October 17, 2023
Adam Hoeksema
Evaluating a business, whether it's a a traditional restaurant or a contemporary dining establishmentt, demands a combination of analytical skills and a solid understanding of the industry. For individuals interested in either purchasing or selling a restaurant, securing an accurate valuation is essential to guarantee a fair transaction. In this article, we'll look at different ways to figure out how much a restaurant is worth by answering these questions:
What Are the Most Common Valuation Methods for Restaurants
Business Valuation requires a deep dive into its financial and operational aspects. For an in-depth understanding, consider checking out our guide titled 'How to Determine the Value of a Business’.
There are several approaches to determine a Restaurant's worth, and the best method often depends on the specific type and sector of the business:
1. Asset-Based Valuation
Rationale: This method considers both physical and non-physical assets of the restaurant to determine its overall worth.
Usage: Tangible Assets: Items such as kitchen equipment, property, stored ingredients, and vehicles that have an easily discernible market valuation.
Intangible Assets: Features like brand standing, proprietary recipes, licensing, and customer rapport which may require more intricate assessment.
Net Worth Determination: Calculated by subtracting the restaurant's liabilities from its total assets.
2. Income-Based Valuation
Rationale: This technique evaluates the restaurant's earning potential, both present and future, to determine its value.
Usage: Discounted Cash Flow (DCF): Anticipates the restaurant's future revenues and adjusts them to present value, accounting for business risks.
Capitalization of Earnings: Calculates the consistent earnings of the restaurant and divides them by a rate that reflects potential returns and risks.
3. Market-Based Valuation
Rationale: By comparing a restaurant with similar entities in the market, this method derives its value based on current market trends.
Usage: Comparative Ratios: Uses financial benchmarks shared by restaurants of similar scale or niche to provide an estimated value.
Recent Sale Analysis: Examines the recent sale prices of peer restaurants to gain insights into the prevailing market valuation.
How to Calculate the Value of a Restaurant
To provide clear and actionable insights, we'll explore different valuation methods using a hypothetical restaurant business, SpiceHub Dining, as our example:
1. Asset-Based Valuation Step by Step Process:
Step 1: Identifying and Valuing Tangible Assets
SpiceHub Dining may have tangible assets such as kitchen equipment, real estate, and inventory:
- Kitchen Equipment: $120,000
- Real Estate (if owned): $500,000
- Inventory: $25,000
Step 2: Identifying and Valuing Intangible Assets
Intangible assets could be the restaurant's reputation, loyal customer base, or its secret recipes. Suppose SpiceHub Dining has:
- Customer Loyalty: $50,000
- Brand Recognition: $40,000
Step 3: Calculating Liabilities
It's essential to account for debts or loans:
- Outstanding Loans: $200,000
- Other Liabilities: $50,000
Step 4: Calculating the Net Asset Value
- Total Assets (Tangible + Intangible) = ($120,000 + $500,000 + $25,000) + ($50,000 + $40,000) = $735,000
- Total Liabilities = $200,000 + $50,000 = $250,000
- Net Asset Value = $735,000 - $250,000 = $485,000
Using the Asset-Based Valuation, SpiceHub Dining's value would be roughly $485,000.
2. Income-Based Valuation Step by Step Process:
Step 1: Forecasting Future Cash Flows
Let's assume SpiceHub Dining projects the following net cash flows:
- Year 1: $150,000
- Year 2: $160,000
- Year 3: $170,000
- Year 4: $180,000
- Year 5: $190,000
Step 2: Identifying the Discount Rate
Let's assume a discount rate of 12%.
Step 3: Calculating Discounted Cash Flows
Using the given discount rate:
- Year 1 DCF = $150,000 / (1 + 0.12)^1 = $133,928
... and so on.
Step 4: Estimating Terminal Value and Bringing It to Present Value
Assuming a perpetual growth rate of 4%:
Terminal Value = [$190,000 x (1 + 0.04)] / (0.12 - 0.04) = $2,660,000
Discounting it to present value: $2,660,000 / (1 + 0.12)^5 = $1,675,869
Step 5: Summing Up All Values
Assuming total DCF for five years is $800,000:
SpiceHub Dining's value = $800,000 + $1,675,869 = $2,475,869
Based on the Income-Based Valuation, SpiceHub Dining would be valued at approximately $2,475,869.
