More Rules of Thumb for Restaurant Valuation - Using the Going-concern Method
The going-concern method of valuing a restaurant is normally used for restaurants that are already making money, including well-run franchises and non-franchises. The buyer intends to run the business the same way, keeping the same menu, operating system and personnel. In some cases, the restaurant may be losing money because of poor management and the new operator plans to turn things around.
This type of sale includes all physical components of the restaurant, including all furniture, fixtures, equipment, leasehold improvements, as well as lease components, licenses and permits. It also includes all goodwill of the business, including its name, brand identity, menu, overall concept, as well as its existing customer base.
Using the Going-concern Method to Value a Restaurant Business
A going-concern valuation is a step-by-step process that involves: 1) determining the restaurant’s yearly adjusted cash-flow/discretionary earnings, then; 2) assigning the appropriate multiple, and then; 3) calculating both figures to determine the value of the restaurant.
1. Determine the restaurant’s adjusted cash-flow/discretionary earnings.
Use the net profit that’s listed on the restaurant’s tax return or year-to-date income and expense statement, and then add back the following items:
- Working owner’s salary and payroll taxes
- Personal expenses the owner is charging to the business like vehicles or travel
- Depreciation, amortization and interest on loans the buyer will not assume
- Net operating loss carry-forward charges
- Any other personal expenses buyer will not assume
2. Assess the restaurant’s profitability, growth potential and risk factors.
For independently-owned, non-chain, non-franchised food restaurants, your multiplier will vary from 1-3 the yearly adjusted cash flow, depending on existing value, growth potential and certain risk factors.
- Consider the restaurant’s current value and future earning potential:
- Lease value - is it above or below market value?
- Fixtures, equipment, leasehold improvements – its quality and condition?
- Potential upside – can the business be improved?
- Future growth opportunities – opportunities to gain customers?
- Whether the operation is full service or self-service
- Consider the risk factors involved in operating the restaurant:
- Degree of difficulty to operate – coffee bar or fine dining?
- Does it require a high degree of expertise?
- How long it’s been in operation – well established or new?
- Sales and profitability history – strong track record or spotty?
3. Assign the appropriate multiple and determine the value of the restaurant.
An established restaurant in pristine condition, that’s also easy to operate and has a strong earning history, would use a high sales price multiplier. In contrast, a restaurant that’s difficult to operate and has a short sales history would use a lower sales price multiplier.
Once a multiple is assigned, you can calculate the restaurant’s sale price using its yearly cash flow. For example, if the yearly cash flow of the restaurant is $75,000 and you use a multiple of 2.5, then the value of the restaurant would be $75,000 x 2.5 = $187,500.
While it’s important to understand the method doing a going-concern valuation, it’s important to work with an experienced broker to get a more accurate sale price. If the restaurant you are considering is an assets-in-place sale, learn about the assets-in-place method in part 1 of this article.