Understanding the fundamental on how to value a restaurant will assist you in making the right decisions regardless if you are looking at buying a restaurant, trying to sell a restaurant or looking at starting your own restaurant. There will be a few differences on depending on your objective and I will highlight them below as we progress.
But first a few tips before we starting getting into the numbers.
- Don’t Use Multiples, Use Discount Cash Flow (DCF)!
I should let you know that I am very hesitant about using multiples (such as EBITDA or cash-flow) as a form of valuation for any type of business. It is the equivalent of putting a square peg in a round hole. I breakdown my position on this on my website dothenumbers.co for more information.A small caveat; multiples can be useful for sense checking your calculations. There is a common rule of thumb that restaurants can be valued between 1.5-3.0x discretionary cash flow. This is a HUGE range of valuation possibilities, however multiples can be useful that after your do your valuation using DCF methodology to make sure that your valuation exists within this range.
- Do your market research
Before you start spending money on anything, you need to do your market research on your restaurant (important for buying or starting your restaurant). This is much easier if the restaurant already exists. Valuation is a simpler process in these circumstances, however if you are just starting out here are somethings you will need to answer which will help define the key assumptions for valuation of the restaurant.
- What type of cuisine will you be serving?
- Do you have access to all the ingredients necessary for this cuisine?
- How long do the meals take to prepare on average (from order to delivery)?
- Where will your restaurant be located?
- Inside a shopping mall / on street / mobile
- What is the passing foot / car traffic?
- Destination restaurant (are there other things to do around your restaurant
- Is there sufficient parking to satisfy a full restaurant?
- How will you serve your food?
- Table service (best dining experience / more staff required / less table turnover)
- Service (less intimate dining experience / less wait staff required)
- Takeaway / Delivery (no dining experience / no wait staff )
- Dining Experience
- Fine Dining (20 sqft per person)
- Full Service Dining (15 sqft per person)
- Fast Food Counter Style (12 sqft per person)
- Capacity of Restaurant. Typically the kitchen takes up approximately 40% of the restaurant space available. Based on the information above, you should be able to calculate capacity of the restaurant.
- Seat Turnover:
- Fine Dining: 0.50 seats / Hour
- Full Service Dining: 0.75 seats / Hour
- Counter Order Dining (Fast Food): 1 seat / Hour
- Operating Hours:
- Breakfast: 7am-12pm
- Lunchtime 12pm-5pm
- 5pm-10pm Dinner
With these assumptions confirmed – we can now calculate the maximum capacity seating / hr.
- What type of cuisine will you be serving?
Setting up your financial Model.
If you are an existing restaurant, your first priority is enter all your financial statements in a presentable format so that various business metrics can be calculated. Please a breakdown of customers on an hourly basis if possible. This will help us define assumptions to project out the model.
Use a 5 year monthly model with a breakdown into the individual financial statements (Income Statement, Balance Sheet and Cash Flow Statement).
Restaurant Initial Investment
Once you have defined what style of restaurant you want, we can start defining what assets and equipment are needed to launch the restaurant. We can split equipment into four types; kitchen, dining, décor & inventory. Calculating this initial investment is the first key step in understanding how to value a restaurant.
Kitchen Equipment: All the equipment necessary in order to serve your particular cuisine.
- Preparation Table
- Kitchen Knives
- Pots & Pans
- Bathroom finishing
- Reception Furniture
Restaurant Revenue Projections
Once you have your location – we can start to put together a preliminary model to evaluate what is our maximum revenues. This is the number if you were working your restaurant at 100% from opening to closing.
The Weekly Revenue Projection
- Prices: Define average prices for Appetizers, Main Meals, Non-Alcoholic Drinks, Non-Alcoholic Drinks for each meal period Breakfast, Lunch and Dinner.
- Maximum Table Servings / Day = Total Seats x No. of Hours x Seat Turnover Rate. All the other elements below will be applied to this maximum capacity to calculate no. of orders during a set period of time.
- Weekly: Restaurants should be evaluated on a weekly basis due to changes day to day. For example Thursday, Friday and Saturday will be busier for dinner than Sunday through to Wednesday. This is important to evaluate as it will determine staffing costs for those days.
- By Meals: The restaurant should be evaluated according to meals. For example, breakfasts will have different pricing for main meals, different drinks will be consumed (more juices and coffees than alcoholic beverages). This will impact how you structure your shifts as well.
The end result of breaking down all the numbers should look something like this (excluding the Average Costs which we will be discussing in the next section Variable Costs)
- Seasonal Fluctuations: Seasonal fluctuations are important particularly if your restaurant is in a tourist sensitive area, highly variable seasons (strong winters and summers). The best way to gauge your restaurants seasonality is to speak with restaurant managers in your area. You will want to ask how much do sales decrease as a % of its normal peak periods.
