The restaurant business is often very unpredictable, and if you’re looking for a clear indication of the current market situation, just check out the number of restaurants for sale at any given time. As the rate restaurants close their doors permanently can be so overwhelming, you should really find out the reasons for the sale, and then make up your mind whether you think you’ll be more successful than the previous owner.
One of the first points that you should think about when going over the documentation is the lease terms. Location is everything when it comes to a restaurant and very often its proximity to a pool of potential and repeat clients can be key. These days landlords are looking for security and will often heavily question the credibility of a new owner. Interaction with the landlord should come at an early stage of your due diligence, to ensure that there is a workaround in case of difficulty.
Setting an accurate value on a restaurant can be quite difficult. Basically, there are two methods that can be used: cash flow multiple or asset-based. If the business you are considering has been dormant, or you are just purchasing the equipment then it is appropriate to use the asset-based method where you simply attach a value to the assets and that is what you pay. On another note, however, if the business in question is ongoing, you can reach a fairly accurate estimate of its value by calculating a multiple of the owners benefit. Ordinarily, the benefit can be calculated by adding any owner salary or other benefits to depreciation and interest expenses, combined with the business net income. Self-service restaurants can specify two times the owner benefit for consideration, while full service restaurants can specify two to three times this figure.
Bear in mind that the hours of operation of a restaurant have a great impact on the owner benefit. Carefully consider the incredible number of work hours involved, and then compare this to the benefit figures to make up your mind on whether the deal is actually worth your while. Many analysts like to use a fairly general rule of thumb, depending on the number of meals and/or the number of days the restaurant is open for business each week. If the restaurant is open five days a week, specify 70% of gross annual revenue; six days a week: 60%; seven days a week: 50%.
You might find it frustrating trying to value revenues as the industry is well known for not reporting income. Most sellers will expect to be paid for the total profit they made, but in most cases they just can’t prove it. The devil’s advocate could easily say that if they’ve been taking money “under the table”, and benefiting with their taxes, they shouldn’t have any expectation of reaping the benefits yet again upon completion of the sale. It may be possible to re-create the financial picture, but you should ask yourself whether you’re willing to believe the final outcome of this exercise, whether the process is realistic and whether you want to go through with it, anyway.
The two major costs in a restaurant operation are food and labor. While costs will vary greatly depending on the type of restaurant and whether liquor sales are involved, as a general rule of thumb the combined total of labor, rent and food costs should not exceed 65% of total revenue. Pay close attention to this rule as you do not want to operate in the red.
Many believe the typical breakdown of costs should be as follows:
Food Costs: 30 to 33%
Labor: 20 to 25%
Rent: 6 to 10%
Again, you should not exceed approximately 65% when combining these items.
The exercise of due diligence is important whenever you buy a business and is especially true when you are considering a restaurant. This critical stage can lead to a review of 125 separate items and you should maintain a critical checklist as you proceed.
When reviewing equipment, bring in an expert. A nearby restaurant supply store can provide you with names to choose from and remember that there is a very large market for used equipment so you should be able to replace any faulty products at reasonable cost.
When you are checking out the reputation of a business, turn to public records to see if the business has performed to health department regulations. You should also include a “representations and warranties” section within the purchase agreement, to document that there were no previous health violations resulting in a fine, closure and so on. Health concerns are paramount when it comes to your restaurant’s reputation and there’s no faster way to put yourself on the street than by enduring a public report in the paper that the establishment has serious bug problems or is not complying with regulations.
You should educate yourself well when it comes to buying a restaurant, especially if the business is new to you. Don’t become one of those negative statistics and make sure that you buy well and build a successful restaurant in this highly competitive environment.
Richard Parker is the author of the How to Buy a Good Business at a Great Price series. As President and founder of Diomo Corporation – The Business Buyer Resource Center, his materials, seminars and consulting have helped thousands of business buyers realize their dream of buying a business.
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