What Drives The Value of a Restaurant?
The valuation of a restaurant is much like any other business valuation. But, there are certain factors unique to the restaurant industry. The universal drivers for many restaurants are pretty simple: quality, hospitality, consistency, value, cleanliness, and customer loyalty.
You may have heard the saying that the three most important ingredients for a successful business are location, location and location. Obviously, there are other factors which are very important as well, but you cannot compromise on location.
In a 2005 publication of Cornell Hotel and Restaurant Administration Quarterly, the authors noted how successful owners were able to describe their concepts – and why people like it – in great detail – those unique reasons why people choose their restaurant over their competitor.
1. Location, Location, Location
A high traffic, high demand, prime location with booming business in the area and a mid-to-high income population can add significant value. Parking, signage, and access are also important. Keep in mind, however, that a good location is not a stand-alone secret to success. Location Location Location must be followed up with Execution Execution Execution! Good management is key. Over the past 40 years we have sold some restaurants and fast food places as many as four times. With good management, the same location that was once a loser can be turned into a winner by good management — and vice versa.
2. Lease / Rent
The terms of the lease, such as assignment provisions, relationship to market rent, rent as percentage of gross revenues, remaining term, escalation clauses, and solid renewal options are key to the value of a restaurant.
3. Age and Condition of Equipment
Do you have a well thought-out plan to rejuvenate your venue and facilities? Are you budgeting and planning for replacing tables, or adding a new awning to your patio? The better the condition of the facility and equipment, the better the perceived value will be. Buyers will consider if there will be additional capital required to upgrade the facility or equipment, which will impact the price paid for the business.
4. Stability of Earnings and Revenues
Accuracy, completeness and ability to verify the financial records of the business greatly impact deal value. Restaurants with revenues and earnings showing year-over-year growth will command a higher value than one showing a decline. Historical profitability is a key factor for determining the actual price. If financial records do not accurately reflect the cash-flow picture of the business, the onus is on the seller to prove the true financial benefits of owning the business.
5. Hours of Operation
While gross revenue and earnings are important, one factor that may be easily overlooked is the number of days and hours the establishment is operated to achieve those numbers. A busy lunch spot in a business district that can make its money during bank hours is worth more than a restaurant that’s open longer hours, more days, and doing the same amount of business.
6. Conversion Potential
Can the restaurant be converted into another concept that will not compete with other restaurants within same particular center or demographic? Are there proper permits and certain licenses, such as a liquor license, or a favorable lease in place, good equipment? Buyers consider taking over such existing establishments, even if it is not profitable.
7. Food & Labor Costs
Food and labor costs are significant considerations in a restaurant business. These costs vary based upon the type of restaurant, whether full service, fast food, or when a large percentage of liquor sales are involved. Costs should be within acceptable industry margin ranges as a percentage of gross revenue.
Cleanliness and appearance is fundamental in affecting the first impression when selling a restaurant. A clean, well-kept establishment assures potential buyers that they are investing in a healthy establishment. A sloppy restaurant, on the other hand, triggers the red flag that the business has even more serious problems lurking beneath the surface.
Organizational stability: High staff turnover can hurt the value of your business and impede success. Be proactive: develop staff training programs, and ask for their input and act on it. Look at promoting highly motivated and effective staff to ensure retention. Consider bonus programs for managers and key staff tied to business performance and profits. Employee attitude and customer service go hand-in-hand and will be noticed. Positive, upbeat employees can be a sign that the restaurant is on the right track, while cranky, disgruntled staff members can be a sign of a problem. Keeping in mind that the new owner will probably want to retain most of the existing staff, problem employees should be replaced before the restaurant goes on the market.
10. Reputation & Goodwill
You can be guaranteed that prospective buyers are going to ask around and check the internet for information. Yelp and other such venues are used extensively these days and serves as the perfect place to check out a restaurant’s reputation. Special awards or special recognitions are a leg-up on the competition and contribute to reputation and goodwill, which will increase perceived value in the marketplace. If possible, respond to any recent negative internet reviews. A web site presence that delivers name recognition to those searching the net has become a very important component of value.
Make sure the restaurant meets all applicable health codes and all licenses are current – including the liquor license if alcoholic beverages are sold. Any issues here could put a successful sale in jeopardy. A liquor license for a restaurant serving dinner will attract customers and increase sales. The value of a liquor license should not be overlooked. The cost of permits, licenses, and fees has driven upwards the cost of starting a new restaurant. For this reason buyers do consider taking over an existing establishment even if it is not profitable.
12. Growth Potential
Is the concept franchisable? Can a catering or delivery service be added? Is there room to add an outdoor venue? Is there an opportunity to establish an advertising campaign, or increase email or text marketing to bring in the customer base? Articulating a solid growth strategy is important in attracting aggressive buyers.
13. Motivation of the Seller / Reason for the Sale
This is one of the first questions buyers ask, whether it be a restaurant or any other type of business. Keep in mind that no one wants to buy a business that the owners no longer believe in. A buyer wants to hear that you are excited about the future potential of your business and that there is a good reason that you personally need to sell. Since this question will most likely be asked of you face-to-face, be prepared to explain your reasons. A crisp, candid response could make all the difference.