- Launch & Ramp Up: Seeing at launch hardly anyone will know about your restaurant, no one will have eaten there prior in order to provide a recommendation to their friends, you will need to take a reduced projection in the first year to ramp up to your normal operations. How fast a restaurant reaches this normal level of operation depends on how likely people will recommend your restaurant, how much you have marketed your restaurant, your location (see foot traffic via your restaurant). This is a good item to evaluate using scenarios – so that your restaurant can be sure to be safe and solvent during a slower ramp up period.
- Fast – 6 month ramp up
- Average – 9 month ramp up
- Slow – 12 Month ramp up
Variable Cost Projections
Define the costs of producing and presenting the food you are selling to your customers.
- Food Costs: Define average costs for Appetizers, Main Meals, Non-Alcoholic Drinks, and Non-Alcoholic Drinks for each meal period Breakfast, Lunch and Dinner. Calculate it based on portions for each meal, i.e, I bought 2,000 grams of steak cost $40 to purchase, the steak meal is a 300 grams so the assigned cost for this meal is $6.
- Additional Costs (disposable cutlery & crockery): Serviettes, Toothpicks, After Dinner Mints etc.
- Food Wastage: Food wastage is typically 10% of food costs. So the cost of wastage for the before mentioned steak meal would be 10% x $6 = $0.6
- Bonus: If you plan to pay your restaurant manager an incentive for performance it will most likely be associated with revenues and variable costs. This article is perhaps the most thorough analysis on how to structure bonuses for your manager.
Fixed Costs Projections:
Hourly Basis Contracted Staff: You should consider an 8hr or 10hr shift which starts the moment your restaurant opens for wait staff and 30 minutes before for cooks and chefs. It is important to review your tipping policy for your restaurant and when and how it should be reported for tax purposes. The amount of contracted staff should be calculated based on your forecasted orders. Your salaries per hour will depend on local market rates. Talk with other nearby restaurants with similar style and type of dining to make sure you get the right staff for the right price with your restaurant.Wait Staff:
- Fine Dining: 1 wait staff per 10 customers
- Full Service Dining: 1 wait staff per 15 customers
- Fast Food Dining: 1 wait staff per 20 customers
Cooking / Chef Staff:
- Fine Dining: 1 cook staff per 15 customers
- Full Service Dining: 1 cook per 20 customers
- Fast Food Dining: 1 cook staff per 25 customers
Restaurant Manager: Fulltime salaried employee that works administrating the whole restaurant.
Full Time Chef: Fulltime salaried employee that works administrating the whole kitchen of the restaurant.
- Accounting: Your accounting cost will depend on your reporting requirements in your country to prepare any tax filings. However in terms of day to day accounting software for small businesses, we recommend you use XERO Accounting Software. Almost all accountants are familiar with this software. Also you can outsource all your book keeping quite easily to a lower cost country.
- Marketing & Advertising: Typically restaurants allocate around 3-6% of their sales towards their marketing budget. The following article has an excellent review on how to structure your restaurants marketing plan. You should note that during your restaurant launch, this marketing budget will be a lot higher. http://www.restaurantmarketinglabs.com/restaurant-marketing-budget-recommendations-for-2016/
- Cleaning: You will need a cleaner every night to ensure the dining area and kitchen are spotless and ready for the next day’s operations. Check local rates on how much it costs for a cleaner.
- Laundry: Cleaning table cloths, kitchen uniforms, waiter uniforms. You can of course place this responsibility on the staff – however you run the risk of a messy appearance.
- Insurance: Insurance tailored specifically to the needs of a restaurant is essential for the smart restaurant owner. The typical insurance can protect against food spoilage due to equipment failure, fire damage and employee and customer injuries on site. Depending on your country, this cost can vary substantially. Talk to your local insurance agency or broker.
- Office Supplies: Often one of the smallest contributor to fixed costs. This would be no larger than $200 per month.
- Permits & Fees: Business License, Liquor license, Building Health Permit, Employee Health Permit, City and Fire Fee. Check with your lawyer or local representative about which permits and licenses need to be acquired to operate in your area.
- Security: Speak to your local security provider for costs of monitoring and an alarm system.
- Telephone: Phone line with answering machine to take reservations whilst the phone is unattended.
- Internet: An internet connection for restaurant administration (if managed onsite), or even to attract patrons.
- Utilities: Watch these costs closely as they can be larger than you think. Particularly if you are blasting air conditioning 24-7.
- Rent: What is your monthly rent?
