In this article we review the financial information you’ll need to evaluate good prospective restaurants, recognize high quality vs poor deals, and demonstrate your credit worthiness to lenders and investors.
Learn about the business
A preliminary step in how to buy a restaurant is to gain a clear picture of why a given restaurant is for sale. Are the owners retiring and uninteresting in maintaining a popular spot? Or is the business struggling to attract customers? Note that business owners may be reluctant to share detailed information until you demonstrate serious interest in purchasing the business. Once you’ve convinced the owners that you’re a real buyer, ask to see their financial information.
When evaluating the finances of a restaurant, seek to inspect the balance sheet, to see the overall assets and liabilities of the business. Also consider the cash flow statement, which details the flow of cash through the business. A healthy property will have positive cash flow, while a struggling business may have more money going out than coming in. Of course, if you’re ready to overhaul a restaurant and make major changes, and have the operational expertise to turn around a troubled business, then negative cash flow need not be a disqualifying condition for you. But know what you’re getting into up front.
WATCH THE FULL VIDEO BELOW!
Going in depth on the financials — what documents to inspect
Profit & Loss Statement, Balance Sheet, and Cash Flow Statements should all be reviewed when assessing the business’s financial health.
Inspect Profit & Loss for consistency in costs, performance against budget, and overall contribution to the bottom line. Here some questions to guide your inquiry into the finances of a given restaurant:
- Does the current structure of the business generate a profit, or are costs too high to support profit?
- Are there large swings in cost of goods indicating opportunities with current operational controls? That is, can better management reduce food costs and make them more consistent?
- What is the current labor structure, and is it sustainable? Could the restaurant staff be reorganized for more efficiency in operation?
- Is the R&M budget used to maintain the property and equipment? Are long term assets well cared for or will they require a big initial investment in reparative maintenance?
When examining the balance sheet, review any unnatural or negative balances. The balance sheet should not house negative accounts outside of depreciation and amortization. Negative accounts indicate that there was an issue with the account where it was either over or under-collected. Also give consideration to the remaining life of asset purchases such as property & equipment. Are the tax accounts trued up? Does the business have outstanding loans, and are they being properly allocated between principal and interest?
These questions all matter most if you’re assuming the complete assets and liabilities of the existing restaurant (also known as a FEIN purchase, because you buy and use the existing Federal Employer Identification Number). If you’re purchasing only some of the assets of the business, you may be able to pick and choose the most valuable parts of the balance sheet, while avoiding major liabilities.
All types of buyers will be interested in the Cash Flow Statement. This document shows the health of the business in terms of cash in and out. Review it to see where the cash position is gaining momentum and to what degree future cash growth can be expected. Do they have income coming from ownership distributions? Are they utilizing credit cards to pay bills when cash is tight? Is the way they are utilizing cash sustainable?
Learn how to distinguish between a safe bet and a red flag in restaurant financials
The following financial attributes make for a relatively safe purchase: consistency in costs (specifically look for large inventory swings period to period), Profit and Loss cost categories are in line with industry averages, consistent trends between revenue and profit when reviewing 3-years worth of tax returns, current and balanced bank reconciliations and accurate balance sheet accounts (no unnatural balances).
Conversely, these attributes raise red flags: unnatural balances on the balance sheet, heavy credit card usage to augment cash flow, inability to provide recent financial statements, inability to produce bank reconciliations, missing expenses or incomplete financials, and negative trends in sales as it relates to profit
How to think about trouble spots in the financials
No restaurant is perfect—if it was, it wouldn’t be for sale. So, as a buyer, you can expect to find imperfections. Yet not all flaws are created equal: some problems are deal breakers, while others can be easily remedied. The biggest question to answer up front is how much of the business you want to buy. If you opt for a total package purchase (a FEIN purchase), then rocky past performance will impact the new ownership, and all previous liabilities would be the new owner’s responsibility. If purchasing the FEIN, increased audits and legal guidance should be sought prior to exploring the purchase to ensure that the new ownership doesn’t incur massive debt or, worse, legal responsibility.
If it is an asset purchase, due diligence should be completed to ensure the financials are holistic. Are small purchases lumped in with asset accounts? Are inconsistencies in expenses tied to timeliness, and if so, are expenses missing in the current financials? If a complete overhaul of the restaurant is going to take place, past performance is less relevant but should still be considered. If sales volume was low, was it due to concept and/or operational performance or is it due to location? Understanding why past performance led to a sale of the business can help you structure the future of the business in a strategic way, so that you do better with the business than the previous owners were able to.
Use financial documents to arrive at a valuation of the property
As a refresher for buyers, the balance sheet reflects the business’ total financial worth. It takes into account the net income (retained earnings) from all years and reflects all current assets and liabilities for the business. A close scrutiny of the balance sheet will reveal the true health of the business you want to purchase.
Once you’ve examined the balance sheet, you should be able to answer the following questions about your prospective deal: Are you purchasing the inventory and equipment as part of the business? If so, those totals should be taken into consideration. If you purchase the business, are you also purchasing the clientele? If so, historical revenue should be considered as part of the valuation to estimate future growth potential. Lastly, is there debt that needs to be taken into consideration? How much is owed and who is responsible for paying it?
If it all looks good, proceed to hire an attorney and business appraiser
At this stage you’ve determined you have an interesting prospect on your hands. The next question is, how much does it cost to buy a restaurant? The answer will depend on how the business is appraised (valued) by a professional business appraiser. This is a trusted third party paid for a neutral assessment of the value of business, including all its assets and liabilities. The appraiser will establish a fair market value for the business.
As a rough rule of thumb, restaurants commonly sell for about three times their annual profit, but the value can go higher for businesses with a great location or committed local clientele. When purchasing a restaurant, the price will be a combination of many factors, such as the condition of the underlying real estate (owned vs rented), the desirability of the restaurant, the local reputation of the restaurant (often demonstrated by online reviews), and the state of the equipment and furnishings.
You’ll want to work with an experienced local attorney to examine the lease agreement and purchase agreement. Your attorney will then draft a letter of intent, which is a formal statement of your intention to purchase the property, pending due diligence.
Secure your funding
You’ve found a property of interest and had it appraised. Now you have a target for how much money you have to raise to complete the purchase. With this figure in hand, calculate the relative balance of investors and loans you’ll need. Sources of investment will vary by buyer, but if you have experience in the industry, past business partners are a great bet, as you already know whether they make for good partners. Secondarily, you might turn to friends and family, or a crowdfunding platform.
Most buyers will finance at least a portion of the purchase with debt. See our recent article on how to get a loan for a restaurant. In summary, your demonstrable credit worthiness will determine the quality and quantity of debt financing you are offered by lenders. Having a strong credit history, valuable collateral, and an impressive business plan will best position you to secure credit on favorable terms. Don’t simply accept the first offer you get—speak to multiple lenders and compare their offers.
LISTEN TO THE FULL PODCAST EPISODE BELOW!
Make the purchase
Finally, it’s time to buy your new restaurant. Establish a transition plan and responsibilities of buyer and seller over the closing period. A typical transition would be one to two months for the seller to prepare the property, deliver financial and regulatory records, and provide access to relevant technical systems, such as payroll and accounting software, along with admin access to the website, web hosting, and social media profiles. Ensure that all property is transferred during this period, including any trademarks held by the company.
Your purchase agreement will specify the terms of closing, transition plan, and how assets are to be transferred. Have your lawyer draft this document and carefully review it yourself to check that all bases are covered. Send the document and it is signed. Congratulations, you’re now the new owner of the restaurant! Now the real work begins…