Want to know what your restaurant or bar is worth in todays tough market? Look no further!
Restaurants can be bought and sold like any other business.
Perhaps you have started a new restaurant and want to know what the return on your capital would look like? Perhaps you have always thought about buying a bar, but are not sure how much it will cost to become a bar owner? Perhaps you have owned a restaurant for decades and are thinking about retiring.
The restaurant business is tough, you have worked hard, but are not sure exactly how much your hard work is worth.
This is where this post comes in, we help you value your restaurant by a few different metrics. Most importantly we take a deep dive into helping you really understand the valuation drivers for your restaurant business.
In this read, we start with practical concepts and take a look at the numbers without bias whether you are a restaurant seller or a restaurant buyer. Then, we sharpen our analytical side of the brain and get started with the valuation of our restaurant business.
To give a wholesome introduction to valuation, we cover the following:
- Factors to consider – what is it that you need to look at to include in your valuation?
- Different methods of valuation – how would you actually use the factors in the above point to come to a final number?
Read Also: Restaurant and Bar Financing For Dummies
Table of Contents
Factors to Consider When Valuing a Restaurant
Current Value of Your Assets
In layman’s terms, assets are resources you use to run your restaurant.
This includes items like your sophisticated oven (kitchen equipment), exquisite ingredients, that fancy lamp you picked up during your Europe travel (furniture), or it could also be some exclusive recipe. This category will include both your short-term (for instance, some bills receivables, inventory items) and your long-term (for instance, building, furniture) assets.
The more assets you own, the valuation of your restaurant is naturally higher. For instance, think of two identical restaurant business models, where one owner also owns the real estate or the land and the other does not. The real estate owner has more assets in his bag and his valuation will be much higher compared to the other one.
Age is not “just” a number, but a rather important one when it comes to restaurants.
Whether the older establishments are worth more or the newer hot spots is highly contextual. One deciding factor could be the number of profitable years of your restaurant. Some older restaurants are more valuable if they can show a proven record of being profitable for a number of years.
All those years of profitability not only amassed money for the owners but also built brand value, a so-called “legacy”. This does not mean the new restaurants, bars, and cafes do not stand a chance. Even though the risk is higher for the new restaurants (probability to fail is higher than the more established ones), the new shiny eating establishments can be credible if they are capitalizing on some recent trend, that the older establishments in an area are missing.
For instance, we now see the exciting vegan trend that is sweeping the nation, with many of these new vegan establishments outperforming their aged neighbors. With this context alone, the brand value of a hip vegan restaurant could be more than the next door 50 years old Italian restaurant. This is a highly situational factor and a one you need to be clever about.
Restaurants stand out from many other businesses due to the fact that they are still highly untouched by artificial intelligence and other similar disruptive forces.
Today, food is still better made by humans and passion, as you know first hand. Although you can consider this factor under your asset – we cover this point separately as it requires that attention. Consider the experience, knowledge, expertise, training of your people, and what they bring to the business.
The key is the systems you have generated over the years, that allow your company to replicate its success in the future.
A simple example is your head chef is what keeps those tables occupied even on Monday evenings when no one else in town has more than one guest. He is probably worth a lot to your establishment, which is why you currently give him/her a hefty bonus every year. Account for this when you value your business. Not just the food, to sell that perfect food, you need a proper management team and a process.
When you value your restaurant, your supply chain for ingredients, your menu updating mechanism, your method to always have smiling waiters – basically, your operating procedures and the team behind it, it all has value.
It is a no-brainer when we say the restaurant is only worth as much as it’s customers’ love. It is in your favor to show-off that love.
Whether it is your “Happy Anniversary” messages, your customer’s obsession with your amazing views, or your free unlimited salsa and chips with an entree. Whatever it is that drives your customers in through that door must be tracked and used as a leverage to increase your valuation.
One way to track this more objectively would be to see the social value of your restaurant. For instance, the ratings and reviews you have on sites such as DoorDash, Seamless, Google, Yelp, Tripadvisor and so on.
Also, the shares on Instagram, travel blogs, and all the new platforms that even Gen Z are not shying away from.
Even the strongest shake a bit, but it is the truth that there are very few restaurants that thrive in economic downward spirals.
