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Restaurant Finance: How Much Is Your Restaurant Worth?

by Ron Gorodesky and Ed McCarron

How much money is your restaurant worth? Is it what the equipment and furniture cost? Is it what your sales are - or is it worthless? Restaurant operators need to value their business for various reasons including negotiating a sale price, for financing purposes or to assess new worth. This article will explain the way to value your restaurant business.

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The value of a restaurant business is termed Fair Market Value ("FMV"). FMV is the highest price available where the following objectives are met in an open market:

  • A willing buyer and a willing seller;
  • Both parties to the transaction acting prudently;
  • Both parties are knowledgeable and informed;
  • There is no duress; and
  • There is a monetary transaction.

A transaction will take place only if it is considered fair by both parties.

We do restaurant business valuations for many reasons. It's important to keep in mind that the valuation is done to reflect actions of buyers and sellers in the market. The valuation procedure described here is based on a restaurant's maintainable cash flow and results of comparable restaurant operations.

After you have restated the financial statements in accordance with USA*, you must adjust the statements for unusual income or expenses. For example, you must include any unreported revenues and exclude any unique or individual contracts that provide revenues. As for expenses, exclude such items as non-performing employees, excessive compensation, personal expenses and corporate overhead.

For example, a $48,500 maintainable earnings figure will be used in the valuation. Maintainable earnings is the net income that a restaurant can expect to earn on a consistent basis before depreciation, income taxes and debt service.

The next thing to do is determine a capitalization rate (or cap rate). The cap rate converts the maintainable earnings into business value. The cap rate is determined either by analyzing purchase prices of comparable restaurants including sales prices and maintainable earnings (not necessarily information that is always available) or by calculating a weighted average cap rate. Cap rates are determined based on factors such as financing (debt or equity), lease terms and cost of capital. In general, a lower cap rate (20 to 30 percent range) effects a higher restaurant value and a higher cap rate (30 to 50 percent range) effects a lower restaurant value. Also, cap rates are sometimes expressed as earnings multiples. For example, a 25 percent cap rate would be a 4 times earning multiple and a 33.3 percent cap rate would equate to a 3 times earning multiple.

Once the maintainable earnings and capitalization rate are established, to calculate the Fair Market Value simply divide the maintainable earnings by the cap rate or multiply the maintainable earnings by the earnings multiple.

The valuation for our sample restaurant is $194,000 and calculated as follows. We have used a 25 cap rate or 4 times earnings multiple:

Maintainable earnings $48,500

Divide by capitalization rate 25%

Restaurant Value $194,000

Using this methodology is the most accurate method of establishing value for your restaurant. This value is based on earnings of a professionally managed business. Since items such as furniture, equipment and a liquor license are used to generate maintainable earnings, they are all part of the business value. Also be aware that if you own the building in which your restaurant is housed, there is a separate real estate value for that building, in addition to restaurant business value.

Restaurant Advisory Services provides full-service consulting services to the restaurant and hospitality industries. The firm offers a full menu of advisory services focusing on every aspect of the life cycle of restaurants and other hospitality organizations, from pre-opening and conceptual planning, to day-to-day operations, to design and brokerage.

*USA - Uniform System of Accounts for Restaurants

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