Investors are constantly looking to purchase or buy into existing restaurants, while existing restaurant owners are always looking to sell a piece or their restaurant business. As acquisition deals are made in the restaurant industry, the main question that arises is, “How do I value the restaurant?” Since many valuation methods are available, care should be taken to ensure the “best” method is selected to lead to the best deal possible. Below are helpful strategies used by the industry for valuing a restaurant:
Gross Sales Valuation
This is a common and simple formula that takes a percentage of the restaurant’s sales to value the business. The percentage can vary, but typically, it can range from 20%-30%. The sales approach may be simple and cut to the chase, but it doesn’t take into account the expenses to run and maintain a restaurant, such as food prices, labor, rent, and other costs.
The cost-to-build calculation is used when a restaurant is new and has no documented sales. This valuation is calculated by taking the actual cost to build based on a builders cost per square foot, multiplied by the total square footage of the restaurant, and then discount the total by a percentage, which typically ranges from 40%-60%.
Income valuation, better known as the seller’s discretionary earnings (SDE) approach, is a strategy frequently used by the industry to value a restaurant. SDE is defined as the pre-tax earnings of business with non-cash expenses, owner’s compensation, interest expense or income, depreciation, amortization, and non-business-related income and expenses all “added back” to the bottom line of the business. Once the SDE is calculated, a restaurant can generally be valued at SDE times a multiple that ranges from two to three. To calculate a more accurate SDE, a salary for a hypothetical person that would take over the CFO or CEO services of the owner that is exiting would be subtracted to lower the SDE, but a higher earnings multiple could be used to calculate the value of the restaurant.
This approach puts more emphasis on the restaurant’s potential and less on the current earnings. Under this approach, the restaurant is valued based on what a restaurant with a similar concept or business model would be worth in an open and competitive market. A newer restaurant could benefit under this approach when, historically, there are less earnings, but maybe a hot trend in the restaurant they are looking to capitalize off of.
This method is a simple computation based on value of the restaurant’s assets (e.g. equipment, furniture, tenant improvements), minus any liabilities of the restaurant. This approach is not that most accurate valuation method and may not net the most profit. However, it is a simple approach for restaurant owners that are looking to quickly sell their restaurant.
Valuing a restaurant is subjective and there is not a one-size fit all methodology for doing so. Restaurant investors and owners that are serious about buying and selling should consult with CPA professionals that have valuation expertise to determine which strategy makes the most sense for their valuing their restaurant venture.
Our tax and valuation specialists are available for consultation on this and other business management topics for restaurants, hotels, or food distributors. Please contact our hospitality tax advisors or Aaron Boker at 301.231.6200 for more information.