Selling your restaurant? Buying a restaurant? Looking into selling or buying equity in a restaurant?
Or maybe you're just curious about the inner workings of the minds on "Shark Tank."
Either way, you've come to the right place. In this article, you'll learn:
- Why you should value a restaurant.
- The considerations to go over when valuing a restaurant.
- Methods for restaurant valuation.
Why Value a Restaurant?
A restaurant is just like any business. Whether you're putting your restaurant on the market tomorrow or you plan on owning it until the day you die, it's worthwhile to know how much your restaurant is actually worth.
If you do decide to sell your restaurant, offer up a share of ownership (or equity) to an investor, or are approached by someone who wants to make you an offer for your business, it's imperative to understand just what your restaurant is worth - and that's why you should value a restaurant.
Considerations for Restaurant Valuation
Keep in mind, there are countless considerations potential buyers and investors will mull over before they cut you a check. Here are just a few of them.
1) Cost of Assets/Equipment
Restaurants have various types of equipment required to run the business. If someone buys your business, are they also buying this equipment or just the name? If they are buying the equipment, is it all paid for, or is some of the larger equipment being leased or rented?
This also ties in to liquidation valuation, since when it comes down to it, the assets is the only guaranteed worth of the business. After all, you can buy a pizzeria with the world's best oven included, but if you don't have a good pizza cook on your team, that oven will only generate its market worth when you sell it after you go out of business.
2) The Economy
The state of the economy and the market can have an enormous impact on the valuation of your business. If the economy is down and the deal is over a high-end restaurant, chances are the sales aren't going to skyrocket overnight, meaning the restaurant could be worth less than it once was or could be. As always, this is a risk one would face when buying or selling any business, and this can be frustrating since this is mostly out of your control.
3) Experience/Expertise of the Investor
If you're like me, you've seen your fair share of "Shark Tank" episodes. In some of these episodes, a shark will make a bid for a larger share of equity (ownership) of a company at a lower price because they believe they will make the company worth more in the long run.
This is all part of the negotiation. Let's say you are looking for a strategic investment partner to help grow your restaurant business or expand into a franchise.
- One investor offers you an equity deal of $200,000 for 20% - a $1 million valuation.
- Another potential investor offers you $200,000 for 25% - only an $800,000 valuation.
At a first thought, you may tell yourself this is simple and side with the first investor. You'll keep more equity and control. However, while the second deal leaves you with less ownership of the restaurant, it does not necessarily devalue your company - at least not in the way that you think it will.
Maybe the second offerer has years of experience growing restaurant businesses. Would you be more likely to accept the offer then? Now you must decide if your 80% retained from partnering with the first investor will be more in the long run than 75% with the second investor.
If the second investor has the potential to grow your business more than the first investor, your slice of the pie would be comparatively smaller - but you'd have a much larger pie. In other words, 75% of a billion dollar company is much more than 80% of a million dollar company.
So when valuing a restaurant, ask yourself what value each partner will bring to the table and how they can grow the business.
4) Age of the Business
How established is the company? If it's a relatively new business but has been performing well, this could entice an investor or a business buyer into getting in on the ground floor. However, it can be just as equally scary to other investors, who may see your restaurant as a fad instead. Ultimately, when it comes to the age of the business, investors want to know how much your business will grow, whether or not it will stay consistent, and if it's doomed for failure.
5) Customer Loyalty
Some restaurant owners make a point to know their customers. Some restaurants also have well-known chefs behind the scenes.
When a restaurant is acquired, one or both of these individuals may be out the door - as could be the customers they bring in.
Before determining a restaurant's worth, find out if the customers are loyal to the brand or the people behind it. If all the business' regulars disappear when the ownership papers are transferred, the initial valuation goes out the window.
Ways to Value a Restaurant
There are countless ways to value a business or a restaurant. Not only do all of the factors listed above play a role in any negotiation, there are several technical methods financial experts will go about coming up with what they believe to be a fair deal.
