Do you have a restaurant for sale or are you interested in buying one? Restaurants can be excellent investments and can generate a healthy cash flow if done correctly. If you are looking to purchase a restaurant it is incredibly important that you conduct your due diligence beforehand to ensure that when the restaurant passes into your hands there are no surprises.
The restaurant business demands expertise & careful planning
Restaurants can be a difficult business, particularly if you are just starting out and trying to gain market share. A study by the Ohio State University reported that 60% of restaurants fail in their first year and 80% of restaurants have failed within 5 years of operation. Many of these failing restaurants will be put up for sale during this time period and there is a lot of opportunity to purchase the business (or assets) and turn it around. It is your job to identify whether and where the restaurant is struggling (and it isn’t always clear in the financials), so that you can take advantage of the opportunity of the restaurant for sale and create a profitable business.
What is Due Diligence?
Due diligence is the most important part of the process when evaluating a restaurant for sale. It is the process of researching and evaluating a business that is for sale to:
- Fair value for the restaurant
- Ensure a proper transition to the new owners
- Identify strategies to solve existing problems and issues
A structured well thought out due diligence process will save you time and sleepless nights in addition to demonstrating to any investors or lenders that you know what you are doing and will be more inclined to invest or lend. The below four topics are the key essentials when conducting due diligence for a restaurant for sale.
1. Location Analysis of the Restaurant for Sale:
It is useful to include a map of the area (from google maps or similar) is useful when analyzing the features of a location to help visualize easily all the information. The location of a restaurant is the single
The following are the most important demographics for restaurants. Most of this information you should be able to obtain from your local government office or website.
- Age: Is your cuisine & pricing suitable for the predominant age range in your area? It is probably not ideal to place a high-end French restaurant in a college town (unless perhaps it’s a particularly posh university).
- Income: The average income of an area can often indicate socio-economic Is your pricing
- Gender: Most areas in the world don’t really vary in terms of gender distribution, but if you were actually planning on targeting a particular gender for some strange reason.
- Job Type: Understanding what your locals do for a living can help you decide your cuisine, pricing and hours of operation.
- Students – Perhaps a low cost late night burger or pizza place?
- Professionals – Perhaps a high-end bistro with decent wine list that opens only during the evenings
- Workers – Perhaps an on-the-go breakfast option with after work drinking specials?
How close are you to your suppliers? If your restaurant constantly requires special ingredients which are hard to source which means you have to travel extensively, perhaps this location isn’t the best location.
Restaurant owners often underestimate the power of visibility of their restaurants from the footpath and nearby roads. Just being visible isn’t necessarily going to convince someone to eat at your restaurant, but it is the first step in getting people to at try your food. Consider the following questions when assessing visibility:
- How far down the street can you see your sign?
- Can it easily be seen from a passing car?
- What is the foot traffic on all the streets leading to your restaurant?
Unless your restaurant is absolutely amazing and without comparison, it is best not to base your restaurant in an area with significant crime problems. If you have no choice, choose a well-lit area, close to public transport, high visibility and easily accessible to the local police station.
Check the zoning around your area. Ideally you will be in a highly residential or commercial area. Avoid industrial zones.
How are people going to get to your restaurant? Even the smallest inconvenience can prevent people going to your restaurant. You need to ensure your location has a variety of options for transport.
- Parking: If people don’t have an easy way to park close to your restaurant you may need to offer a valet service.
- Public Transport: Where are all the closest stops? Will people have to hike in order to enjoy your meal?
2. Financial Analysis of a Restaurant for Sale:
You will need to really dig deep into the financials to identify some of the sore points of the business. Unfortunately there are many restaurants who don’t have a highly sophisticated reporting system which breaks down all the information into the necessary detail. These would be the specific metrics I would ask for by the owner of the restaurant for sale:
- Income Statement, Cash Flow and Balance Sheet for last 5 years (or the maximum amount of years that make sense)
- Prices & costs of all meals, drinks currently on offer and their daily sale volumes for as long as they have the information.
- Organize all the data into their menu sections
- Total Customers per day
You should be able to get all this information from the Point of Sale (POS). The good systems should allow you to download all the information into excel so that you can manipulate the numbers directly.
What you should look for:
- Check the sales numbers match up with what is in the financial statements. If they don’t match up, ask why not. Often there will be a good reason – i.e. an event that was hosted that wasn’t registered in the POS system.
- Check that the costs of goods sales match up roughly with what is in the financial statements. (i.e. multiply the cost of each meal my the number of meals sold for each item).
3. Asset Analysis of a Restaurant for Sale:
As a restaurant purchaser you should have a good understanding on the status of all the equipment and assets on site. You do not want to be the restaurant owner that just after paying full price for a restaurant realize that you have to take out your wallet again to purchase a new industrial size refrigerator as the old ancient one.
Create a table to help your summarize all the assets and which ones will be included in the sale. Request from the current restaurant owner of the restaurant for sale the following:
- List of all high value assets (fridges, freezers, ovens, stoves, fryers, chairs, tables, computers, printers).
