How to Value a Restaurant

What is the Purpose of a Business Valuation?

A small business valuation determines the average buyer's price to take over ownership. For many businesses, the buyer would be an owner-operator looking to take over day-to-day management while earning additional income through cash flow distributions from the business.

The key word mentioned above is average. The goal is not to calculate the highest price that someone on planet Earth will pay nor the price that will sell the business the quickest. 

Instead, the goal of a business valuation is to calculate its fair market value (FMV), which is what the average buyer of a business in a normal market would pay.

Owners may want to know the fair market value for several reasons.

1. Financial Planning: How much of my net worth is tied to my business? What are the key ways I can increase the value of my business?

2. Estate Planning: How much is my business worth? Should I put the business in a trust? How will I set myself up for retirement?

3. Divorce: What is the value of the business in the eyes of appraisers? How would I divide it up as an asset?

4. Retirement: How long should I continue working before considering a sale? What are the likely sums of money a buyer would pay to buy me out?

5. Capital Raise: What is the business's pre-money valuation? How much of it will I need to sell to raise enough capital?

6. Partnerships: How much would it cost a partner to buy into a slice of the business? How much would it cost me to buy a partner out?

We recommend using the valuation method of the seller’s discretionary earnings to calculate the fair market value. This is the most common approach for valuing a “Main Street” business. Owners need to first calculate their seller’s discretionary earnings and then determine the right multiplier to use.

How Much Is My Restaurant Worth?

Calculating your restaurant’s worth follows a similar process to how to value a cleaning business and how to value an auto repair business. The first step in a small business valuation is to calculate your earnings. The best bet is to use the past three years of federal tax returns. If you use Quickbooks or Xero for accounting or bookkeeping, we recommend exporting your profit-and-loss statements as well.

Once you have your financial statements ready, the initial analysis is to calculate Seller’s Discretionary Earnings (SDE) for the past 3 years. For a quick refresh on SDE, check out our blog deep dive on Seller's Discretionary Earnings! To calculate SDE, add up the following:

• Net Income, as reported on the tax return

• Interest, as reported on the tax return

• Depreciation, as reported on the tax return

• Amortization, as reported on the tax return

• Owner Compensation: Add the owner’s salary from the tax return as well as any benefits from your profit-and-loss statement, such as retirement plans and healthcare, that you, as the owner, receive.

• Discretionary Expenses: Add up any line items from your profit-and-loss statement that aren’t business-related. Common examples include personal phone bills and country club memberships.

Now that we’ve added all of the discretionary items to net income, the next step is to adjust the earnings for what a new buyer would receive. Some standard adjustments include the following:

• If you own the restaurant’s building, are you under or overpaying rent? Adjust the rent expenses to account for what you would charge the buyer of your restaurant on an ongoing basis.

• Did you make a big purchase of a personal vehicle? Make sure to add back the cost of the vehicle (and subtract any depreciation), as the buyer would not be forced to make such a purpose.

• Do you employ family members as waiters, line cooks, or bookkeepers? Adjust the payroll to remove family members who do not work and factor in the market wages of family members who would need to be replaced.

• Did you book PPP or EIDL as income? Make sure you remove any COVID-related loans from the income statement.

Lastly, we need to determine a fair summary of the SDE that a future owner can expect. 

Typically, this is a weighted average. In other words, we can’t simply pick the year with the highest SDE. We should average the last three years and weigh the most recent year as the heaviest, as things can change. Typically, the most recent year is the best depiction of where the business will be when a buyer takes over.

We recommend that owners perform a “back-of-the-envelope” valuation to weigh the most recent year at 50%, the second most recent year at 37.5%, and the third most recent year at 12.5%.

Once this calculation is complete, you now have a good proxy for the earnings that a buyer would receive as the owner of your business.

What Multiple Should I Use? 

A typical rule of thumb is to value a restaurant at 1.5x to 3x the seller’s discretionary earnings. The exact multiple used is based on several factors, such as the time in business, the number of new hires a buyer would need to make, and the type of restaurant. As you can tell by the numbers below, the multiple can vary widely and depend on a number of data points.

For those performing a quick valuation at home, we recommend the following approach, which tiers multiples by annual revenue and type of restaurant (e.g., full-service vs. quick service):

What Drives Up the Value of My Restaurant?

• Minimal Owner Involvement: If you’re a relatively passive owner, you can often slide up to the top end of the multiple range for your revenue size. The number of potential buyers who can afford a restaurant but do not have time to operate it actively is greater than the number of potential buyers who can afford a restaurant and have time to operate it actively. As the saying goes, the more potential buyers, the better the price.

• Minimal Family Involvement: We’ve seen several good restaurants where the owner has a few family members involved in running the business, whether they serve as line cooks, help run the cash register, or do the bookkeeping and payroll. The fewer family members involved, the better the multiple and value. Why? Because the new buyer does not need to worry about replacing a number of employees on day one.

• Quality of Equipment: Kitchen equipment isn’t cheap. The better the quality of your equipment, the more your restaurant is worth. The buyer can focus on ensuring a smooth transition without spending tens or hundreds of thousands of dollars on upgrading the equipment.

• Liquor License: For states with strict alcohol laws, the presence of a liquor license will drive up the value of the business. This is even more the case in states that have capped the number of licenses given out to establishments.

• I-9 Verified Employees: It’s no secret that some restaurants pay people under the table and do not verify that all employees are authorized to work in the U.S. For restaurants with a clean back office and strong recordkeeping habits, buyers will often pay a premium.

• Long-Term Lease: If you have a long-term or transferable lease, buyers will pay a premium as they do not need to worry about negotiating with the landlord over rent increases. Owners who own the real estate that their restaurants operate out of share in this benefit, as they can draft a fair long-term lease with the buyer.

Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.