Selling your pizza store: What is it worth?

[bodegahwy]

Many of the TTers know but others do not, that I do commercial and business brokerage and that I went back to school two years ago to pursue a credential in business appraisal. I completed the course work and passed the exam for a CBA designation (certified business appraiser) in 2010.

Questions about the value of pizza stores come up here on the TT regularly along with often heard “rules of thumb”… So I thought I would add some information on the subject here for discussion.

First of all, industry customary practices for valueing businesses are important. In the case of our industry, price/SDE is what many are referring to when people talk about a business selling for 2X, 3X earnings etc. SDE (Seller’s Discretionary Earnings) is described by Bizcomps as follows: “Seller’s discretionary earnings is calculated by adding to the most recent full year’s Net Income Before Taxes (NIBT): Amortization, Depreciation, Interest, Owner’s compensation, Owner’s benefits, Non-business related expenses, and onetime-only expenses. Normally to one working owner.” In other words, the cash and economic benefits one owner takes from the business whether they are W2 wages, S-corp dividends or paying your kids cell phone bills plus non cash expenses and interest. For example, if an owner takes 40K W2 wages, 50K in profit and pays 10K in interest and the business takes 10K depreciation and deducts 10K in personal benefits for the owner, the SDE would be 120K. If the business sold for 240K that would value the business at 200%. (240/120=2)

If there is a spouse or partner in the business you count what they make too, but then you add back what it would cost to hire someone to perform the duties that spouse or partner performs whether the amount you have to add back is greater or lesser than what that spouse or partner earns.

Another common way to value similar businesses is to describe the selling price as a fraction of annual gross revenue. For example, if a store does $600K per year and sells for $200K the value was 33% of gross revenue. (600/200=.33)

Typically these values do NOT include inventory.

I pulled a sample of 100 pizza store sales whose gross revenue was between 200K and 1M that were profitable. Here is an interesting summary of the range of values they sold for:

Median Gross Sales 409K
Median SDE 63K (17%)
Median Price/SDE 176% or 1.76X
Median Price/Sales 30%

What the “median” means is that half sell for more than 1.76X and half sell for LESS than 1.76X.

In the sample here are the number of transactions summarized by how many were in various brackets of value:

3X SDE 12%
2.5X - 3X 9%
2.0X - 2.5X 17%
1.5X - 2.0X 30%
1.0X - 1.5% 22%
< 1.0X 10%

What does this mean? First of all, among these brackets, the most likely range for a sale is between 1.5X and 2.0X SDE. Yes, some businesses sell for 3X or more but only some. About as many sell for less than 1X. For a business to sell for more than the median value, one might expect to look for reasons why the opportunity was better than average. For example, a steady growth rate, an advantageous lease, a location where competition is not possible all would be things that might lower risk for a buyer and increase what a buyer might be willing to pay.

The data on small businesses for sale tells us that a large majority of those listed for sale NEVER SELL. The reason they do not sell is often that the price is simply too high. Misleading rules of thumb may make some sellers unwilling to take offers that are, in fact, good offers.

No one should interperet any of what I have written as an appraisal of any specific business. I hope you find it interesting and useful.

 

[Rick_G]

Re: Selling your pizza store

Very useful, thanks, I copied and saved into word for when the time comes.

 

[paul7979]

I don’t know what resources you have available to you to find this information but how difficult would it be to find the same stats for a sampling of pizza stores doing over a million in sales?

 

[bodegahwy]

There are not very many of them but I can get the same data. Fundamentally, it does not change much. For a single location business, The multiples rise by about 15%. i.e. the median goes from 1.8X to about 2.1X. It was interesting to me when I pulled the data that the range of multiples was much tighter (closer to the median). I guess the small stores have a lot more odds and ends in the numbers that are not fully described in the data base.

Again, that is not to say that any particular store is worth a specific multiple. I perform appraisals for that purpose (and get paid for doing so!)