Below are three of the most common business valuation methods that restaurateurs should consider first.
1) Income Valuation Method
The income approach looks at how much income a business will generate for its owners. Needless to say - the higher the projected income, the higher valuation a business tends to be given.
There are two ways within the income valuation method to determine a restaurant's worth. One is Multiple of Discretionary Earnings (and you can see an example walkthrough here), the other is Discounted Cash Flow. Of these two, I'll suggest sticking with the multiple method, as it's better fit for smaller businesses and adjusts for factors like the company's net working capital.
According to Valuadder,
"Multiple of Discretionary Earnings method establishes the business value by multiplying the seller’s discretionary cash flow by a composite valuation multiple which is derived from a number of business, industry, market, and owner preferences factors."
The multiple method is an accurate representation of a company's worth at one time to make an educated estimate of its worth in the future. Because of that, it's simple enough to find this number and apply it in the valuation process.
Because this number tends to be more of a simplified snapshot of what the restaurant's worth will be, the multiple method can be less-than-reliable, especially when external forces like the economy come into play. The number is also the trajectory of a business based on it's current performance, and so a change of hands in leadership could also change the valuation.
2) Market Valuation Method
This method speaks to a restaurant's potential more than its current earnings. Like its name alludes to, the market valuation method is a subjective approach where a company is valued based on what it would be worth in an open, competitive market.
For smaller restaurants, this number can be based on what other restaurants have recently sold for in the area or with the same concept. Two fast casual restaurants might have all of the same assets, but if one is by an office complex and one is on a road inaccessible from the interstate, you can bet one will be worth more than the other.
For larger restaurants, the number can be based off stock performance of other enterprises and - you guessed it - how the stock market is behaving.
If both parties go into a negotiation with the same knowledge, this can result in a pretty fair and mutually beneficial deal for everyone.
If a larger investment firm or conglomerate company goes in with more experience in interpreting and/or manipulating these numbers, they can negotiate under the guise of the market-based approach and strike a better deal for themselves.
Additionally, the market can be read in a multiple of ways.
When Chipotle took a dive in late 2015, this was not because the world stopped eating burritos! In fact, one could argue a burrito restaurant could be worth more after Chipotle's stock dip because people need to get their fix from somewhere. Those with a stronger understanding of market behavior and those without the right financial advisor could be at a respective advantage and disadvantage in dealings like these.
3) Asset Valuation Method
Sometimes, it's just time to call it quits. If a restaurant had a bad publicity scare it could not recover from or if years of poor service resulted in no loyal customers, a restaurant may be worth nothing.
But the material in the restaurant could be.
Asset valuation just looks at the worth of a restaurant based on its assets and minus its liabilities. If all the tangible assets a business owns equate to $30,000, that is the asset-based valuation for the business.
It's relatively straightforward and tends to be the lowest a business is worth. In the end, if an investor tries to revamp the restaurant, but to no avail, they could theoretically break even on their investment by selling the supplies one-off. It's also an easy way for a new owner to enter the industry due to low acquisition cost of used materials.
For the seller, this is essentially throwing in the towel and acknowledging your business failed. For the buyer, it's an uphill battle for re-branding and re-building.
Neither of these hindrances can be seen as "unfair," but it's important to know both parties aren't getting any extra benefit from this deal - just the bare bones.
Whether you're buying or selling a restaurant business, make sure to try out a few of these methods to understand the price floor and ceiling you should consider when it comes to the restaurant's valuation. Every restaurant is different, and therefore, the valuation will vary based on countless considerations.
Internal factors such as sales, profit margins, and customer loyalty, and external factors like the market and the economy impact the history and the future of sales performance. Before fronting hundreds of thousands (or even millions) of dollars, go over all of these aspects and consider consulting a financial professional to make sure the sale is fair and the deal will be beneficial to both parties.