What is the value of your restaurant?

You may not be thinking of selling your restaurant right now, but at some future time you may. Also, at some point, you may be thinking about buying a restaurant. In either case, knowing how to establish the market value of a restaurant will help you avoid over or under estimating the price. There are three industry standard approaches to determine the value of a restaurant. Keep in mind that there have been books written on this subject, so this is a general overview.

Let's begin by stating that these formulas are based on the overall condition of the restaurant being very good, especially the kitchen, and there are at least 10 years remaining on the lease.* If the restaurant is outdated or not in good condition, then the cost to refurbish or renovate should be considered.  Having said this, don't overlook counterbalancing factors such as demographics, location, rent, sales and history of success.

1. The first approach is the Gross Sales Approach. This is the most common and simple formula that is based on a percentage of gross, or top line, sales. This figure is typically documented on the tax returns. (This is a very good reason to report all your sales.) The percentage can vary between 20% and 30%.
   

2. The second approach is the Cost-to-Build Approach. If the restaurant is new and there are no documented sales, or if the gross sales are low and the restaurant is in distress, this is the formula to use. Determine the actual cost to build based on a builders cost per square foot and then discount it by 40% to 60%.
   

3. The third approach is based on Sellers Discretionary Earnings (SDE). The definition according to ValuAdder is: "The pre-tax earnings of the business before non-cash expenses, one owner's compensation, interest expense or income, as well as one-time and non-business related income and expense items." Depreciation, amortization and interest paid by the business are items that are discretionary and generally "added back" to the bottom line of the business. Basically this approach is used when there is a documented (tax return) net profit. A restaurant can sell for approximately 1 to 3 times SDE. The higher the percentage the net profit is of gross sales the higher the multiple.

Now that you have a general idea of how restaurants are valued, keep in mind that, similar to real estate, the actual value of a restaurant is only what a qualified buyer is willing to pay for it. In other words local market conditions play a significant roll in influencing the value or price of a restaurant.

Curious about the value of your restaurant? Contact me and I will be happy to a give you a free valuation of your restaurant. There are no strings attached and you can be completely assured that I will maintain strict confidentiality. 

* If you own the real estate, then a separate value must be placed on the building in addition to the business. As a commercial real estate agent, I can guide you on this valuation as well.

What are you buying when you buy a restaurant business?

When a restaurateur asks me to consider selling their restaurant, one of the first things I do is read their lease. It should not be a surprise that the lease typically favors the landlord. However, the tenant has specific rights as well. Recently I read a lease that said that all the equipment and assets of the restaurant were the property of the landlord. It also stated that any new furnishings, fixtures and equipment (FF&E) that were added by the tenant also became the property of the landlord.

This is an immediate red flag. If the landlord owns everything in the restaurant, then what is there to sell to a new buyer? This was not the first time I have seen this; some of the explanations I have gotten for this type of lease are: "A buyer is buying the rights to operate the restaurant" or "a buyer is buying the lease" or "who cares who owns the equipment as long as the buyer can operate the restaurant." These are not justifiable reasons for a restaurateur not to own the FF&E.

It is imperative to realize that when purchasing a restaurant a buyer is buying the ownership of all the furnishings, fixtures and equipment. Tenant improvements, like a bar or other built in improvements are owned by the landlord and are not part of FF&E and can only be changed with approval from the landlord.

If the landlord owns all the FF&E, then there is nothing to sell. Some landlords have taken ownership of the FF&E because their previous tenant defaulted on the lease and left the space owing the landlord several months' rent. When this happens the FF&E becomes the property of the landlord; since the landlord was owed back rent, they are reluctant to give up their ownership. The landlord entices the next restaurateur/tenant by charging little or no key money. If you can save $100,000 to $200,000 or more, why not take the deal? The reason why this is not a good deal is because when it comes time for you to sell the business, you have nothing to sell.  

The legal document that is required to complete the transaction, and show that you are purchasing all the FF&E, is an Asset Purchase Agreement (APA). This does not include food and liquor inventory. An APA is an agreement between a buyer and a seller that finalizes terms and conditions related to the purchase and sale of a company's assets.  Lawyers create this document, which includes a list of all the FF&E. As an experienced restaurant broker, I create this list. It includes silverware, dishes, tables, chairs, artwork (if included in the sale) and kitchen equipment. This is further documented in NY State by filing a Bulk Sales Tax Form.  And in CT it is called Successor Liability for Sales and Use Taxes.  Obviously each State is interested in collecting taxes on the sale. However the numbers have to make sense. In other words you can't substitute "goodwill" for assets. The buyer's attorney and accountant will object to this and the deal will not close.

