How Much is a Restaurant Worth?

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Our real estate practice is exclusively devoted to the buying, selling, leasing and locating of restaurant business opportunities. We are frequently asked "How much is my restaurant worth?". Over the years, we have participated in a great many formal and informal restaurant business valuations.

Experience teaches that there is always more than one answer to the question of how much a restaurant business is worth. Some answers are driven by the marketplace, some are driven by academics and some are driven by the ramifications of the tax laws. Some answers are driven by mathematical or accounting formulas related to cash flow and asset value, while some rules of thumb relate to the level of sales or the owner's compensation. Sometimes the answer is as simple as what does a seller want and what is a buyer willing to pay.

Let's begin this discussion by stating several important facts. The first is that we are talking about the valuation of a business and customarily this valuation does not include the valuation of the real property. This is pertinent knowledge for two reasons. One is that when real property is involved, it is valued separately from the business and then the two are lumped together for a single, consolidated value. The second reason is that most urban and suburban restaurant situations involve leased space rather than owned real property.

Our work as restaurant brokers generally only involves the buying or selling of a leasehold interest, plus the trade fixtures, furniture and equipment. In other words, we sell the assets, financial capability and the goodwill of the business. And we would like to state that a restaurant business is like any other financial investment. It is expected to yield an adequate return to the owner, so that in placing a value on a restaurant business, generally, the single most important attribute of the business is the cash flow it generates.

To start the determination of a restaurant's value, one needs to assemble and analyze a fairly wide range of financial and non-financial documents. Items to review can include tax returns, financial statements, accounting records, notes and liens against the business, real and personal property leases, contracts and other agreements. Then we start to look at the furniture, fixtures and equipment, the neighborhood, the staff and management and even competitive trends. Generally, our list of factors to evaluate will number forty or more items.

Most of the time the two most important factors are the lease and the level of cash flow. The lease is critical to both the remaining life span of the business at this location and the level of monthly financial obligation, which must, at the very least, be within generally accepted industry standards.

Cash flow should generally be the primary determinant of the worth of a restaurant business. The discretionary cash flow (profit plus depreciation, amortization, interest expense, unique or one time expenses and personal expenses billed against the business) effectively tells you the rate of return that you will have for the cash that you have invested in the business.

The worth of a restaurant, based on its cash flow, coincides with the income approach to property valuation. When we have determined the cash flow of the business we will then apply a capitalization or cap rate to determine a starting point for the worth of the business. Then we will adjust the value of the business up or down according to what we have found from the other aspects of the business that we have analyzed.

Capitalization rates for the restaurant business are typically high because of the relative risk of the business. Restaurant cap rates run from 20% to as high as 100% and at the high end it is equivalent to saying that the business has little or no worth. The typical cap rate for a well-run, well-maintained, average to above average cash flow business with an average to better than average lease will normally be 33%. Thus, if a restaurant had discretionary cash flow of $150,000 per year, for the last three years, it probably will be listed for sale somewhere in the neighborhood of $450,000.

And if you don't like cash flow based valuations coupled with lots of reasonable analysis of the business, here are several common rules of thumb used in the restaurant business: 25 to 50% of average gross annual sales, three times the owner's compensation and the one all too frequently used in the marketplace - whatever the seller wishes to receive!

Please feel free to call us if you have any questions on this information.

We're happy to assist you.

4500 S. Lakeshore Drive, Suite 595
Tempe, AZ 85282
480.491.0123 | 480.820.4459 Fax

© 2007 "The Restaurant Brokers"