Food service is big business. In the US alone, over 570,000 eating and drinking establishments generate nearly $375 billion in annual revenues and employ some 6.8 million people.
The industry landscape is increasingly dominated by regional or national chains which account for more than 70% of the market. Yet the average restaurant grosses $1,200,000 and employs just 17 people. And there is still opportunity for independent restaurant owners with innovative concepts to tap into affluent niche markets, especially in major metro areas.
Approaches to restaurant valuation
As with any business, you can approach restaurant valuation three ways:
Given the diversity of businesses in the food and drink industry, there is no single “formula” to measure what a restaurant is worth. To get accurate results, you should consider a number of business valuation methods under these approaches.
4 key restaurant value drivers
A number of factors affect what a business is worth. For restaurants, the key value drivers are these:
- Track record of sustainable sales growth.
- Stable earnings.
- Condition of furniture, fixtures, equipment and leasehold improvements.
- Lease terms.
How well the restaurant stacks against its competitors across these key value drivers affects its value. For example, you can use pricing multiples under the market approach which are derived from sales of similar restaurants.
You determine your restaurant value by applying these multiples to your gross revenues or seller’s discretionary cash flow. Typically, the revenue and cash flow bases are calculated as averages over several years. Hence, if your restaurant shows stable, above average sales and cash flow, its value will be higher.
Income-based business valuation methods are very often used for valuing restaurants. The Multiple of Discretionary Earnings method, in particular, is very well suited for valuing owner-operator managed food service businesses.
In addition to the four key factors above, this method lets you account for such important elements as the restaurant location, its employee base, and ease of operation. Needless to say, a “turn-key” operation is more desirable than a poorly organized business and is likely to command a higher selling price.
Condition of the restaurant assets determines the amount of capital reinvestment to keep the business running. If the restaurant requires significant investment for renovation, concept change or code compliance, the savvy buyer would discount the offer price accordingly.
Rent is a significant part of a restaurant’s operating expenses. Generally, rent which exceeds 10% of the gross revenues is considered excessive. Experienced restaurant buyers would discount the offer price to bring the rent expense in line with the industry norms.