There is also a significant regional variation in typical multiples. When you break out comparables by broad regions the mean ranges from around 1.5X to about 2X. Still a pretty tight range, but when you are talking about what a business that produces 200K might sell for the difference would be 100K so worth looking into.

When appraising a specific business I look at these multiples as well as other approaches to valuation such as discounted future earnings or liquidation value and apply variables such as growth rate, lease terms, age and condition of equipment, size, consistancy of earnings and region. In the end, though, appraisals do not wander out of the statistical range. For pizza stores, as shown in the stats in my first post, 2/3rds of sales are made BETWEEN 1X and 2.5X and very few above 3.5X. (none of the million dollar stores I looked at were above 3X)

 

[jefferey13]

I know I’m not very active here but thanks for your post. Very applicable to any business.

I always look at deals as a three step process for reaching the end value.

Property + Equipment + Good Will = Selling Price

Agreeing on the good will number is always the trickiest.

 

[bodegahwy]

Jefferey, There are certainly several ways to approach value. In the end I think most boil down to the future value of an income stream and the combination of what rate of return vs risk is acceptable to the population of buyers for that kind of opportunity. In some methods, a separate rate of return, representing a different level of risk, might be assigned for investment in capital items vs good will. This is not how pizza stores are generally valued.

Equipment can be valued in several ways. Here just a few:

1. Liquidation value. What a used equipment broker would pay you for it assuming they have to come get it, transport it, clean it up and resell it for a profit. As you might imagine, this is a pretty small value in general.
2. Replacement cost. What you would pay to buy equipment of similar age and condition from the broker in #1.
3. Used, in place. What you would pay to the broker in #2 plus transportation and installation.

It would not be uncommon for #3 to be more than 3X the value of #1.

In the sale of a going concern of the types most TTers own, sales are generally made on value of the multiples discussed above. It is assumed that all the equipment being used is average condition and is included in the sale. It is also assumed that no cash or liabilities (payables) are transferred in the sale. If the equipment was in exceptionally good or bad condition that would argue for a somewhat higher or lower multiple. The same is true if the capacity of the equipment was maxed out and further investment would be required to achieve growth; the multiple would be held back somewhat.

Real property is not generally part of the value of the business unless the business is collecting rent such as a storage facility or a motel. For the purpose of comparison to Direct Market Data, an appraiser will restate the rent to the current market for new leases unless the existing lease has a long time to run and will transfer in which case the actual lease rate would probably be used. When the property is owned by the business or has identical ownership as the business, an appraiser would also restate the “rent” at the current market rate for comparison.

 

[jefferey13]

Bodegahwy- Ya I agree there are different ways to appraise something like equipment. I just think those 3 simple things I mentioned are the basis of any deal. When I was referring to property it was for the circumstances where you will also be purchasing the land/building as part of the deal. And I consider the multiples you discussed above to be part of goodwill-basically paying for future earnings. Obviously this can cause a lot of controversy because the seller might want 4x while the purchaser wants to pay 3x and take the NPV of those earnings.

I liked your article because I think it helps people seek realistic amounts in the selling and valuing of their businesses. In a pizza business the goodwill could very well be the most expensive piece of the equation, but in all businesses I think you need to look at all three pieces. For instance, if you wanted to buy Delta and they made $1,000 profit last year, you cant just offer 5K or 5x earnings. You have to account for the hundreds of millions in land and equipment and the possibilities of that capital. That’s why I think business appraising can be very difficult. And it is also difficult because the multipliers in each industry trend with the economy.

Also on a separate note, I would be willing to pay a higher multiple for a pizza business that was absentee over one where the owner had to put in a 100 hours a week to end with the same NIBT.

