Written
By: Richard D. Williams
&
Matthew Williams
How often have you
asked yourself this question? Restaurant operators often need to know
the approximate value of their restaurant business and/or real estate
and personal property, even if they are not currently contemplating a
sale of the business. Knowledge of value becomes important for a
variety of reasons. Some of the reasons include refinancing of the real
estate; dissolution of a partnership or sale of stock representing a
majority or minority interest in the business; a divorce settlement;
property tax protest; insurance settlement after a fire or natural
disaster; and settlement of an estate upon the death of an owner. The
purpose of this two-part article is to provide the reader with an easy
way to answer this question.
Restaurant value
can be separated into at least three components, which include the value
of the business (business enterprise value), the value of the personal
property (furniture, fixtures, and equipment), and the value of the real
estate. Real estate value can be broken down further to leased fee
value (value to the landlord of the lease encumbering the property),
leasehold value (the value of the tenant’s interest in the lease), and
the value of the fee simple ownership interest in the real estate. In
the United States, approximately one-half of the restaurants occupy a
leased building and land, and slightly less than one-half own the
building and land. I will address the business value of the restaurant
and the value of personal property in Part I of this article, and the
value of the real estate interests in Part II.
The following table shows a statement
of income and expense for a hypothetical restaurant.
In this example,
the value of the leasehold interest in the real estate has been removed
by subtracting rent paid to the landlord from income. The remaining
earnings before income taxes, depreciation, and amortization (EBITDA)
equal $290,500. This is the cash flow available to cover a return of
and on the investment in personal property, and a return to the business
component of the going concern value of the restaurant. The return
requirements for the non-real property components are typically
significantly higher than the return to the land and building. As the
net income allocated to the personal property and business is received
by the business owner after all occupancy costs have been paid,
including rental income attributable to the land and improvements, the
risk of the operator is significantly higher than that of the landlord.
Capitalization rates for a restaurant
operator’s invested capital typically fall into one of three ranges: for
an efficient, profitable operation with new equipment, good location,
and expectations of strong annual growth in revenue, a capitalization
rate of 13% to 19% is appropriate. Stable, mature restaurants with a
track record of steady cash flows, but annual growth in sales
attributable to inflationary menu price increases, may use cap rates
ranging from 15% to 25%. Capitalization rates for restaurant businesses
with declining revenue may range from 20% to 30%. The following table
indicates the value range for the hypothetical restaurant business based
on the three scenarios listed above. The values shown include the
depreciated value of personal property, which must be subtracted from
the total capitalized value to isolate the business value.
The personal
property within a restaurant consists of its furniture, fixtures, and
equipment. On average, restaurant equipment has a useful life of ten
years. In the example above, we will assume that the original value of
the furniture, fixtures, and equipment was $800,000 and it is now seven
years old, or 70% depreciated. On a straight-line basis, the value in
use of this personal property would be:
$800,000 x 70% = $560,000
$800,000 - $560,000 = $240,000
depreciated value in use
If the personal property were to
be sold at auction or in a liquidation of the business, it might sell
for $0.05 to $0.10 on the dollar of original cost.
Subtracting the depreciated value
in use of the furniture, fixtures, and equipment from the three values
indicated in the table above, the value of the business ranges from
$836,000 to $1,576,000.
There are other variables to
consider in the valuation of the restaurant business, such as the
immediate need for capital improvements, which may also need to be
deducted from the capitalized value of the business and personal
property. This approach uses only one year of cash flow, which does not
account for future variation in cash flow. However, the above method of
valuing your restaurant business will give you a “ball park” indication
of value. Estimating the value of the land and restaurant improvements
(real estate), will be covered in my next article.
Richard
D. Williams
Matthew Williams
HVS Food &
Beverage Services
7883 S. Locust Court
Englewood, CO 80112-2426
303-771-4104
303-290-6533 Fax
