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How to Value a Restaurant??

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VaPizzaMan

New member
Hello All
I’ve read these forums for quite some time and they have been very informative for me. This, however, is my first post and I need some advise. I have been a pizza man going on 18yrs now both as a GM for one of the big three, manager of a small Mom/Pop and most recently as owner of my own store.

An opportunity has come about to purchase an exsisting pizza shop in our city. The store has been established since 1993 and had sales of $600,000 in 2007 with sales tracking up from 2005 and 2006. There is an absentee owner with a GM and Assistant in place. It is carryout only with seating for about 30 serving pizza(take and bake only), sandwiches and a liquor liscense for beer two blocks from a major university. We have not yet looked over any financials but plan to do so. We also do not yet know lease terms or length only that rent is $2400 mo.

Here’s my question. From what I’ve read on these boards and through my experiences 2-3x bottom line profit should give a rough idea for a sales price on this pizza store. So, $600,000 putting 15% to the line is $90,000yr profit which translates to a selling price between $180,000 and $270,000. At 20% the selling price would be between $240,000 and $360,000. I don’t know the full financials yet. The seller is asking for the sales price to be based on 60% to 70% of net sales or a selling price of between $360,000 and $420,000. Is this an acceptable way to value a store? Anyone have any experience selling or buying a store this way? The numbers seem high, especially not knowing any financials. Any advise would be appreciated.

VaPizzaMan
 
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wait a couple more minutes, and bodeghawy will find you. He is our valuation fiend right now. Some others will also pop in with good information. I think PizzaDiva sold her shop in the last year as well.
 
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There are several ways people arrive at a value. Asking and getting are very different things as well. Fundamentally, I do not think that value based on gross sales is valid as an approach, but that does not mean the seller is wrong about the number; just that way he got there is not related to the validity of the number. On 600K in sales I could break even with cost problems or I could make 150K. In my store with similar sales if you lowered the rent to the level you quote (I pay myself $4700 per month) the business would produce about 160K ODCF. A price of 390K equates to 3X ODCF of 130K which is plausible on that sales volume paying that rent… so not neccessarily a wrong number even though the seller gets there the wrong way. But you need to see all the numbers.

The way I like to look at it, for a healthy profitable business, I want to see two different approaches “agree” or be in my favor. The first is a multiple of owner’s discretionary cash flow and the second is replacement cost. Further, the lease is a key element. How much time is left on what terms? If not long enough, will the property owner give you a new long term lease. (New Long term is 10 years or more).
  1. I like the method you mention of 2-3X ODCF. To get to Owner’s Discrectionary Cash flow take the profit from the 2007 Fed Tax Return and add back items that the owner could have pocketed. In the case of a store with an owner that does not work there, I would add back the GM salary and benefits since an owner could do that job and take that pay check. I would also add back any amortization, depreciation and interest.
To get to 3X everything has to be right: Long time left on the lease or new lease available, (to me, a long time left is at least 5 years) sales growth better than inflation over at least the last two years ('07 to '06 to '05), solid equipment package with no major headaches on the horizon. (For example, if the POS system is 5 years old I would want to ding the selling price by 15K… but a seller may or may not agree). Make sure that the expense side of the numbers makes sense by checking expenses for the 60 days before and after the year in question. It is pretty easy to shift expense ahead or back to dress up the year for taxes. Look for outsized marketing, utilities, insurance bills in Nov-Dec '06 and in Jan-Feb '08 making the '07 number appear different from the actual results.
  1. The second approach I like is replacement cost. What would it cost to find a location, lease it, build it out and equip it, develop receipes, hire and train and get open followed by marketing expense and operating losses to get to that sales volume. You have to add in the value of the time you work without a paycheck. Building a store that will do this sales number could easily cost 250K 300K before you are done and take 2-3 years to get to that number depending on what kind of locations are available. Adding in the time value and the uncertainty I find it pretty easy to justify the kind of number you are talking about if the business makes that kind of money. Even taking over a failed location that has all the right equipment in place will run you 150K-200K and take a couple of years… and still be a crap shoot. Do not underestimate the value of risk.
Summary: for a profitable business, “Value” is combination of reliable profit, secure location and barriers to competitor entry.

