Restaurant Valuation Rules of Thumb - Using the Assets-in-place Method
If you are looking to purchase a restaurant, bar or nightclub, the three primary considerations are locations, lease terms and price valuation. If the lease terms are acceptable and the location is ideal, the next step is to determine if the seller is asking a fair price. The two ways of valuing a restaurant and determining its fair market value are the asset-in-place method and the going concern method.
Using the Assets-in-Place Method to Value a Restaurant Business
An assets-in-place valuation is used to value restaurants that are fully intact and are either not making any money at all, losing money, or marginally profitable. The buyer usually plans on changing the name, menu and other proprietary aspects of the business.
There is no standard formula for this type of valuation; it’s largely subjective and based on one’s experience in handling asset-in-place business for sale transactions.
What to consider in an asset-in-place restaurant valuation:
- Physical components. The value of all the major physical components of a built-out business will be considered, including all furniture, fixtures, and equipment, including cooking equipment, prep room, refrigeration, back office, restrooms, dish washing and storage. This also covers any lease improvements made to the property, such as heating, air conditioning, ventilation systems, electrical or plumbing.
- Goodwill of the business. Any intangible value of the business will also be considered. Oftentimes, there is residual goodwill which comes in the form of returning customers who have developed a habit of frequenting the restaurant business because of its convenience and familiarity.
- Lease components. Any value found in the existing lease should be considered. The term should extent at least five years and the rent should be at a fair market rate. Any increases or additional occupancy expenses should also be considered. In some cases, landlords will charge triple net expenses (NNN), which means the tenant will be charged taxes, insurance and maintenance costs, in addition to the base rent.
- Past sales history. While asset-based sales put very little emphasis on financials, the restaurant’s sales history can be used as a baseline for sales projections. Menu prices and guest check averages can be used to structure the buyer’s new menu and prices, as well as help recapture a large percentage of the former owner’s customer base.
- Past operating expenses. The cost of operating the business is also considered when determining its value. Expenses such as utilities, insurance and other occupancy costs will help the buyer determine his or her own future costs, which can be helpful when preparing projected income and expense statements.
- Licenses and permits. Any licenses or entitlements included with the business are considered to be very valuable. This would include food service-use permits and alcoholic beverage licenses. In many cases, the only way an operator can establish themselves in a certain area is to buy an existing business that already has these licenses in place.
While no standard formula exists for an asset-in-place valuation, historically, these businesses have sold based on their annual sales levels. For example, a restaurant that brings in $200,000 - $500,000 in annual sales would sell for approximately 32% of annual sales. A larger operation that brings in $501,000 - $999,999 in annual sales would sell for approximately 29% of annual sales.
In some circumstances, the restaurant may be going out of business and the owner is desperate to sell. In this situation, the seller wants to move fast before getting evicted and stuck with thousands of dollars of bills owed. They may be lucky to receive a sale price equal to 5% - 10% of their annual sales. Yet, they are released from the lease liability.
While it’s important to understand the assets-in-place method of valuing a restaurant, it’s also important to work with an experienced broker to get a more accurate sale price. If the restaurant you are considering is being sold as a going-concern, learn about the going-concern method in part 2 of this article.