Generally there are four different valuation methods used to value a food and beverage business.
A. PERCENTAGE OF REVENUE: One method is the percentage of revenue. This method, in my opinion, has some serious flaws and leads to bad valuations. I don't suggest using it.
That being said, to derive a value, one merely selects a percentage, say 30%, and multiplies it by the revenue or sales of the business not including sales taxes.
For example, if the business revenues are $1,000,000 and the percentage factor is 30%, then the business value is $300,000. This method is used when financials are not readily available and/or are not accurate.
To determine what percentage is used, one considers five factors: (1) the strength of the revenue - are they growing, flat or shrinking; (2) the condition of the facility - does it need a facelift or is it in great shape; (3) the lease and location - is the rent fair market, below market and is the location good; (4) the strength of the management team and cost management of the business - does it run industry standard margins? and finally; (5) the type of restaurant business - easy to operate or a complex fine dining restaurant?
I generally look at each item and assign a number between 1 and 6, 6 being it's awesome and 1 being not so good. The closer the average is to 6, the closer the percentage factor is to 40%-50%. The close to 1, then the percentage will be closer to 20%.
B. SELLER'S DISCRETIONARY INCOME(SDI): This method takes education, financial statement reading skills, and skills to accurately apply the accounting concepts. This is the standard banks use to give loans. Few brokers have the training and talent to accurately perform this analysis.
Simply said, SDI attempts to identify all the seller's perks including salary, payroll taxes, personal auto expenses, medical insurance and any other personal items included in the profit and loss statement that's truly not a business expense. The key wording is "included in the profit and loss statement." All too often some people think draws are add backs when in fact they are not included in the profit and loss statement and are mere balance sheet entries to the owner's equity.
To arrive at a value one uses the SDI and multiplies it by a market multiple factor. Every region and country has differing multiple factors and only a well trained and educated broker can help determine what should be used. For example, the average multiple across the U.S. is about 2.2 times. That means one takes the SDI and multiplies it by 2.2 to determine the value. However, every region has differing multiples. In California for example, the multiple tend to be significantly higher than say Phoenix or Kansas. Why? I think it is in the variability of the earnings. The higher the variability, the lower the certainty; therefore the lower the multiple. California's multiples tend to be in the 2.5-3.0 range while in Phoenix they tend to be in the 2.0 to 2.2 range. In Phoenix, for example, restaurant sales in the hot summer months drop as much as 50%, placing higher risk than say Los Angeles where season variability is minimal.
I use the same logic to determine the multiple as I do in the example of Percentage of Revenue method described above and adjust for regions. A 4 will receive a multiple in the 2.8-3.0 range while a 1 will receive a 1-1.5 range.
C. CAPITALIZATION OF INCOME: This technique is widely used to value income producing assets such as commercial real estate. The premise is based on what the market expected return on investment is at the time the transaction takes place.
The SDI must be calculated first as described above in Section B. Then SDI is divided by the capitalization rate (Cap rate) to derive the value. For example, if the business' SDI is $100,000 and the determined Cap Rate in the area for this particular type of restaurant is 30%, then the math is $100,000/.30 = $333,333.
To determine the cap rate is the challenge and a simple drop of a few percentage points can make a huge difference in price. For example, in the above example, if the Cap Rate were 35% the value would be $285,000.
There are several considerations to think about when trying to determine the proper Cap Rate. First, the higher the risk of the investment, the higher the percentage used. In other words, when the income is risky, the expected rate of return the market demands is higher. Restaurants are very risky. So I like to start out at the 35-40% range and go up or down from that point.
Then again I apply the method described above and assign a number to the business. The closer the number is to 4, the closer my cap rate will be to 25-30%. The closer the number is to 1 the closer my cap rate will be to 50%. The lower the CAP rate the higher the value.
D. REPLACEMENT COST METHOD: Finally, the replacement cost method assumes a buyer pays the seller a large premium over the income value and annual gross revenue techniques in order to benefit from the existing investment in the restaurant facility, the lease and the location of the restaurant. In other words, a buyer will pay for the right to avoid spending hundreds of thousands and even possibly a million+ dollar to avoid all the city regulations, delays and headaches of building a new restaurant. How much a buyer pays depends on the buyer's need. Some buyers will pay more for the same space because they may see the value in a lease or location while others may see that they have too much improvements to make to convert to their existing concept.
Be smart about selecting a restaurant broker who knows what he's talking about. Make sure he/she have sold a lot of restaurants in the past, both income generating as well as asset sales and they have the proper university degree and education related to finance. We at SellingRestaurants have sold over 700 restaurants during a tough economy because we know how to market and value restaurants resulting in getting you top dollar! We've done it over 700 times since 2004.
So give us a call and we'll gladly show you how to value a restaurant business!
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CALL Stone Path Brokerage Services, Inc. 619-892-2765 For Details. How do I value my restaurant? It is more of an art then a science; however there is a science behind analyzing financials, which is an important part of a restaurant's value, requiring skills and experience of a good restaurant broker.
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