Without the solid lease the value drops FAST. So fast that with a year or two or worse, a month to month lease I would have to think twice about buying the business at any price. You could end up buying it all over again if you had to move.

Of course, anything for sale is worth what a willing buyer will pay and what a willing seller will accept. A motivated seller might well take less after waiting for a buyer. Another challenge with pizza shops is finding a buyer that wants to be in this buiness AND has that kind of funding available.

With your background, I assume you are able to look over store numbers and spot oddities. My own opinion is that 3X is really for a deal where everything is perfect and 2.5 to 2.8 times is kind of the sweet spot for a high volume shop most of the time. Low volume shops or shops where the owner makes a manager’s paycheck (<50K) are often worth less than the replacement cost. Used equipment sitting in place might be the value. (about double the equipment broker selling price)
 
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bodegahwy:
There are several ways people arrive at a value. Asking and getting are very different things as well. Fundamentally, I do not think that value based on gross sales is valid as an approach, but that does not mean the seller is wrong about the number; just that way he got there is not related to the validity of the number. On 600K in sales I could break even with cost problems or I could make 150K. In my store with similar sales if you lowered the rent to the level you quote (I pay myself $4700 per month) the business would produce about 160K ODCF. A price of 390K equates to 3X ODCF of 130K which is plausible on that sales volume paying that rent… so not neccessarily a wrong number even though the seller gets there the wrong way. But you need to see all the numbers.

The way I like to look at it, for a healthy profitable business, I want to see two different approaches “agree” or be in my favor. The first is a multiple of owner’s discretionary cash flow and the second is replacement cost. Further, the lease is a key element. How much time is left on what terms? If not long enough, will the property owner give you a new long term lease. (New Long term is 10 years or more).
  1. I like the method you mention of 2-3X ODCF. To get to Owner’s Discrectionary Cash flow take the profit from the 2007 Fed Tax Return and add back items that the owner could have pocketed. In the case of a store with an owner that does not work there, I would add back the GM salary and benefits since an owner could do that job and take that pay check. I would also add back any amortization, depreciation and interest.
To get to 3X everything has to be right: Long time left on the lease or new lease available, (to me, a long time left is at least 5 years) sales growth better than inflation over at least the last two years ('07 to '06 to '05), solid equipment package with no major headaches on the horizon. (For example, if the POS system is 5 years old I would want to ding the selling price by 15K… but a seller may or may not agree). Make sure that the expense side of the numbers makes sense by checking expenses for the 60 days before and after the year in question. It is pretty easy to shift expense ahead or back to dress up the year for taxes. Look for outsized marketing, utilities, insurance bills in Nov-Dec '06 and in Jan-Feb '08 making the '07 number appear different from the actual results.
  1. The second approach I like is replacement cost. What would it cost to find a location, lease it, build it out and equip it, develop receipes, hire and train and get open followed by marketing expense and operating losses to get to that sales volume. You have to add in the value of the time you work without a paycheck. Building a store that will do this sales number could easily cost 250K 300K before you are done and take 2-3 years to get to that number depending on what kind of locations are available. Adding in the time value and the uncertainty I find it pretty easy to justify the kind of number you are talking about if the business makes that kind of money. Even taking over a failed location that has all the right equipment in place will run you 150K-200K and take a couple of years… and still be a crap shoot. Do not underestimate the value of risk.
Summary: for a profitable business, “Value” is combination of reliable profit, secure location and barriers to competitor entry.

Without the solid lease the value drops FAST. So fast that with a year or two or worse, a month to month lease I would have to think twice about buying the business at any price. You could end up buying it all over again if you had to move.

