When the buyer is purchasing a restaurant, bar or club the purchase includes 1. Fixtures and Equipment, 2. Licenses, 3. Leasehold Improvements, 4. Premises Lease, 5. Goodwill, 6. Cash Flow and 7. Covenant Not to Compete. All of these items are discussed in depth as indicated below.
- Fixtures and Equipment. This includes all the fixtures and equipment which are included on the equipment lists which accompanies the purchase contract at the time the offer is made. The equipment list is signed by the buyer and seller for the transaction when the offer is made and again it is signed by the seller and buyer when the buyer takes possession of the premises to assure that all of the equipment is in place immediately before the close of escrow. In many situations the seller has personal items such as family paintings and artifacts, unique equipment such as a pasta maker and other personal items which are not included with the sale. In this case these items should be indicated on the fixtures and equipment list as items not included with the sale to make it perfectly clear to the buyer what is and what is not included in the sale. There are times when some of the equipment is leased or rented. If the equipment is leased it may be a condition of the sale that the buyer formally assumes the equipment lease at the close of escrow. If this is the case the leased equipment list should be disclosed to the buyer before the offer is made and the lease will include the monthly payments and the current balance on the lease. Most equipment leases are set up so at the end of the lease term the buyer pays a fixed nominal amount (sometimes only one dollar) and then the buyer owns the equipment. Another possible situation is that some of the equipment is rented in which case the buyer normally has the option to terminate the rental agreement if he desires and have the rented equipment removed from the premises. There are some situations where all the equipment may be owned by the landlord and the tenant is responsible for maintaining it and replacing it when necessary during his tenancy. Usually attached fixtures such as duct systems and hoods, some built ins such as the bar, counters, back bars, etc. belong to the landlord when the tenant vacates. These items are normally spelled out in the premises lease with the appropriate schedules attached.
- Licenses. Included in the sales price are the operating licenses such as any food or bar permits necessary to operate a restaurant, bar or night club and any other licenses such as alcohol beverage control licenses, entertainment licenses or franchise licenses, etc. Although these license are included in the sale the buyer has to go through a transfer process which requires them qualifying for these licenses and paying transfer fees.
- Leasehold Improvements. These include the heating, ventilating, air conditioning, plumbing, and electrical systems which the tenant has use of during his tenancy. The tenant is usually responsible for the maintenance and/or replacement of these items although these items belong to the landlord at the end of the lease and can not be removed from the premises.
- Premises Lease. The premises lease is probably the most valuable item one is acquiring when they purchase the business. The premises lease is a legal contract between the tenant and landlord which gives the tenant the right to occupy the premises. The lease is analogous to a promissory note to the bank. It is a legal contract which obligates the tenant to make a designated number of payments for a designated number of years to the landlord. For example if the tenant has a five year lease and the monthly payments are as follows: year 1 – $4,000 ($48,000 per year), year 2 – $4,250 ($51,000 per year) , year 3 – $4,500 ($54,000 per year), year 4 – $4,750 ($57,000 per year), and year 5 – $5,000 ($60,000 per year). This translates into the tenant being legally obligated to pay the landlord $270,000 ($48,000-year 1+$51,000-year 2 +$54,000-year 3 +$57,000-year 4 +$60,000-year 5 = $270,000) over a five year period. The terms and conditions of a lease include paying the rent on time, maintaining the premises in good condition and respecting the rights of adjoining tenants and neighbors in the area. I recommend that in order to control your business destiny you should ideally have a five to ten year base term with several five year options with a clear definition of your rent payments for the entire projected duration of your stay at the premises.
- Goodwill. This is the reputation of the business occupying the premises immediately before the new tenant takes possession of the premises. It consists of the trade name of the business, the menu and menu items, all the business systems – service systems, standard operating procedures, intellectual property, trade marks, phone numbers, fax numbers, email addresses, websites, etc. If you are buying a going concern business which is a business which is making money then goodwill is extremely important. A buyer buying this type of business will generally not change anything about the business and will try to run the business exactly as the prior owner did. Even if you are not buying a going concern business and are buying an assets sale goodwill is still important as the prior business drew some customers and was most likely a similar business to the one you will operate and some of their customers will be potentially your customers.
- Cash Flow. If a buyer is buying a going concern business, a business that is profitable, the buyer is also acquiring the cash flow or profits of the business. The cash flow of the business is an important component of the purchase price. A buyer’s motivation for buying a going concern business is largely driven by the profits the business makes. Gong concern businesses will sell for 1 to 3 + times yearly adjusted cash flow. Yearly adjusted cash flow is the actual cash flow benefit that the owner receives yearly from running the business.
- Covenant Not To Compete. When you purchase a business you can negotiate with the seller that he will not compete against you within a certain radius from the business being purchased in similar business for a certain number of years from the close of escrow date. This is to protect you from the seller stealing your customers which is a major component of the price of the business you are purchasing which is called goodwill as discussed above.