Habif, Arogeti & Wynne
Whether it’s because of an impending sale, for financing purposes, buying out a partner, or resolving a dispute, restaurateurs frequently need to understand and quantify the value of their business. But where does the value lie? Is it in the equipment and furniture costs? Is it in your sales? How can you credibly determine a value for your business?
Determining a fair value that is reliable and credible requires reliable financial statements. Any intelligent buyer will ask to understand your maintainable earnings. Utilizing your financial statements in accordance with US GAAP, adjust the statements for unusual income (such as a beneficial lawsuit settlement) or expenses (such as an unexpected, expensive equipment repair). Your income statements should also be adjusted to eliminate personal expenses run through the business (trips, cars, and so forth) and to reflect market levels of management salaries. If a typical McDonald’s general manager makes $50,000 per year, and you are paying yourself $100,000 per year, $50,000 should be taken out of expenses and added back to income – otherwise your income will look artificially low, resulting in an inappropriately low valuation.
For example, consider a restaurant with maintainable earnings of $62,000, and revenue of $550,000. Earnings before interest on debt service, income taxes, depreciation and amortization (EBITDA) and maintainable earnings are equivalent for this example. Now, we add back $50,000 for excess compensation and another $10,000 for personal expenses run through the business, giving us an adjusted EBITDA of $122,000.
Next, estimate your EBITDA multiple or the capitalization rate. EBITDA multiples and capitalization rates are determined either by analyzing purchase prices of comparable restaurants, including sales prices and maintainable earnings, or by calculating a weighted average cost of capital (or required return on investment). Higher risk leads to a higher cost of capital. EBITDA multiples and capitalization rates are related – a very general relationship holds that your EBITDA multiple = 1/your cost of capital. If you work through the simple math, higher risk leads to higher cost of capital, which leads to a lower multiple, which leads to lower value.
Let’s say in our example above that an EBITDA multiple of 5 is deemed appropriate for the restaurant being discussed. This translates into a required return on investment of 20 percent.
Once you have both of these figures, multiply the maintainable earnings by the EBITDA multiple (or divide the maintainable earnings by the cap rate).
For our theoretical restaurant, the valuation for our example is $610,000 and based on the following calculation:
- Adjusted EBITDA - $122,000
- Multiply by the EBITDA multiple – 5 (a fairly high EBITDA multiple for a restaurant)
- Sample Fair Value - $610,000
In addition to the raw calculations, you should, at a minimum, understand the following elements to your business:
- Is the real estate on which the restaurant is located included in the proposed sale as well?
- Is more than one restaurant for sale (multiple restaurants often command higher sale prices)?
- How much working capital is required to operate the restaurant and fund growth?
- How does the restaurant compare to its peers operationally?
- What is the restaurant’s historical growth or short-term growth potential?
- How does the restaurant’s employee turnover compare to its peer group?
- How long have the restaurant’s managers been working there?What is the restaurant’s Yelp rating? How are the ratings and comments trending?
- How strong is the location? Does it generate a great deal of traffic?
To learn more about how to value your business, contact Scott Hutchinson, audit partner, at email@example.com or Michael Blake, director of Business Valuation Services, at firstname.lastname@example.org.