Of course, anything for sale is worth what a willing buyer will pay and what a willing seller will accept. A motivated seller might well take less after waiting for a buyer. Another challenge with pizza shops is finding a buyer that wants to be in this buiness AND has that kind of funding available.

With your background, I assume you are able to look over store numbers and spot oddities. My own opinion is that 3X is really for a deal where everything is perfect and 2.5 to 2.8 times is kind of the sweet spot for a high volume shop most of the time. Low volume shops or shops where the owner makes a manager’s paycheck (<50K) are often worth less than the replacement cost. Used equipment sitting in place might be the value. (about double the equipment broker selling price)
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This is such an incredible response, I felt the need to quote the entire section. I did however feel the need to address the one section with respect to building from scratch and the associated expenses. We started with 1400 sq’ of walls and completed our place for under 75K and negotiated reasonable allowances from the LL. We did 85% of all construction and put all new equipment in place; our deck ovens the exception. Because my husband is a builder and had built two others, he understood how the floor plan would work, the engineering required (with the buddy engineer), code, variances, change of use, permits, etc. We did it all. We started in March but did not get the permit until October - opened in late Feb. Yep, we saved thousands by framing, flooring, wall covering (huge deal with code) working with electrician and plumber, design building counter tops and cabinets, etc. If you have the time and someone that can guide you, it is quite the cost saving adventure. And you would be amazed at the beautiful hand tossed gourmet pizzas a former builder puts out!

When I sold my place, the rule was as described above. That was then, this is now. I’m not sure that in my area of the country with the horrible economy that the rules have not changed. 5000 sq ft houses - empty, shops closing left and right or barely making it - so, so many unemployed contractors - foreclosures and repossessions beyond belief - empty gas and oil tanks.

I just got news today that a shop that had been very popular and busy had sold for 50K (total). Unreal. I’ve worked three so far and the low sales are enough to drive one insane.

If you come to some sort of agreement, a small refundable (intent) deposit with an agreement to work it for two weeks would probably allow you the opportunity to view all required invoices, lease, utility bills, volume, management, customer base, employees, equipment, food cost and prep, etc.

Good Luck.

PD
 
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What we have right now is a letter of intent with the Seller. We have not signed it yet because of the stipulation I wrote about above that the sales price for the store be based on 60% to 70% of sales over the last 12 month period, not including the month the sale takes place. I had not heard of this method of calculating a sales price and the posts here confirm its not a practiced method.

Before finalizing the contract, I will have the opportunity to work in the store(for up to 120 days) to determine if the store is a right fit for us. I can sign off on the contract at any time during the 120 period. The store is an institution in this area having opened in 1993 and the guy that owns it now is one of the original owners. He attempted to open another store in another city 2 yrs ago and it failed. He is still carrying large loan from the failed store and wants to get out under it. His thinking is that he doesn’t work in the store at all any more(and doesn’t want to). He has two young guys running the store and they are doing a good job but his concern is that if they leave he’s stuck with a fairly high volume store and no manager and a large loan to pay off. He still pays himself $50,000 yr.

VaPizzaMan
 
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VaPizzaMan:
What we have right now is a letter of intent with the Seller. We have not signed it yet because of the stipulation I wrote about above that the sales price for the store be based on 60% to 70% of sales over the last 12 month period, not including the month the sale takes place. I had not heard of this method of calculating a sales price and the posts here confirm its not a practiced method.

Before finalizing the contract, I will have the opportunity to work in the store(for up to 120 days) to determine if the store is a right fit for us. I can sign off on the contract at any time during the 120 period. The store is an institution in this area having opened in 1993 and the guy that owns it now is one of the original owners. He attempted to open another store in another city 2 yrs ago and it failed. He is still carrying large loan from the failed store and wants to get out under it. His thinking is that he doesn’t work in the store at all any more(and doesn’t want to). He has two young guys running the store and they are doing a good job but his concern is that if they leave he’s stuck with a fairly high volume store and no manager and a large loan to pay off. He still pays himself $50,000 yr.

