sales comp metric is 26.43% of yearly sales.  In our analysis we use our sales comps for a 6-year period – 2018- 2023 with 39% of our total sales comps coming from 2018 through early 2020, the pre-Covid years and 61% of our total sales comps coming from March 2020 through 2023, the Covid and post-Covid years.

A specific example of this category is as follows:  a business is doing $450,000 in yearly sales and the valuation will be $118,935 which is calculated as follows: $450,000 yearly sales x 26.43% = $118,935 sales price.  In this example and all three other Assets in Place Valuation categories discussed below when calculating the yearly sales, we use the most current year’s sales and if we are doing the analysis in a partial year, we will possibly annualize the year-to-date sales to calculate the yearly sales assuming the business has historically not had seasonal sales fluctuations.  If the most current yearly sales are an extraordinary year such as Covid or the Great Recession we will disregard that year and analyze the most current stabilized year’s sales results.

The second category for Assets in Place Valuations are for businesses doing between $500,000 to $999,000 in yearly sales and our average sales comp metric is 20.53% of yearly salesIn our analysis we use our sales comps a 6-year period – 2018- 2023 with 39% of our total sales comps coming from 2018 through early 2020, the pre-Covid years and 61% of our total sales comps coming from March 2020 through 2023, the Covid and post-Covid years.

A specific example of this category is as follows:  a business is doing $750,000 in yearly sales and the valuation will be $153,975 which is calculated as follows: $750,000 yearly sales x 20.53% = $153,975 sales price.

The third category of Assets in Place Valuations are for businesses doing $1 million or more  in yearly sales and our average sales comp metric is 17.97% of yearly sales.  In our analysis we use a 6-year period, 2018- 2023 with 24% of our total sales comps coming from 2018 through early 2020, the pre-Covid years and 76% of our total sales comps coming from March 2020 through 2023, the Covid and post-Covid years.

A specific example of this category is as follows:  a business is doing $1,250,000 in yearly sales and the valuation will be $224,625 which is calculated as follows: $1,250,000 yearly sales x 17.97% = $224,625 sales price.  

The fourth category of Assets in Place Valuations is the Combo Method which uses all sales comps in the above three categories and our average sales comp metric is 23.04% of yearly sales.  In our analysis we use a 6-year period, 2018- 2023 with 37% of our total sales comps coming from 2018 through early 2020, the pre-Covid years and 63% of our total sales comps coming from March 2020 through 2023, the Covid and post-Covid years.

.A specific example of this category is as follows:  a business is doing $800,000 in yearly sales and the valuation will be $184,320 which is calculated as follows: $800,000 yearly sales x 23.04% = $184,320 sales price.  

In all four Assets in Place Valuations Methods the metrics used above are averages and there could be some variances in values and sales comp metrics used subject to the following:  1)  the quality of the location, 2) the premises lease terms and conditions, 3) the condition of the business improvements and 4) the value of the hard liquor license, if applicable.  Additionally, if the buyer wants to purchase the salable inventory (food, beverage, cleaning supplies and paper supplies) the buyer will pay extra for these items at the sellers cost based on a physical inventory to be taken at the close of escrow.

Going Concern Valuation Method

This method means that the lease, leasehold improvements, fixtures and equipment, licenses, name, menu, concept, goodwill, and all proprietary items (website, domains, email addresses, social media accounts, etc.) are all included as part of the sale. The primary valuation method used for the Going Concern Method is the Seller’s Discretionary Earnings (SDE) Method. 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, 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, net operating loss carry forward charges, 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. Also, if the seller has bought a major piece of equipment that was supposed to be capitalized on the balance sheet and they expensed it instead on the Income & Expense Statement an adjustment would need to be made for this as well.  Once the Sellers’ Discretionary Earnings (SDE) 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 Selles Discretionary Earnings depending on the risk factor and other factors listed below. Independent chains and franchises have their own multipliers based on their unique sales comps for their specific concepts.