- Entertainment: Will you be having entertainment events during the week to generate interest? You should work out exactly what is your incremental income generated by these events to make sure you aren’t losing money on these events.
This points will help drive the most important numbers of your restaurant business.
Building out your business model will help you define how much capital you need to raise in order for your business to be successful. If you use the DoTheNumbers Restaurant Valuation Model, you will be easily be able to calculate it after you have entered and confirmed all your assumptions. Essentially the model calculates all your upfront costs associated with launching your business and adds in any negative cash flows which will occur during the first months of operation until the restaurant breaks even. Theoretically speaking, how a restaurant is financed doesn’t impact the process on how to value a restaurant, however it does impact some important return metrics which are vital to investors.
Finding a loan for a new restaurant without any historical income is a difficult proposal, particularly when the restaurant industry has a large default rate. That said it isn’t possible. If you have a well thought out business plan and financial model which demonstrates that you understand the business, in addition to previous expertise in the industry, it starts to become exponentially easier to source a loan.
Loan amounts are typically around 20-50% of the total capital raised. Be prepared to be asked to secure the loan against your home. Interest rates will depend on your country, location, how much experience you have had previously running similar businesses.
An alternative to obtaining a loan for your company is obtaining a capital lease over your key most expensive equipment. Essentially the bank (or leasing company) purchases the equipment and then lends it to you for a fixed fee (which will include the interest payments). The loan is secured against the piece of equipment so if payments are not made, the bank can reclaim the equipment. This is a great way to reduce your upfront costs and thus the total amount of investment you require is obtaining your key and via a capital lease. Although you will be paying a larger cash amount in the future (unless you purchase the equipment once the cash flows of your restaurant have stabilized).
You will have to source between 50-80% of the capital needed from your own cash. Consider asking friends and family to help invest with your, or ideally a business partner who complements your skills.
One key point if you are working with a business partner with your business, make sure all equity contribution is assigned to the value of their contribution. This is straight forward if your business partner is passive and isn’t interested in the day to day operations of the restaurant. However, if you have partnered with a business partner (such as the head chef), you will need to work out how much equity they will receive for the work they have done without remuneration and the amount in cash they have contributed separately.
Learning how to value a restaurant can be a little bit of art in some ways. Once you have prepared all your operating projections we have to calculate the Unlevered Cash Flow. This is essentially calculating what cash flow generated not is taking into account any financing costs (note you should still include any capital lease costs into your calculation). It is calculated in the following way.
Step 1: Operating Financials
Place all your financials calculated for the 5 years into your excel file.
Step 2: Terminal Value
The terminal value is calculated based on the assumption that after 5 years the restaurant earnings have now stabilized. In this instance it can be possible to use a direct multiple of EBITDA comparable. For restaurants this can be approximately 3x EBITDA + Inventory on hand (i.e. any inventory that is currently paid for, this is to take into account any large purchases for inventory). Add this cash flow at the end period (month 60) in your excel file. You may say that maybe this is hypocritical of me, taking into account my dislike for using valuation multiples. The restaurants industry is where I relax this rule due to the limits on scalability; once a restaurant reach capacity – there is no way to grow revenues. This eliminates the need to take into account investment and revenue growth which other terminal value calculations take into account.
Step 3: Discount Unlevered Cash Flows & Valuation.
Sum all the unlevered cash flows including the terminal value calculated in step 2. Now you need to discount the cash flows using a discount rate. Choosing a discount rate is not an exact science unfortunately. If you are inexperienced at running a restaurant, an investor may require a larger return on capital. If you have chosen a somewhat unproven restaurant cuisine or model, an investor may also require a larger restaurant. For this reason usually the valuation is presented with a range of different discount values. For a restaurant – you should evaluate the business using a discount rate between 10-15%.
Use the formula in excel XNPV(Discount Rate, Values, Dates). This will calculate the value of all your cash flows and thus the value of your business. See below an example of the calculation.
Step 4: Sensitivities
Once you have your valuation calculation, you can start playing around with your assumptions. See how sensitive you are if your revenue growth after launch isn’t as fast as you thought. What happens to your demand on cash? Will you have enough cash to survive still? Change the discount rate to see how much it affects your valuation – you will be able to identify you minimum value acceptable.
How long does it take?
I have been building financial models and teaching my clients how to value a restaurant for many years now. Building a model from scratch can take a lot of time, it typically takes me a week or so just to build the base model. If you would like to save weeks of work and avoid making errors, please purchase the DoTheNumbers restaurant valuation model. It will save you a lot of time and you will avoid all the errors. Additionally I am available for a consultation via my Clarity account. Book a time with me!