VaPizzaMan
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It would have been nice to have discovered this business in 1993. Tread waters with caution; he should be golden despite a failed attempt. (IMO) On the flip side, 120 days is pretty good providing you can opt out.

PD
 
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I would suggest that you insist on getting rid of the value formula in the LOI and go to a number for business you agree on if your inspection during due diligence supports it. Don’t bother argueing with the seller about how to reach the number, just stick to your guns about whether YOU can justify the numbers by whatever means YOU are comfortable with. It is not neccessary that the two of you agree on HOW to get to the number as long as you can agree on the number itself.

I assume you are getting real numbers to look at including tax returns, 941s, bank statements etc.

The LOI should also call out what specifically is included in the deal like major equipment, store name, signage, non-compete, leases, contracts etc and what is not included as well as what is “extra” (often usable inventory at current cost at the time of closing)

If the deal includes financing from the seller or you need to get it approved by a bank etc, that contigency and those terms should be there too. Getting a lease assignment or a new lease should also be defined.

The next step after your LOI is goung to involve earnest money. You need to have an attorney looking things over before you get there.

Good luck.
 
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I agree with Diva that the buildout can be done for less, but even if you get all the equipment and buildout done for 100K you will still burn another sizable chunk on operating expenses and working without a paycheck (that is also how you are getting the build done for a small number) while you get the business up to a comparable sales level.

I stand by my numbers that the value expended to get to 600K in sales is at least 200K and in many places will be quite a bit more.

You can jump the sales growth with a large marketing budget or you can wait for the growth. Either way is an “expense”.
 
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Just an update. I met today with the agent for the seller. And he absolutely refused to budge of the 60% to 70% value of the store base on $600,000 sales. He said he wouldn’t take a dollar less than $360,000. Needless to say, it was a short meeting and told the agent to call when they were serious in selling the store.

My take on this is that the store might very well be worth the $360K but this was the sellers low end. Without seeing their numbers I would consider $360k on the high end. Thanks for all the advise. You were all very helpful.

VaPizzaMan
 
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Without seeing their books and $600k+ I guess a fair asking price would be between $275k and $375K.

VaPizzaMan
 
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If I could make a suggestion, get over your resistance to HOW they are valuing the business and concentrate on whether you can justify the number, there is nothing to be gained by arguing about the method used.

If you are really interested in buying the business you need to get to the stage where you can see the books. You should not have to be commited to a price to get there. Make sure that the LOI includes a provision for due diligence. A competent seller should understand that a buyer needs to review the books BEFORE agreeing to a price.

They have an asking price. Fine. if they ask you to sign a non-disclosure that is fair. They may also ask for some information on your finances and ability to complete a contract of this size. This is also reasonable. Review the books and make an offer at the low end of what you can justify. At least that gets the conversation started. You can politely state that you have you own views about arriving at a value for the business and that you hope that you and the seller will arrive a number that works for both of you regardless of how you arrive there.

Every deal has elements on both sides that the other side wonders about or resists. It really is the broker (agent) job to work around these thingsw, but if this guy can not you need to find a way to do it while protecting your interests.
 
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By the way, if the laws regarding brokerage where you are work like they do here, the agent is forbidden to indicate a seller will take less than the asking price unless authorized by the seller to do so. It would also be poor sales tactics to “bid against yourself” at the start of negotiations. They have an asking price which is $360K so they have taken the first step. Now it is your turn to look things over an make an offer if you want to. If the offer you end up wanting to make is quite a bit lower than the asking price (more than 10%) it would be a good idea to prepare them for it.

I also strongly suggest that you be represented by a broker or an attorney or both when you get to the point of making an offer. If you decide to go with a broker get one that has done at least a number of business transaction (preferably restaurants), not a residential broker with no experience in business. Also, if you go with a broker, do it now before going to the next step or getting the sellers broker to split the commission will be a challenge.

Don’t get hung up on the number at this point.
 
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