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So….You want to Buy a Restaurant?

Everyone dreams of being in the restaurant business. From the on-set it seems like a great idea, it feels good and you think its going to be a lot of fun … and with some hard work … it is fun!

You do a little research or become friends with the owner of your favorite hangout and discover (on the skinny) that he wants to sell the business … but to someone who knows the customers and loves the restaurant.

You think to yourself that opportunities like this only happen for other people … and you are going to take advantage of it. But what should you do next?

Step back and take a deep breath!

Think for a moment, that when you are in the restaurant as a customer, you are being waited on hand and foot, you’re standing with a drink in hand and simply having a good time. Now you are going to change your role from waited-on to waiter — make sure it is what you want to do!

If you are still at the table, then move forward slowly and methodically and … get all of the data you need to make the right decisions and negotiate the right deal.

Is this the business you want?

Your friend wants to sell the on-going business and not the chattels and therefore, you are going to be purchasing the current customers and cash flow of the business. You must ensure that you are planning on running the business in much the same manner as the current owner. You may add some component parts to increase sales, but in essence, you are about to buy an existing business. As a result, you will not be changing a burger joint into a high-end steak house, but will be running the same concept under the same name. If you don’t want to do that, then don’t buy the business. If you do want to do just that, then you are well on your way.

Conduct a Financial analysis!

The very first thing you must do is understand the financial performance of the business. You will be purchasing the business based on its sales and operating profit (profit before debt, interest and tax), and it is essential that you have a clear understanding as to those numbers.

In terms of gross sales you should look for a business whose sales are increasing year over year. A business with increasing sales is a growing business. A business with level sales is considered a mature business and a business with decreasing sales is one, which should be avoided.

You should also ensure that the business is achieving a reasonable sales per seat average in order to ensure that you can cover many of your costs and that it is achieving operational efficiencies. Sales per seat should reflect, at the lowest, in my opinion, the industry average which ranges per sector from about $6,500 to over $12,000. As a rule of thumb, you would want to purchase a restaurant with sales per seat in the $8,500 or higher range. I prefer to have clients purchase restaurants with sales per seat over $10,000. There are many restaurants in major centres with sales in excess of $30,000 per seat; therefore the $10,000 range is not unrealistic.

In terms of operating profit, the industry average has ranged from 9.8% to 12.5% (which includes management/owners salary) over the past ten years. You should buy a business that is achieving an operating profit within the range of the industry average or higher.

You should also take a look at the costs of sales to make sure they seem reasonable. While costs vary significantly depending on concept type — labour should be in the 25% to 33% range, food costs should be in the 28% to 35% range and rent should be 8% or less. If costs in these areas are higher, you should find out why. If you think you can get them down, that would be a bonus — but don’t pay extra to a vendor for potential unrealized profits. In order to assess the operation you are considering purchasing, review the CRFA’s Industry Operations Report so you can perform an educated analysis of the operation’s performance.

Analyze the length and terms of the lease!

You will need to conduct a careful examination of the lease, which you will be responsible for in the future. While there are too many aspects to consider in this article, a few of significant ones include the following:

• One of the critical concerns any buyer should have is the remaining length of term of the lease. If the lease has ten years left on the term then the restaurant is more valuable than if it only has two years remaining, as you will have eight additional years to earn back your equity, pay down your debt and earn a profit.
• The renewal terms should be at the buyer’s options and not the lessor’s option. If the renewal term is at the lessor's option, then the lease is far less valuable as you are not guaranteed an extension of a term. No matter what the vendor tells you, ensure that your lease extension is guaranteed in writing, or don’t consider it when negotiating a price.
• Look carefully for any rent-free periods at the beginning of the term, which may positively effect the financial results shown to you, and beware of any annual rental hikes built into the lease, which may have a negative impact once you buy the business. For example many leases are structured with a low rent in the first few years and a higher rent in the last few (basically enabling the lessee to recover some start up costs quickly and pay for the landlords helping hand at the back end). Ensure that you are not buying into the increased rent which will reduce your potential operating profits.

Keep the Vendor around for awhile!

When buying an operating business you are, in essence buying the goodwill associated with the business (it’s cash flow and customer base). The person who built that goodwill is, in many instances, very important in maintaining it within the market. It is typical for a buyer to ensure that the vendor work with them at the location for several months (in some cases longer) so that the vendor can introduce the buyer to customers and help the buyer create ties to the customers, with the hope of continuing their relationship with the restaurant.

The vendor will also be able to introduce and slowly hand over the relationships with suppliers, landlords and others, keeping all (or as many as possible) the business relationships in place.

Don’t let the vendor compete

Ensure that the vendor does not take your money and then set up direct competition to your business by building a similar style restaurant nearby and poaching the customers, which they have recently sold you. You must ensure that the vendor does not end up as your direct competitor, as his relationship with your clients is likely stronger than yours.

Determine a fair price and don’t over pay

In order to determine the fair price for the business you must look at numerous factors and examine all aspects of the business. In general though, you should be paying a multiple of the maintainable operating profit of the business – rarely to exceed 4 times. The operating profit should be adjusted to eliminate non-realistic expenses, like the owners car, but should add expenses, which may not really be paid, like the owners salary. Once the adjustments are made, the buyer will have a reasonable base upon which to determine a fair multiple of earnings.

Many vendors will tell you about the ‘cash’ they are taking from the business and that the unaccounted for cash should be valued as well as that shown as operating income. If you cannot see the cash flow on the books, then you should not pay for it. While there may be some unaccounted for ‘cash’, you can never be sure just how much it is and, therefore, you should not pay for it.

Once you determine what the maintainable cash flow is you must assess what you can pay for the business. In very rough terms — if your lease has over seven years remaining, and the business is profitable, you can pay upwards of four times earnings. If the lease only has three years left, then paying three times earnings would be far too high as, in the best-case scenario, you could only hope to get your investment back without realizing a profit. It is best to obtain impartial third party advice when valuing a business.

Conclusion

Purchasing an existing business has a lot of advantages. First you will be buying and capitalizing on someone else’s hard work and goodwill. You will be able to examine the results of a business in progress, which should eliminate much of the risk that is associated with start-up operations. You will be able to assess your client base, your cash flow and your likely profit at the end of time in order to make a safe and reasonable business decisions. Given that there is so much information to base your decision, you should take your time and make a sound purchase.

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