Tips when Buying a Restaurant

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The restaurant business can be very volatile and this will often be reflected in the number of restaurants available for sale at any one time. As the failure rate can be so staggering you need to get to the bottom of the reasons behind the sale and conclude whether you will be successful as the new owner.

One of the first things that you should think about when looking over the documentation is the lease arrangement. Location is everything when it comes to a restaurant and very often its proximity to a pool of potential and repeat clients can be key. These days landlords are looking for security and will often heavily question the credibility of a new owner. Communication with the landlord should start early on in your due diligence process, to make sure that other alternatives are available in case a difficulty arises.

Placing a value on a restaurant can be quite a challenge. Basically, there are two methods that can be used: cash flow multiple or asset-based. If the business you are considering has been dormant, or you are just purchasing the equipment then it is appropriate to use the asset-based method where you simply attach a value to the assets and that is what you pay. If, however, the business is ongoing you can get a good idea of its value by calculating a multiple of the owners benefit. Traditionally, the benefit can be calculated by adding any owner salary or perks to depreciation and interest expenses, coupled with the business net income. Self-service restaurants can specify two times the owner benefit for consideration, while full service restaurants can specify two to three times this figure.

Bear in mind that the hours of operation of a restaurant have a great impact on the owner benefit. Take into account the sheer number of work hours required and compare to the benefit figures to see if the deal is indeed attractive. Some analysts use a rather general rule of thumb depending on the number of meals and/or the number of days the restaurant is open each week. If the restaurant is open five days a week, specify 70% of gross annual revenue; six days a week: 60%; seven days a week: 50%.

You may find it difficult trying to value revenues as the industry is notorious for not reporting income. Sellers will expect to be paid for the total profit, but often cannot prove it. The devil’s advocate might say that if they have been “cheating” and benefiting tax wise, they should not expect to reap the benefits a second time during the sale process. It may be possible to re-create the financial picture, but you should ask yourself whether you’re willing to believe the final outcome of this exercise, whether the process is realistic and whether you want to go through with it, anyway.

The two most significant expenses in a restaurant business are food and labor. While costs will vary greatly depending on the type of restaurant and whether liquor sales are involved, as a general rule of thumb the combined total of labor, rent and food costs should not exceed 65% of total revenue. Pay close attention to this rule as you do not want to operate in the red.

Many believe the typical breakdown of costs should be as follows:

Food costs: 30 to 33%

Labor: 20 to 25%

Rent: 6 to 10%

Again, you should not exceed approximately 65% when combining these items.

The exercise of due diligence is important whenever you buy a business and is especially true when you are considering a restaurant. This critical stage can lead to a review of 125 separate items and you should maintain a critical checklist as you proceed.

When reviewing equipment, bring in an expert. A nearby restaurant supply store can provide you with names to choose from and remember that there is a very large market for used equipment so you should be able to replace any faulty products at reasonable cost.

When you’re looking into the reputation of a restaurant, check out the public records to see if its been consistently performing above health department standards. You should also include a “representations and warranties” section within the purchase agreement, to document that there were no previous health violations resulting in a fine, closure and so on. Health concerns are of the utmost of importance when it comes to your restaurant’s reputation, and there certainly isn’t a faster way to end up closing the doors permanently than by having to face a public report in the newspaper that says your place of business has serious bug problems or isn’t meeting the minimum standards for health regulations.

You should learn everything you can about purchasing a restaurant, particularly if you don’t have much experience with the business. Don’t become one of those negative statistics and make sure that you buy well and build a successful restaurant in this highly competitive environment.

Category: Business
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