How is a Restaurant, Bar, Club or Other Food Service Business Valued During this Post Covid Period and How Have Business Values Been Impacted by Covid?
Businesses have been impacted to varying degrees based on how well they pivoted during this challenging period. Those businesses that shifted to take out and delivery and outdoor seating performed better than those that did not adjust accordingly.
Overall, most food service businesses that were not modeled so that the majority of their sales were takeout and delivery with large outdoor seating areas pre-Covid suffered dramatically.
How do we adjust for the negative impact Covid has had on a business’s financial performance between March 2020 and today? Each business is handled independently subject to the impact Covid had on its individual performance.
There are two basic methods for valuing a restaurant, bar, club or other food service-related business which are discussed below – the Assets in Place Method and the Going Concern Method. These two methods don’t include saleable inventory which include food, non-alcoholic and alcoholic beverages, paper supplies and cleaning supplies which the buyer pays for in addition to the purchase price should the buyer desire to purchase these items.
Assets in Place Method of Valuation – If the business is not making money or is marginally profitable this is called the Assets in Place sale.
With these types of sales, 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 usually 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 and have come from the over 1,000 sales comps that we have completed in the past twenty six years. Businesses generating $300,000 or less in yearly sales are selling on an average of twenty-six-point four percent (26.4%) of yearly sales. For example, if a business is doing $300,000 in yearly sales the average sales price is approximately $79,200 ($300,000 yearly sales x 26.4% = $79,200 sales price). Businesses generating between $300,000 to $1 million in yearly sales are selling on an average of twenty-three-point three percent (23.3%) of yearly sales. For example, if a business is generating $500,000 in yearly sales and the sales price is $116,500 – the sales price is approximately twenty-three-point three percent (23.3%) of the yearly sales ($500,000 yearly sales x 23.3% = $116,500 sales price). Businesses generating over $1 million of yearly sales are selling on an average of fifteen-point eight percent (15.8%) of yearly sales. For example, if a business is doing $1.5 Million in yearly sales it will sell for approximately $237,000 ($1.5 Million yearly sales x 15.8% = $237,000 sales price). Remember the above metrics are averages and there are usually extenuating circumstances in each deal which result in the above metrics being either higher or lower than the averages indicated above. We have found over the years that the metrics for the assets in place sales have declined. We believe this is the result of the accelerated number of independent non franchised non chain restaurants that have opened in recent years ending up failing quicker than in previous years due to the increased costs (primarily food, labor and occupancy costs) of doing business in California.
Going Concern Method of Valuation
The Going Concern Method normally means that the business is profitable 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 Seller’s Discretionary Earnings (SDE). 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 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 SDE depending on the risk factors and other factors listed below. From Covid to current multipliers have dropped from an average of 2.2 pre Covid to 2.03 post covid.
Multipliers have been reduced even prior to Covid and Covid accelerated multipliers to drop further. I think this is a result of generally most operators’ profit margins dropping over the years as costs have risen far greater than the operator’s ability to offset them by increased menu prices.
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 Sellers Discretionary Earnings (SDE) 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 SDE multiplied by 2.5 (the appropriate multiplier to be used based on the facts discussed above) which equals $187,500 ($75,000 SDE times 2.5 = $187,500 sales price).
In utilizing the Going Concern Method we usually use the three most current years for valuation and we use an average weighted method with the most weight being put on the current year’s performance as this year is usually most indicative of the future performance of the business. The next most recent year is next weighted and is lower than the most current year but higher than the businesses third most recent year of performance. Since Covid occurred during the past three years we usually eliminate 2020 in the analysis all together and put a lower weighted average on 2021 as this year represents a year still under Covid although improving over 2020.
Using a combination of the Assets in Place Method and the Going Concern Method of Valuations
In order to obtain the maximum sales price for a seller we will in some cases use a combination of both of these above-mentioned methods. This is especially the case during these challenging times. With this approach in some years when the business is not profitable, we’ll use the Assets in Place Method and in other years when the business is profitable, we’ll use the Going Concern Method and we’ll use an average weighted method as described above using these two approaches.
Putting a value on a restaurant business in today’s economic environment must be finessed. We at Restaurant Realty have the experience to help get the maximum value for your business. Please reach out to us if you need further information.
If you would like further information regarding valuations or any of the above information please contact Steve Zimmerman at email@example.com.
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