The risk factor is determined by the criteria indicated below: 

  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.
  2. How long the business has been in operation and the 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 indicted below:
    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 a beer and wine license where there is potential for a strong lunch and/or brunch business and liquor sales with the addition of a hard liquor ABC.
    3. The future growth opportunities of a particular location. For example, if there is 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 Sellers Discretionary Earnings business are $75,000 and the multiple to be used is 2.5, the value of the business would be calculated as indicated: $75,000 (Sellers Discretionary Earnings) multiplied by 2.5 (the appropriate multiplier to be used based on the facts discussed above) which equals $187,500 ($75,000 Sellers Discretionary Earnings times 2.5 = $187,500 sales price).  Additionally, if the buyer wants to purchase the salable inventory (food, beverage, cleaning supplies and paper supplies) the buyer will pay extra for these items at the sellers cost based on a physical inventory to be taken at the close of escrow.

In utilizing the Going Concern Valuation Method we use the most current three years of tax returns and calculate the Sellers Discretionary Earnings (SDE) for each year. If we are utilizing the most current year’s results and a tax return has not been prepared for the current year we will calculate the year to date SDE from the most current year to date Income and Expense Statement and then annualize and/or adjust it for seasonal sales and profit fluctuations.  

We then use the Weighted Value Method to calculate our final vale and please see below an example of how this works.  The weight factors for individual years will vary depending upon each individual location and the circumstances regarding sales and expenses for individual years.  For example, if a business is taking longer to recover from Covid or some extraordinary negative year we will put a heavier weight factor on later years after these extraordinary years and less of a weight factor on the years closer to negative years financial results.

Weighted Value Method for the Going Concern Valuation Method

We weight the past 3 years values to determine my recommended value. 2023 the most recent year is given the most weight and is assigned a 40% weight factor as this year is most indicative of the business’s future performance. 2022 is given a 35% weight factor and 2021 is given a 25% weight factor.

The Value Based on the Weighted Value Method Using the Going Concern Method is roundly $220,000.  

The Earnings Before Interest, Taxes, Depreciation, and Amortization Valuation Method  (EBITDA)

This method is utilized for larger businesses where the owner is not working directly in the business functioning as the General Manager and/or Executive Chef/Kitchen Manager.  The owner is these larger operations with higher sales volumes have a General Manager and full staff and works in an overall supervisory function.  In calculating the EBITDA, we make similar adjustments to the net income on the tax return or year to date income & expense statement as the Going Concern Method however we do not add back to the calculation of EBITDA the general managers salary and/or perks (health insurance, auto allowance, vacation pay, etc.).  However, if the owner is paying himself compensation other that for performing a specific function, then this amount would be added back in calculating EBITDA.  The multiples used in calculating this method are usually higher than the Going Concern Valuation Method and are in the three to five times EBITDA range depending again upon the risk factors and other factors as discussed above in the Going Concern Valuation Method explanation.

If you would like to obtain more details on any of the above valuation methods, please contact Steve Zimmerman at steve@restaurantrealty.com.

About Restaurant Realty

Now celebrating our 28th year, Restaurant Realty Company® has a successful track record helping over 3,200 clients in completing over $1,000,000,000 (billion) of Business and Real Estate Transactions including the following: Selling/leasing over 1,600 restaurant, bar and/or nightclub businesses, Selling over 70 related commercial buildings,  Leasing over 3 Million square feet of commercial space and Completing over 5,000 valuations. The majority of our staff have either owned and/or managed restaurants. Our deep experience as operators means we understand your business from the inside out. Restaurant Realty has Closed Escrow and/or Leased 350+ Deals since Covid!

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About The Author
Steven Zimmerman, CBI, M&AMI, CBB, FIBBA

Steve is the Founder, Principal Broker and Chief Executive Officer of Restaurant Realty Company. Steve has personally sold/leased over 1,000 restaurant, bar and/or nightclub businesses and many related commercial buildings totaling 2+ million square feet of commercial space, collaborated with over 2,000 clients and completed over 3,000 valuations since 1996.His real estate experience also includes sales, acquisitions, management and ownership of numerous properties throughout California including restaurants, hotels, apartment buildings, single family houses, an office building and a multi-use retail building. Steve is also the author of Restaurant Dealmaker – An Insider’s Trade Secrets for Buying a Restaurant, Bar or Club available on Amazon. Prior to starting Restaurant Realty Company Steve had over 20 years of restaurant experience and was President and Chief Executive officer of Zim’s Restaurants, which was one of the largest privately owned restaurant chains in the San Francisco Bay Area. READ FULL BIO | HIRE EXPERT WITNESS - LEARN MORE