Generally there are four different valuation methods used to place a value to a restaurant or bar.
1. PERCENTAGE OF REVENUE: One method is the percentage of revenue method. To derive a value, one merely selects a percentage, say 30%, and multiplies it by the revenue or sales of the business not including sales taxes.
For example, if the business had revenues of $1,000,000 and the percentage factor of 30% was used, then the business value is $300,000. This method is used when the financials are not readily available or are not accurate.
To determine the percentage to use, one takes into account five factors.
The strength of the revenue,
The condition of the facility,
The lease and location
The strength of the management and cost management of the business and finally (
The type of restaurant business.
In general, look at each item and assign a number between 1 and 4, with 4 being it’s awesome and 1 being its awful. The closer the average is to 4, the closer the percentage factor is to 40%-45%. The close to 1, then the percentage will be closer to 20%.
2. SELLER’S DISCRETIONARY INCOME (SDI): This method takes some education and skills to accurately apply the concepts, but it is the standard the banks use to give loans to buyers.
Simply put, SDI attempts to identify all the seller’s perks including salary, payroll taxes, personal auto expenses, medical insurance and any other personal items included in the profit and loss statement that’s truly not a business expense.
To arrive at a value one uses the SDI and multiples it by a market multiple. Every region and country has differing multiples and only a well trained and educated broker can help you determine what you should use. For example, the average multiple across the U.S. is about 2.2 times. That means one takes the DSI and multiples it by 2.2 to determine the value. However, every region has differing multiples. In Georgia for example, the multiple tends to be significantly higher than say Alabama. Why? I think it is in the variability of the earnings. the higher the variability, the lower the certainty; therefore the lower the multiple. Georgia’s multiples tend to be in the 2.5-3.0 range while in Alabama they tend to be in the 2.0 to 2.2 range.
You may use the same logic to determine the multiple as in the example of Percentage of Revenue method described above and adjust for regions. A 4 will receive a multiple in the 2.8-3.0 range while a 1 will receive a 1-1.5 range.
3. CAPITALIZATION OF INCOME: This technique is widely used to value income producing assets such as commercial real estate. The premise is based on what the market expected return on investment is at the time the transaction takes place.
The SDI must be calculated first as described above. Then that income is divided by the capitalization rate (Cap rate) to derive the value. For example, if the business’ SDI is $100,000 and the determined Cap Rate is 30%, then the math is $100,000/.3 or $333,333.
To determine the cap rate is the challenge and a simple drop of a few percentage points can make a huge difference in price. For example, in the above example, if the Cap Rate were 35% the value would be $285,000.
There are several considerations to think about when trying to determine the proper Cap Rate. First, the higher the risk of the investment, the higher the percentage used. In other words, when the income is risky, the expected return the market demands is higher. Restaurants are very risky. So It is good to start out at the 35-40% range and move from there.
Then again by applying the method described above and assigning a number to the business. The closer the number is to 4, the closer the cap rate will be to 25-30%. The closer the number is to 1 the closer the cap rate will be to 50%.
4. REPLACEMENT COST METHOD: The replacement cost method assumes a buyer pays the seller a large premium over the income value and annual gross revenue techniques in order to benefit from the existing investment in the restaurant facility, the lease and the location of the restaurant. In other words, a buyer will pay for the right to avoid spending hundreds of thousands and even possibly a million plus dollars to avoid all the city regulations, delays and headaches of building a new restaurant. How much a buyer pays depends on the needs of the buyer. Some buyers will pay more for the same space because they may see the value in a lease or location while others may see needed improvements to be made in order to convert to their existing concept.
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