If you are considering buying a local restaurant and are wondering what a realistic ballpark price might be, there are some methods you can use to calculate a basic figure. Of course, there are many variables to consider, but a simple number is a good base to build on when calculating total cost.
Approximate Cost Of Acquiring A Restaurant
Let’s say you are looking to buy a restaurant in your area, but have not even reached the point of considering any specific establishments. In this situation, the best way to calculate a ballpark restaurant price is to use sales data from the restaurant industry, provided by the National Restaurant Association.
According to industry data in 2014, restaurants sold for a median price of $150,000. Restaurant prices vary widely. You may find something cheaper in your area, but it is always better to assume a higher price based on location, real estate price fluctuations, and existing assets at the time of purchase. The year 2014 is a good example because for this article because the economic conditions were stable, and the restaurant business was operating at normal levels of expansion.
Restaurant investors and owners will aim to sell their restaurant for 25-40% of their yearly operating income. For example, if the business is making $1 million in sales a year, they would decide a sales price, but it would be around $250,000-$400,000. It is important to remember that a business operating with $1 million in sales is not netting $1 million, and the cost to do business – labor, lease, food costs – steadily erodes profit potential.
How to Calculate using SDE
A restaurant's seller's discretionary earnings, or SDE, is, in essence, an equivalent to a business's net income, meaning the pre-tax income of a business after costs are deducted (profit), but including the owner’s salary and certain other expenses. Revenue is the gross earnings of a business before any costs or taxes are deducted.
If you know a restaurant’s SDE, you can multiply these figures by their respective industry multiples to get a ballpark estimate of how much you can expect to pay for the restaurant.
Based on an SDE multiplier of 1.96, a restaurant with an income of $100,000 is expected to sell for about $196,000. If a revenue multiple of .39 is used, the selling price of a restaurant with $500,000 in sales is expected to be $196,000. While sometimes the expected prices that are calculated using the SDE multiplier and revenue multiplier respectively might be the same, they will frequently not be the same. Between the two of them, you can get a reasonable range of what a restaurant should cost.
SDE multiples are generally between 1 and 3. Restaurants are often on the lower end of the multiples scale, because the restaurant industry is pretty volatile (many go under within 4-5 years of transfer), and restaurants often have a lot of owner risk associated with them. The more assets, overall industry growth, and transfer viability (likelihood of successful transfer from one owner to another) a business has, the higher it's multiple. Fewer assets, industry stagnation, volatility and high owner risk (click here to learn more about owner risk and how multiples work) lead to a lower sales multiple.
Putting It All Together
So let’s say you are interested in buying a sit-down restaurant in your area called Sal’s Steaks. You look online and find a listing for Sal’s Steaks that gives you its annual SDE and revenue.
Here are the numbers: $624,000 = Revenue/Gross Income, and $150,000 = SDE/Cash Flow/ Net Income. Using these numbers, you calculate an approximate price/value for Sal’s, using the previously mentioned industry multiples as follows: Generally, a true business value falls somewhere in-between the two estimates: $243,360 = Revenue Multiple Cost Estimate ($624,000 x .39, or 39%), and $294,000 = SDE Multiple Cost Estimate ($150,000 x 1.96).
These are just estimates based on industry averages. If Sal’s is run by an owner that is more absentee, there is more of a likelihood that it will transfer successfully to a new owner, possibly raising the multiplier above industry averages. If it has a killer location or Sal owns the building, the price will be higher. If there are lots of liabilities, like old equipment or a lease that is just about up, then the cost might be a bit lower. Franchises almost always have a higher multiplier, because they are generally more likely to succeed due to the help and guidance provided by the parent corporation. (For related reading, see article: What's The Best Franchise Investment?)