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AN ASSET IS ONLY WORTH THE INCOME STREAM IT GENERATES!

Apr 8, 2015
Article #292
Author: Mel Jones

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As a restaurant broker for the past 11 years, the number of times I have heard a restaurant owner say "I put $500,000 into this restaurant and I want $500,000 in order to sell it!" 

I reply simply, "that's great and I'll gladly sell it for $500,000 if you can show me you're making $200,000+ a year in owner cash flow."

Of course, they say "of course I'm not making that money, if I were I wouldn't sell it!"

So I go down the road to determine what the cash flow really is and often it is nothing or even a loss. 

That's when I have to have the "conversation of reality economics" with them. 

Reality economics, as I term it, is simply this: an asset is only worth the income it can generate. A restaurant is an asset.  Oh sure a restaurant has a lot of little assets that combined to form one big asset, but the concept is the same. 

People buy income streams and price them according to risk categories.  Restaurants are high risk while the lowest risk asset is a U.S. savings bond. The rate of risk is measure in expected return.  A U.S. saving Bond may give an expected return of 2% while a restaurant's expected return could be 30% on the amount invested. 

A restaurant should generate an income stream, otherwise it is a second generation restaurant space for sale and nothing more. 

Back to our story. This restaurant owner invested $500,000 in a restaurant expecting to get at least a 30% annual return on his or her investment of $150,000 a year.  In today's market that would put the sales price at about $375,000. Are you shocked?  He or she already lost money!

So this tells you that when investing in a restaurant business you need to have at least a 40% return on your investment to maintain its value. 

So this owner is making nothing!  He or she made a bet their investment would pay them $150,000 and they failed. The income stream is gone. No investor cares about how nice the restaurant looks or how much one invested in it. They only care about the income stream the business generates.

Sorry about the bad news, but why would someone pay an owner $500,000 for an asset losing money.  They won't!

That's it folks!

                                                                                                                                                                                                                                                      

Mel Jones is one of the premier restaurant brokers in the nation having published hundreds of articles on buying and selling a restaurant and bar business, selling thousands of restaurants in CA., WA and AZ and building one of the most copied business models in the brokerage industry.  Mel started SellingRestaurants in 2004 with the one simple concept, give the buyers the information they need to make intelligent buying decisions without being pestered by a broker or hiding information, prepare the business for market by researching key details that make or break deals and educate the buyer on the buying process to create an intelligent buyer.  Prior to SellingRestaurants, Mel was a Chief Financial Officer for Universal Music Group, the largest music company in the world.  There he participated in more than $11.5 billion of merger and acquisition transactions.  He also work for top companies such as Nestle Foods, USA. He hold a Bachelors in Business Administration Finance as well as attened Law School at Gonzaga University.  Give Mel a call at 480.274.7000 or e-mail him at [email protected] if you have any questions. 

 


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