Buying a restaurant for sale can be a great way to get into the restaurant business and there are quite a few pros to the concept. For example, you should have immediate cash flow and customers and a good idea of the operating history of the business. You should also have an easier time finding financing and you get to skip a lot of the work that goes into starting a restaurant from scratch or even with buying a franchise.
On the other hand, you have to be very careful when buying a restaurant that you aren’t A) paying good money for someone else’s loser B) you are paying the right price for the actual value you are receiving.
The first step in selecting a restaurant to buy is to narrow down your search area by location and type of restaurant. You can broadly narrow it down by price, but since the asking price and selling price can often be widely different, don’t let the price enter your mind too much.
Assuming the above example fit your starting criteria, let’s take a thumbnail look at what it is offering. First, I like to compare the sales to the net to get the profit margin. Both of these figures may be either off or way off but it’s a starting point. You already know the numbers aren’t exact because they are way too round. That could be a lazy broker but more often means the owner isn’t reporting everything and has estimated sales and profits.
In this example the profit margin (net profit divided by sales) is 19.5% which is a healthy profit for a restaurant and a really healthy profit for a franchise which has to give up a royalty to the parent company which makes the net profit lower than an equivalent non franchise restaurant doing the same volume of sales.
A net profit of 10% or less can either mean a bad restaurant or just bad management or an absentee owner or some other problem- it doesn’t mean you shouldn’t investigate if the business otherwise fits your requirements but it does mean you should pay less for it. A net between 10%-20% is good. Once you start getting past 25% however things start to look suspicious.
Occasionally a restaurant can make more than 25% net profit but it often is because of a unique situation that may not last once the business is sold. For example- if the current owner owns the building and pays no mortgage that would help the profits significantly. A new owner, however, who would have to make a monthly lease payment to the owner (or a mortgage payment if you bought the building with the business) would have a lot less profit to show for the same sales.
In this case, the profit looks OK so then we look at the rest of the figures. Unfortunately, the broker hasn’t provided many. We don’t know the estimated value of the furniture, fixtures and equipment (usually abbreviated as FF&E) which can help determine the value of the business. We also don’t know how much inventory they have on hand, which is an amount that is paid at the time of sale on top of the purchase price. You can’t run a restaurant without inventory, right? So you have to buy it, at cost, so you can run the restaurant from day one.
One way to get a reasonable ballpark estimate of inventory is to work it out from the sales. In this case, we use the following formula: $654,000 (annual sales) / 26 weeks (average inventory on hand is two weeks) X 30% (average food cost). The answer is $7500.
Next, I look when the restaurant was established. Anything two years old or newer is suspect. It may be doing fine, but it could just as easily mean the business never made a profit and the owners have finally run out of money to keep it open so they are trying to sell it. Not many people who go to all the trouble of starting a restaurant turn around and sell it less than two years later- unless it isn’t doing well unless there are some extenuating circumstances. You can go check it out, but bear in mind the most likely scenario is that it is losing money.
Finally, I look at how many employees there are. While this doesn’t tell you a lot, it can tell you something. If the business seems understaffed it may mean the profit is higher than normal because the owner is killing himself, and maybe a few family members, working 80 or 100 hours a week for little or no pay. Unless you are going to do the same you can’t count on the same profits. On the other hand, a restaurant that is obviously overstaffed may represent an opportunity to increase the profit by running a leaner operation.
Once we’ve given the initial info a once over, it is time to read the description and see if we can learn any more important clues as to whether this restaurant for sale is one to investigate further or steer clear. In the next post, I’ll get into the write up and see what else we can determine.
