Generally there are four different valuation methods used to place a value to a restaurant or bar.
A. PERCENTAGE OF REVENUE: One method is the percentage of revenue method. 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 had revenues of $1,000,000 and the percentage factor of 30% was used, then the business value is $300,000. This method is used when the financials are not readily available or are not accurate.
To determine the percentage to use, one takes into account five factors. (1) the strength of the revenue, (2) the condition of the facility, (3) the lease and location (4) the strength of the management and cost management of the business and and finally (5) the type of restaurant business.
I generally look at each item and assign a number between 1 and 4, 4 being it's awesome and 1 being its awful. The closer the average is to 4, the closer the percentage factor is to 40%-45%. The close to 1, then the percentage will be closer to 20%.
This method, in my opinion, has some serious flaws and leads to bad valuations. I don't suggest using it.
B. SELLER'S DISCRETIONARY INCOME(SDI): This method takes some education and skills to accurately apply the concepts, but it is the standard the banks use to give loans to buyers.
Simply put, 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.
To arrive at a value one uses the SDI and multiples it by a market multiple. Every region and country has differing multiples and only a well trained and educated broker can help you determine what you should use. For example, the average multiple across the U.S. is about 2.2 times. That means one takes the DSI and multiples 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. 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.
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 tecnique 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. Then that income 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 is 30%, then the math is $100,000/.3 or $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 return the market demands is higher. Restaurants are very risky. So I like to start out at the 35-40% range and go from there.
Then again I apply the method decribed 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%.
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. We at SellingRestaurants have sold nearly 600 restaurants during a tough economy because we know how to value restaurants, getting you top dollar and how to qualify and find find a buyer for your business!
So give us a call and we'll gladly show you how to value a restaurant business and get top dollar for it.
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CALL 800.576.3615 For Details. How do I value my restaurant? This is more of an art than a science; however there is a science behind analyzing the financials, that is an important part of a restaurant's value, that requires a skilled and experienced restaurant broker.
We at SellingRestaurants feel obligated to educate the public, our customers and our clients with information that can help them make more intelligent buying and selling decisions.
Mel Jones is one of the leading 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.