The important message here is twofold:

1. Read the lease (or use a restaurant broker to read it first)

2. Realize that when you are buying a restaurant business you are purchasing to own the FF&E.

Buying and selling a restaurant involves numerous and very important details that can cost you money or save you money. Involving an experienced business broker who specializes in restaurants will benefit you by bringing to your attention any critical issues and ironing them out before you engage an attorney. This will save you time and money, and insure a smooth closing.

How Much Rent is Too Much Rent for Your Restaurant?

Rent is your largest fixed expense. Food costs are variable. If your food costs are too high, you can make menu adjustments, portion size adjustments or, as a last resort, change your chef or cook to better manage your food costs. Some high-end restaurants offer financial incentives to their chefs to maintain low food costs.

Your labor costs are the next largest overhead expense. If your labor costs are too high you can reduce your staff schedule, and thus your labor costs. You might have to adjust to less staff and possibly move yourself from owner to owner/manager, but it is still within your control to adjust. 

However if your rent is greater than 10% of your sales, and your sales are somewhat maxed out after a series of adjustments to food and labor costs, then your rent is too high.

You have signed a 10-year lease; can you do anything to lower the rent?  Not in most cases. The landlord is under no legal obligation to lower the rent.

How do your avoid this painful situation?  Sales are influenced by the number of seats you have, and rent is influenced by the price per square foot (SF) you are paying. The important formula is that rent should be no more than 10% of your sales (some restaurateurs feel 8% is the right number).

So, let's work the formula backwards by dividing the annual rent by 10% to learn how much annual sales is required to afford the rent.

• Example: A 2,000 SF restaurant at a rent of $50 SF has an annual rent of $100,000 which is $8,333.33 per month.
  
  $100,000 (rent) divided by 10% is $1,000,000 (sales)

So before you sign a lease you now know that you must do $1,000,000 in annual sales, or $19,231 in weekly sales, in order to afford a rent of $8,333 a month. Is this what you expected from your business plan? Of course, for a complete evaluation, the number of seats must be taken into consideration. Review last week's newsletter on Square Feet, Seats and Rent.

It is always wise to know what you need to be doing in sales before you sign a lease. Feel free to contact me at 800-591-0894 with any questions.

Square Feet, Seats and Rent - What is the Correlation?

Having conducted business with restaurateurs for over 20 years, and being a past New York State Restaurant Board member, restaurant brokerage is my expertise and passion.

Let's begin with the correlation of restaurant square feet to number of seats it holds and how that equates to the rent. A few years ago I had two restaurant listings in the same town, both were approximately 1,700 square feet (SF). One restaurant had 70 seats and the other had 44 seats. At about the same rent of $50.00 per SF, which was the better deal? All things being equal, obviously the restaurant with more seats was a much better opportunity. The discrepancy in number of seats was because one restaurant had no basement, so their office, storage space and prep room took up valuable dining space.

Without two restaurants to compare, how do you know what is the right amount of seats for any size restaurant? Believe it or not, there is a formula.

Total SF divided by 2, then divided again by 15 will give you a good estimate of how many seats should fit into a space.

The logic is that 50% of a restaurant is taken up by the kitchen, bathrooms, storage and hallways. The number 15 represents the square foot size of one seated customer.

• Example: 2,000SF /2 = 1,000SF/15= 66 seats. This could extend to 70+ or shrink to less than 50 depending on the layout of the restaurant. But now you have a formula to base how many seats a certain SF should have.

Why is this important? Because your rent is based on SF.

• Example: 2,000SF x $50.00SF = $100,000.00 in annual rent, and $8,333.33 of monthly rent.

Obviously the more seats you have in the space, the higher your potential sales can be. This formula is also very important if you are creating a business plan for a new restaurant.

When searching, every restaurant you see will be different in SF, seats and rent. Now you have a formula to compare and determine which one is the most cost effective. Feel free to contact me at 800-591-0894 with any questions.