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The Buyer’s Due Diligence Process – Part II

By in 2012 - Volume 14 with 0 Comments

This is the second series on the buyer’s due diligence process that is essential for a buyer to follow in determining the viability of purchasing a restaurant, bar and/or club.

In addition to the items spelled out in the last article the following items need to be reviewed by the buyer during the due diligence period.

Review of Books and Records

  1. Federal Tax Returns and Sales Tax Returns – The actual sale of a business is determined by a review of the Federal tax returns for prior years’ sales history, and a review of the sales tax returns for the current year’s sales history.
  2. Unreported Sales – Frequently, in the restaurant, bar, or nightclub business, single-unit owner operators do not report all of their sales—which is a violation of the law. Typically the sellers do not receive credit for any sales not reported for tax purposes, as they have already been compensated by receiving increased profits (the result of not paying taxes on unreported sales). However, to truly determine the actual sales of the business, a good restaurant broker will recast the actual sales by tying in the cash register, or point-ofsales system sales tapes, with the guest checks and the invoices, to determine the true sales.
  3. Income-and-Expense Statements and Balance Sheets – Specifically, a buyer needs to review the income-and-expense statements and balance sheets for the prior three years, and for the current year’s year-to-date income-and-expense statement and balance sheet.
  4. Bank Statements – Additionally, the buyer will want to review bank statements for the prior twelve months, evaluating the cash sales and charge sales to help further support the actual reported sales.
  5. Invoices – The buyer will also want to review invoices for various items including: 1) a detail of the premises rent. This is especially true if there are NNN expenses which will detail the monthly common-area maintenance costs such as taxes, insurance and maintenance costs, or 2) any tax bills the buyer may be responsible for, such as property taxes or unsecured personal property taxes.
  6. Buyer’s Discretionary Cash Flow Statement – The broker will also prepare a buyer’s discretionary cash flow statement, which is the actual income-and-expense statement recast. This means adjusting the income and expense categories to truly reflect the actual cash benefits the owner is receiving.

Review of Special Licenses
If the business being purchased has a license allowing the owner to serve alcoholic beverages, you want to examine those licenses to see if there are any special conditions attached, such as restrictions on certain days and hours when you can’t serve alcoholic beverages. If you are buying a nightclub with an entertainment license, you need to review the conditions to see what days and hours you are allowed to provide entertainment, and what type of entertainment you can provide, such as dancing, live music, DJ, and karaoke. Specifically some licenses will allow live music, but only certain types, such as live music, but with no amplified instruments.

Review of the Premises Lease
Make sure if you are assuming an existing premises lease that all of the terms and conditions, and length of the lease are adequate. Make sure the lease is transferable, subject to the approval of the landlord, and that the existing rent and future rent schedules will work for your operation.

Other Agreements to Review

  • Franchise Agreement – If you are purchasing a franchise business, make sure to review the terms of the franchise agreement in detail. Make certain that the length of the franchise agreement is long enough to satisfy your business requirements.
  • Equipment Lease – If you are assuming an equipment lease, make sure you understand the terms of the equipment lease, and determine if the equipment will belong to you at the end of the lease, or if it reverts back to the equipment lessor. Most equipment leases at the end-of-the-lease period belong to the owner of the business for a nominal payment (like $1) at the end of the lease.
  • Phone Book Yellow Page Contract – In some cases, you will be assuming the “Yellow Page” phone book annual contract, so review this contract.
  • Equipment Rental Agreements – Some equipment is rented on a month-to-month basis. If you do not want to continue this agreement, you can usually give a 30-day notice to terminate this agreement.
  • Seller’s Disclosure Statement – This agreement discloses all of the seller’s possible business problems, and is completed by the seller, and submitted to the buyer before he enters into the purchase contract. Review it carefully to make sure there are no pending lawsuits, no major future developments in the area which may hurt your business, or any other factors which will negatively impact your business.
  • Attorneys Review of Documents – The buyer must have his attorney review the various legal documents used in the business. If the operator is not familiar with some legal points, there could be legal restrictions that are unacceptable to him, but need to be renegotiated before the operator purchases the business. It is prudent to have the lease reviewed by the operator’s attorney to assure that the current and future terms and conditions are acceptable, Section VII has additional information regarding the lease. The operator’s attorney should also review any other legal documents, if applicable, including the franchise agreement, the equipment lease, and all use permits—food permit, alcohol license, conditional-use permit and entertainment permit, etc. All of the above-mentioned documents have terms and conditions which legally bind the operator. Noncompliance with the terms and conditions could result in the operator losing his right to continue running the business, or force him to run the business in a compromising way, which could have a negative impact on the his sales and profits.
  • Accountant Review of Financial Statements – It is important to have the operator’s accountant review all the business financial books and records. This assures that the seller had properly recorded all of the businesses income and expenses activities, and that the financial statements accurately reflect the true financial picture of the business.
  • Review of all Web related contracts / accounts – It is important to review all web related contracts and accounts. Make sure you understand the domains and/or websites that will be transferred to you, social media sites (ie. facebook pages/twitter accounts), details on any discount coupons outstanding (ie. Groupons), details for managing directory site accounts (ie. Yelp, TripAdvisor, CitySearch, etc.), email addresses used for managing these sites, email marketing list, online reservation/delivery contracts, etc.. This information is especially relevant when you are assuming the restaurant name/menu.

Restaurant Realty works closely with their clients throughout the due diligence process to assure all of the above items are thoroughly reviewed.

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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 1000 restaurant, bar or club businesses, sold many commercial buildings and completed over 4,000 restaurant 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