The couples on dates do not shy away from splitting an entree when the economy is down. But a boom in the economy also means that people are not hesitant to shell out those extra dollars for an aged scotch (my drink of choice if you were wondering).
So the economy plays a significant role in the restaurant business and hence has to be accounted for when you value yours. This concept plays more into the valuations calculations covered later in this post, like revenue multipliers and discount values. These inputs often ebb and flow based on the economic environment.
It is possible that even with the cheapest assets and a simple operational process, to have very strong revenues with a nice profit.
For example, think about your neighborhood cart vendor. They have low capital investment, very simple 1-2 man operations, and run on daily purchasing with one vendor. Even with a simple business model, some of these cart vendors are very profitable and bring in solid revenue.
Now think of the opposite situation – a five-star seafood restaurant with fancy wood tables, complex operations, two stories on the waterfront, a large management team with multiple layers of reporting, and lots of customers. They are not breaking even due to the high costs of operations, such as expensive least and management staff.
So a glance into the actual profits and cash flows is always a good idea to gauge the actual health of the business. In a restaurant business, revenue inflow alone does not guarantee healthy business performance because of factors such as variable costs (labor costs, food costs, and beverage costs) or high fixed costs (think about labor and inventory). These factors could weaken the bottom line or enhance it, either way, having a well-rounded idea of the financial performance of the business is invaluable.
Lastly, what could also be looked at here is the restaurant performance compared to the industry standards. These standards are usually uniform across the industry but vary depending on the type of restaurant operation (sub-industry).
For example, we expect different costs related to operating a bar, full-service restaurant, quick service restaurant, ghost kitchen, or coffee shop. Some have higher labor costs, some have higher lease agreements, while others have a lower cost of goods sold, knowing your specific sub-industry will prove invaluable.
Going back to the cart vendors, let’s assume that in general, they are profitable businesses, but some particular carts may perform better or worse compared to the industry standard. This individual vs industry comparison could also help you judge or defend your valuation as a seller or as a buyer.
When the prospect looks at your restaurant, bar or cafe, he or she will in most cases have plans to make it bigger or better.
So, when you can show new growth avenues, you increase the valuation of your business out of the gate.
Currently, you are your neighborhood’s favorite baker, but can you become the favorite of the next two neighborhoods also? For this expansion to happen, are you equipped to go online and make online delivery possible? Can you currently take orders for events and parties, offering customized selections for the discerning buyer? As a seller and buyer, your job and goal are to better understand the opportunities for upside.
You need to define realistic growth channels, horizontally (say, you are now only selling fresh baked goods, but you also have the talent to expand to crisps and other storable baked goods) or vertically (say, you plan to connect with that new delivery service that will help you reach out to new neighborhoods).
Different Methods of Valuation (Top 3 and Most Used)
- Income Valuation Method
- Market Valuation Method
- Asset Valuation Method
Income Valuation Method
As the name suggests, the income that is projected for the business helps us derive the valuation figure under this method. Further under this – two approaches are primary. Namely, the Multiple of Discretionary Earnings and the Discounted Cash Flow.
Multiple of Discretionary Earnings
It is a more well-rounded approach, in the sense that it determines a composite valuation multiple (based on a number of factors such as the industry conditions, market conditions, owner’s preference and many more) and then multiplies this with the cash flows.
This helps get a more realistic valuation of the business. This method can also be used to make strategic decisions that are aimed to increase your restaurant’s valuation. This is because you understand factors that affect your business and also understand how sensitive your valuation is to said factors.
To understand better, let’s take a look at an example of a simple bar. This is a two-step method. First, you will calculate your bar’s discretionary earnings for the next several years. Simply take your most recent annual net income, and estimate what those earnings could look like going forward (I recommend building out a 3-year budget/ financial model to ensure your assumptions are accurate). Step two is to find your multiple. This multiple usually ranges between 1 and 3, most restaurants average around 1.5.
Really good performing establishments with a long track record could use a higher multiple, better regions can use a higher multiple, etc.. You can consider factors like your customer base, product mix, tangible assets, customer loyalty, goodwill, market conditions, and so on. This can also factor in your personal preferences. For instance, if you really need to sell the restaurant quickly, you could choose a lower multiple.
