ESSENTIAL TIPS FOR BUYING AN EXISTING RESTAURANT OR BAR
So you’ve identified a local restaurant or bar for sale and want to fulfill that lifelong dream of owning one yourself. Before you jump on an opportunity, make sure to complete your due diligence. Here’s what you need to do before pulling the trigger.
WHY IS THE BUSINESS FOR SALE?
First, you need to find out why the current owners are selling the business. It could just be they’re ready to retire or want to invest their money more passively. But it also could be that the profits are nose-diving or permits or licenses are expiring or being revoked.
Obviously, you want to ask the owners their reason for selling, but unfortunately, they might not always be above board with you. For that reason, you need to take the next step:
CRACK OPEN THE BOOKS
At this point, you’ll need to hire an accountant. Yes, they’re expensive, but it can save you from making a potentially huge financial mistake. Have your accountant look over at least the previous three years of financials from the current owners. If the current owner has a wonderful bookkeeper like Digidern, they’ll easily be able to get you detailed financials.
If the current owners won’t show you the books, offer to sign an NDA (non-disclosure agreement). If they still won’t show you, that’s a huge red flag and you should walk away from the sale immediately.
Your accountant will be able to tell you if there are things that seem amiss. Here is where you see how profitable the business is. You’re also able to take a look for any liabilities that might come back to haunt you after you purchase.
You’ll also be able to start seeing areas for potential improvement. If the business is for sale because profits are declining, you can find out why from the income statement. Are labor expenses abnormally high? Are food costs skyrocketing? If you make adjustments to these areas, you can turn a failing business into a thriving one.
NEXT UP: PROPERTY INSPECTION
Inspecting the property can come in two flavors depending on whether the business owns or leases the property. If it’s owned and would be part of the deal, you’ll definitely want to have a building inspector go through with a fine tooth comb. While income and profits probably make up most of the valuation (which we’ll get to in a minute), if owned property is included in the deal it can also have a big impact.
After you have a building inspector run through, you’ll probably want a restaurant/health inspector to also take a look. Anything they come up with is going to have to be fixed before the sale or you’re going to have to foot the bill after, in which case you’ll want to deduct that from the purchase price.
If the property is leased, you’ll still want to have a restaurant/health inspector come through. In addition, you’ll want to have a lawyer look over the lease agreement. You never know what the previous owner might have agreed to and you don’t want to get locked into someone else’s ill-advised contract.
While you’re going through the property, make sure to pay attention to fixtures, furniture, and equipment that would potentially come with the sale. Old or damaged FF&E is essentially worthless. But if the deal comes with a brand new industrial oven, you’ll want to factor that into your valuation.
BRING IT ALL TOGETHER: VALUATION TIME
Now that you’ve inspected everything, it’s time to put a price on the business as a whole. There are two major factors that we alluded to earlier that will determine how much you pay for a restaurant or bar: income and assets.
For these, you’ll need those financials your accountant looked at earlier. Let’s start with the income statement. This will likely make up the bulk of the value. Typically, when buying a business, you would value it using a multiplier of gross operating revenue OR net profit.
For example: If the restaurant you’re buying has $400,000 in annual gross operating revenue, you might take that number and multiply it by 2.5 to get a purchase value. In this case, $1,000,000. The multiplier you use depends on a variety of factors like the type of restaurant, the location, and market conditions.
Alternatively, you can use net profit. Net profit is simply all the revenue minus all the expenses. In our example above, if our gross operating revenue was $400,000 annually, our net profit might end up being something like $75,000 annually. When using net profit, our multiplier will be higher. We can take something like a 12x multiplier and come up with a value of $900,000. As you can see, these will yield different results.
In your case, you’ll want to use whichever number (gross operating revenue or net income) you think is more accurate. Typically when gross operating revenue is used, it’s because it is easier to measure and usually more consistent. Net income can be convoluted by things like one time expenses or sales of assets. (This is why we use gross OPERATING revenue. It’s possible to have revenue from a gain on a sale of assets, but that’s not going to consistently happen.)
Either way, valuing the future income of the business is something that absolutely needs to be handled by a professional accountant; somebody that does this type of thing regularly. Spend the money on a good accountant up front and you will save yourself a lot of headache down the road.
Now that we have the income valued, it’s time to look at the balance sheet. This is where all our FF&E (furniture, fixtures, and equipment) reside. Many times, this FF&E part of the valuation will bring our sales price down; unless there is a load of new furniture or new kitchen appliances. You usually won’t see this though since someone selling a business isn’t going to make that decision after investing a lot of money into new things for it.
Get an idea of what’s going to need to be replaced in the next couple years, then figure out how much those things will cost. To be more fair, you can factor in the replacement cost to get some used equipment or fixtures. Take the replacement cost of all that and subtract it from whatever you determined the income value to be. On the other side, figure out a fair market value for things that should last well into the future and add that to your valuation.
Then look at things like the building itself (if it’s included in the sale) and the reputation of the business. Though intangible, if a business has a good reputation, it can be quite valuable. Again, this is where a professional accountant comes in to help you get an idea of what’s worth something and what’s going to cost you money.
This should get you to a pretty solid sales price for the business. Obviously there’s always going to be haggling and negotiating, but the basis will always be the value of income adjusted for the value of assets.
THERE YOU HAVE IT
It’s not the most comprehensive buying guide on the planet, but if you engage in these steps, you’ll be guided along the path by those inspectors, accountants, and lawyers that you’ll get involved. And now you know who to call at what point in the buying process. Happy hunting!