3. Market-Based Valuation Step by Step Process
Comparative Ratios:
Let's assume that, based on industry research, restaurants similar to SpiceHub Dining typically trade at a price-to-earnings (P/E) ratio of 10 and a price-to-sales (P/S) ratio of 3.
If SpiceHub Dining has:
- Net Earnings of $150,000: Using the P/E ratio, $150,000 x 10 = $1,500,000.
- Sales of $600,000: Using the P/S ratio, $600,000 x 3 = $1,800,000.
Recent Transactions:
Upon investigating recent transactions in the dining sector, we find that similar restaurants have sold for approximately 2.5x their annual profits. Given SpiceHub Dining's profits of $150,000:
- Using this multiplier, the valuation is $150,000 x 2.5 = $375,000.
Result Summary:
Taking the average of the values obtained using the three different metrics:
- P/E Ratio Valuation: $1,500,000
- P/S Ratio Valuation: $1,800,000
- Recent Transactions Valuation: $375,000
Total = ($1,500,000 + $1,800,000 + $375,000) / 3 = $1,225,000.
Based on the Market-Based Valuation, SpiceHub Dining would have a value of approximately $1,225,000.
How to Buy a Restaurant
Thinking of acquiring a restaurant? Here's a brief outline to assist you. For a more detailed view, check our guide on “How to Buy a Restaurant.”
Restaurant Industry Overview
The US restaurant industry, with over a million establishments, accumulates approximately $800 billion in annual revenue. Its growth is propelled by emerging culinary trends, evolving dining preferences, and innovative delivery mechanisms. Restaurants present an opportunity for steady returns and community engagement.
Restaurant Acquisition Costs
The cost of procuring a restaurant varies, influenced by its type, location, and size. Starting a new establishment might range between $275,000 to $2 million. Acquiring an existing entity often proves more economical, with prices usually around three to five times the annual net earnings.
Choosing the Ideal Restaurant
Begin your search with specialized brokers, online listings, or firsthand visits. Evaluate factors such as menu diversity, customer flow, kitchen infrastructure, and strategic location. Identify any potential for revamping or expansion.
Find Funding
There are various funding options available, including traditional bank loans, or investor partnerships. Remember, it's imperative to have a comprehensive restaurant business plan with precise financial projections when approaching potential financiers.
Conducting Due Diligence
Thoroughly vet all financial statements to ensure accuracy. Assess the condition of equipment, review existing contracts (like leases), and gauge the competence of the current staff. Address any gaps or concerns before negotiating.
Closing the Deal
After your assessment, negotiate the purchase terms. Ensure you understand all financial and operational aspects before finalizing your acquisition. With diligence and strategy, restaurant ownership can be a fruitful endeavor.
If you're on the path to buying a restaurant, consider how a QoE Report can offer financial transparency for your venture
How to Fund the Acquisition of a Restaurant
Considering buying a restaurant? The Small Business Administration (SBA) loan stands out as a premier financing option. Given the SBA's classification of restaurants as "active businesses", they often qualify for such funding. For an in-depth dive, refer to SBA Funding for Restaurant Acquisition.
When applying, it's key to emphasize your active role in management and any prior experience in the restaurant industry. If you're targeting an established restaurant, having records of its historical performance is a plus. Choosing the SBA loan route brings with it a slew of advantages: competitive rates, versatility in fund allocation, and relatively lower down payments, positioning you well for your culinary venture.
Creating Financial Projections for a Restaurant Acquisition
Each restaurant has unique operational factors, from seating capacity to daily customer flow. When creating financial projections for buying or selling a restaurant, focus on:
- Gather Historical Data: Review past revenue from food and beverage sales, operating expenses, and net profit.
- Analyze Physical Assets: Assess the condition of kitchen equipment, furniture, and the overall premises.
- Forecast Revenue: Consider current food trends, location, and the existing customer base.
- Project Expenses: Estimate costs for ingredients, utilities, maintenance, labor, and any licenses or permits.
- Determine Valuation: Combine all financial data, potentially using valuation methods like DCF or asset-based valuations.
Utilizing an acquisition or a restaurant financial template can simplify this process. This template integrates income statements, balance sheets, and cash flow forecasts. With this comprehensive financial analysis in hand, you're primed to negotiate the value of the restaurant effectively with potential buyers or sellers.
I hope this has been informative. If you have questions about valuing your restaurant, feel free to contact us!