So, if you calculated your discretionary earnings to be $10,000 and your business performs above average, so you multiply it by 2, to reach a value of $20,000. And that’s your value.
Restaurateur Pro Tip
This number tends to be more of a simplified snapshot of what the restaurant’s future valuation, meaning the multiple method can be less-than-reliable, especially when external forces like the economy come into play. The number is also the trajectory of a business based on its current performance, and so a change of hands in leadership could also change the valuation in a positive or negative manner.
Discounted Cash Flow
This valuation is based on the company’s ability to generate cash flows in the future. It lies in the theory that the value of the business is equal to the present value of its projected future benefits (current cash value of future cash values).
It is less preferred in the restaurant industry as compared to the former approach.
The restaurant industry is quite challenging to calculate future cash flows relative to say the commercial real estate industry with its long term leases and clearly defined future revenues. It could be a suitable method for a restaurant’s new business with many growth prospects, or for a restaurant business that is currently in flux.
The discounted cash flow method is too complex to cover in this post and has some customizable inputs based on preferences. There are plenty of templates across the internet, and as always I am happy to craft a custom financial model based on your needs.
The core concept is as follows, the discounted cash flow method determines the restaurant value by considering a few inputs; net future cash flows, discount rate, and the expected gain from the sale of the restaurant or assets at the end of the holding period.
Just remember, to use this valuation correctly, you need to generate a proper 3 and 5 year budget for your restaurant.
Restaurateur Pro Tip
This is a very narrow method, in the sense, that the valuation ignores many other factors that could increase the valuation of your business. For instance, the good economy, which would increase your restaurant’s average customer count or ticket price. So do not rely solely on the discounted cash flow method, but rather use it as a good starting point and then look into other factors that could have an impact on your valuation.
Market Valuation Method (Comparable Sales Method)
If you were to sell your restaurant today in an open and competitive market – what is the worth of your restaurant? That is your market valuation.
Now how do you decide this worth? The answer to this lies more in the earning potential of your business.
This concept is as easy as it is complex. One way to get to this market valuation would be to look at a comparably sized restaurant in a similar area and that serves a related cuisine. It can be assumed that the two restaurants are worth about the same and you can base your market value off of your competitors.
Make sure you dive deep though as your location could be slightly better, customers more loyal, or your business could be more profitable. Then you can safely increase the valuation of your restaurant.
Don’t stop there though, if you know that you are capitalizing on the farm to table trend and that will only pick up in the near future, go ahead and further increase your restaurant’s valuation. Analyze all your factors and accordingly adjust your market valuation.
Restaurateur Pro Tip
Some restaurants on the market may have unrealistic prices set, that’s fine, remember to just throw out these outliers. As your goal here is to fairly price your restaurant (asset) and make a timely translation, don’t spend the next 10 years trying to sell your restaurant.
Asset Valuation Method
The asset valuation method is one of the simpler methods out there and is calculated by the following equation:
Assets – Liabilities = Asset-Based Valuation
This method could be used to find out the floor price of your restaurant also known as the fire-sale price. This method is used by restaurants that have shuttered their operations (or is about too), and only sell their assets and not “business”.
For instance, the concept of your restaurant did not work, but the infrastructure and competitive lease still have value to another restaurateur. This is often the best valuation method if you are just looking to get out of your business quickly without focusing on the upside (but rather managing the downside).
Restaurateur Pro Tip
This usually reveals the lowest valuation of your restaurant as compared to the other calculation methods. So depending on your reason to sell, you may want to avoid this valuation.
Final Thoughts on What Your Restaurant Is Worth
Now that you are equipped with the restaurant valuation basics and concepts, it is time to delve further details. Take your financials and start using the above techniques to play with your restaurant valuation, research recent sales in your area, review public restaurant company multipliers and more. Most importantly define your own unique story, every restaurant business also has special valuation drivers that make their establishment special.
There are a complex number of factors to consider when thinking about buying or selling a restaurant, and also the challenge of leaving the emotional side out of the equation. This post should have helped you better understand possible options, and what are the right things to research further. As always, I am available to help, simply shoot me an email.