- Purchase price and date of purchase next to each high value asset, and the expected life of the asset.
- If a piece of equipment was serviced or had a part replaced make a note of this on the chart.
• Make sure all the assets are specified according to the list provided by the owner of the restaurant for sale. The restaurant should have all the assets necessary for the normal functioning of the restaurant. If an asset doesn’t appear on the list and it should do, you should adjust the purchase price for this asset.
• Look for any assets which are reaching their end of life. When you are building out your financial model for your restaurant you should take these future expenditures into account.
4. Legal Analysis of a Restaurant for Sale:
Managing a restaurant involve the processing and executing of many different types of contracts and permits. You will need to request all these documents for your analysis. Below is the list of what you will need and what specific items you will need to look out for.
1. Lease Agreement (If you will be assuming the lease)
a. What are the renewal conditions of the lease? Ideally the lease will be a long term lease which would increase according to CPI or inflation.
b. What are the intentions of the owner of the property in the mid to long-term?
c. What is the relationship like between the owner of the property and the current restaurant owner? Will you be walking into a toxic and stressful relationship? Best to talk to both parties to obtain the full story.
2. Sales tax records
a. Check that the sales reported on all tax filings match up with the sales reported in the POS and the financial statements.
b. Check that all tax filings have been filed.
c. Check to see if there is any outstanding tax payments due.
3. Vendor invoices, particularly the ones from major food suppliers
a. Are all the invoices registered properly with your accountant and/or accounting software? Look at all the invoices for the year and add them up. Reconcile them with all the payments for them.
b. Does the inventory on the balance sheet reflect what is actually in stock at the restaurant?
4. Payroll records
a. Check that all current employees are properly registered in payroll.
b. Check that there are no payments outstanding (this can happen if the restaurant is facing bankruptcy).
5. Health inspection reports
a. Identify any problems from health inspection reports and how to resolve them. This may adjust your purchase price as your costs could be higher if they haven’t put in best practices for the restaurant.
6. Permits (Liquor license/Food Service Establishment Permit/Business License)
a. Check what permits are required and which permits the restaurant currently has.
b. When does it need to be renewed? How much does the renewal cost?
c. Has there been any residential complaints about noise or violence which could make it difficult for the renewal?
7. Current insurance policies
a. What insurance policies does the business have currently? Which ones would you need?
i. Business Property – Covers against losses on the property due to disasters.
ii. Business Liability – Covers against losses due to a customer’s claims.
iii. Business Crime – Covers against theft or robbery.
iv. Worker’s Compensation – Covers against and accidents or injuries of employees whilst they are working.
8. Employee work schedule
a. Review the current work schedule. Is it consistent with your plans for the restaurant? Perhaps want to include a breakfast service for restaurant for sale?
9. Leases on any equipment – Most of the time these are soda machines and/or dishwashers
a. Check the status on when the leases are up for all the machinery.
b. Check if they are an operating lease or a capital lease
10. Contracts with any service providers (linen and uniform companies, janitorial companies)
a. Review contracts with service providers. Are they providing competitive prices?
5. Marketing Analysis of a Restaurant for Sale:
Conducting an analysis on the current marketing strategy for the restaurant can be useful to see if you can improve the restaurant’s sales. Identifying who your customers are and how they are coming to your restaurant is key. This is something you probably won’t be able to do until you own the restaurant. However you can do some preliminary research.
1. Online Review Websites: Yelp / Zomato (previously Urban Spoon) / OpenTable / Zagat / Trip Advisor:
Reviews on your restaurant are the predominant way that people will decide whether to go to your restaurant or not. It is imperative to monitor these channels to see what things your customers won’t say to your face and how you can improve.
a. Check all the reviews on these websites. Focus on the comments that have constructive criticism. Is there a trend with the comments? Quality of Service? Quality of food?
b. Encourage your patrons (without being too pushy) that they write a commentary on one of the review sites.
2. Delivery: Does the restaurant do delivery? If not, why not? Delivery allows the restaurant to leverage the kitchen staff but not have to be concerned with high cost wait staff. Have a look at seamlessweb, grubhub, domicilios etc.
3. Loyalty Programs: Depending on your type of restaurant and your financial you may wish to investigate whether a loyalty program makes sense for your business.
a. Usually better for higher margin food and drink products which can offer the loyal members free product every 10 purchases.
4. Local Business Catering: Does the restaurant provide any catering for businesses or events?
a. Providing catering can provide an additional revenue stream during those slower weekdays.
If a lot of these avenues are already implemented, this is great! But it also means that there will be very little growth possible for the business. This has some implications on valuation, particularly when you look at it from a multiples perspective.
This list for conducting due diligence is by no means a fully complete list. Some restaurants will have specific issues that you may need to investigate further. The key is to identify these deal breaking issues as fast as possible in order to not waste time. Many owners will be forth-coming with the issues and may even provide recommendations on things that they would have done if they could start again.