 

[bodegahwy]

jefferey,
I think you may be mixing apples and oranges. I was only describing the most simple version of a direct market data approach to the value of a pizzaria. Since that is how most businesses of this type are bought and sold it is an appropriate place to start. When pizza industry people (and business appraisers) talk about a price as a multiple of SDE that is the entire price and includes all the FFE as well as goodwill, trademarks etc etc. It assumes a cash deal. Typically, the only add-ons would be inventory at closing and deposits such as for the lease or possibly a prepaid bill of some kind like a computer support contract. That is it. Not FFE + Goodwill in the form of some multiple. Yes, the accountants will take the deal apart and assign cost to the various elements you mention and others for the purpose of the new balance sheet and future tax reporting, but that is not how prices are typically arrived at.

Large public companies trade stock on the open market. It is assumed that the stock price ALREADY takes account of “the hundreds of millions in land and equipment and the possibilities of that capital” and so yes, the earnings multiple that the stock price represents is the whole value. It is the markets estimation of the current value of those resources, future earnings and comparison to other opportunities that determines what an investor might be willing to pay.

The value of an absentee owner business typically does not come out different because most valuation professionals would add the managers comp back into SDE as a replacement for income the owner would otherwise enjoy if he operated the place. In the event that an owner worked 100 hours per week, I would expect to see SDE discounted based on some assumption of a “normal” work week for a small business owner. The discount would be the cost of replacing those extra hours with another employee. For example, if the assumption was that 50 hours was “normal” and the owner put in another 50 hours on the line, an appraiser might discount SDE by the cost of 50 hours of line-cook wages and benefits.

Yes, It is complicated. That is why I had to go to school for it and pass an exam.

 

[314]

Just to toss in a few extra notes on this topic (which is very awesome and informative! - Thanks!) in today’s banking world there is pretty much NO BLUE SKY (Good Will) so to get that in the sale of your business they buyer better have CASH ON HAND or the seller will have to carry some kind of note.

Since I just recently sold my independant sub shop and am currently trying to sell a couple of my shops and finding tons of interested parties but no money from banks to match the true value of the business.

 

[bodegahwy]

Dale, Have a talk with your banker about SBA lending. That is pretty much the only show in town right now for small business lending unless the borrower has other relationships with the bank or there is property involved.

You are right about seller carry. The data I look at shows that a large majority of business sales of this kind include a seller carry. The good news: it increases the proceeds of the sale to the seller.

 

[LittleMissPizza]

Thanks Bodega for taking the time to spread your knowledge! You probably remember one of my recent posts in which I was inquiring about ways to learn about business valuation in which you responded, so you can imagine my joy seeing this post from you

 

[bodegahwy]

Staying within the bounds of using direct market data for valuation there are a number of variables that might impact where in the range of likely multiples a specific business might fall. Here are few of them and what moves the needle. (Each of these have differing weights in how important they might be… so do not just add them up!

In no particular order:

Location: There are regional variations in what businesses sell for. An average multiple in the NE might not be the same as an average in the midwest.

Time: Muliples might change over time… not a lot, but they sometimes do. It important to consider how recent the comparables are and evaluate whether there has been any change over time in the category of business.

Size: There can be some variation in the multiples according to size of business. Again, not a big difference but it can be there.

Trend: Are sales and profit growing? How steady and reliable is the growth? How likely to continue?

Lease: Good, bad, long, Short? Risk of loss of the location or change in costs?

Key Industry Benchmarks: How does the business compare in the areas the idustry commonly evaluates? In our case food cost, labor cost, occupancy expense… you get the idea.

Balance sheet: On a restated balance sheet, how valuable are the assets that will transfer and how does that compare to the typical business of this type? What is the condition and age of the equipment package?

Competition: How much, how good? How easy or difficult is it for new businesses to open and compete?

How long in business? How stable is the market? What is the local economy doing and how does the business performance relate to that?

There are more… but you get the idea. Most businesses will have a combination of factors that work for and against them which naturally causes most values to regress to the mean.

It is very difficult to find examples of businesses that sell for more or less than one standard deviation from the median once these factors are evaluated.