Bvr's guide to restaurant valuation 23 pgs

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  • 1. BVR’s Guide to Restaurant Valuation 2010 Edition Ed Moran Business Valuation Resources, LLC 1000 SW Broadway, Suite 1200 Portland, OR 97205 (503) 291-7963 Fax • (503) 291-7955 • www.BVResources.com Published by
  • 2. Copyright © 2010 by Business Valuation Resources, L.L.C. (BVR). All rights reserved. Printed in the United States of America. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, with- out either the prior written permission of the Publisher or authorization through payment of the appropriate per copy fee to the Publisher. Requests for permission should be addressed to the Permissions Department, Business Valuation Resources, LLC, 1000 SW Broadway St., Suite 1200, Portland, OR, 97205, (503) 291-7963, fax (503) 291-7955. Information contained in this book has been obtained by Business Valuation Resources from sources believed to be reliable. However, neither Business Valuation Resources nor its au- thors guarantee the accuracy or completeness of any information published herein and neither Business Valuation Resources nor its authors shall be responsible for any errors, omissions, or damages arising out of use of this information. This work is published with the understand- ing that Business Valuation Resources and its authors are supplying information but are not attempting to render business valuation or other professional services. If such services are required, the assistance of an appropriate professional should be sought. Managing Editor: Colin Murcray Chair and CEO: David Foster President: Lucretia Lyons Sales: Linda Mendenhall Customer Service Manager: Stephanie Crader ISBN: 978-1-935081-25-8
  • 3. Table of Contents Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Chapter 1: Rules of Thumb . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Examples of Rules of Thumbs . . . . . . . . . . . . . . . . . . . . . . . . . 11 Restaurant Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Why Do Owners Use Rules of Thumb? . . . . . . . . . . . . . . . . . . . . . 16 Simple Formula for Future Net Cash Flow . . . . . . . . . . . . . . . . . . . 18 Transfers at “Cost” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Chapter 2: Restaurant Economy and Restaurant Industry Overview . . . 23 We Are Already Experts In Restaurant Valuation . . . . . . . . . . . . . . . . 25 My Valuation Thoughts after Looking into these Winning Kitchens . . . . . . . 26 Types of Restaurants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Industry Information You Will Not Get . . . . . . . . . . . . . . . . . . . . . . 28 National Economic Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Regional and Local Economies . . . . . . . . . . . . . . . . . . . . . . . . . 30 Industry Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Effects of the Economic and Industry Outlook on this Valuation . . . . . . . . 41 Chapter 3: Restaurant Site Visit . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Assumption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 Restaurant Drivers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Arriving at the Restaurant . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Plan Your Visit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .49 Competitors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Chapter 4: Market Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 Nielsen Claritas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 The Retail Market Power (RMP) Opportunity Gap—Retail Stores . . . . . . . 57 Restaurant Top Chain with Map . . . . . . . . . . . . . . . . . . . . . . . . .57 Traffic Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Examples . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 Advanced Capabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Why Use Market Reports? . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Growth Rate Development . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Problem Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 How Do You Assess the Market? . . . . . . . . . . . . . . . . . . . . . . . . 65
  • 4. Linkage to Subjective Risk Premium . . . . . . . . . . . . . . . . . . . . . . 66 Chapter 5: Management Interview & Request for Info Addendum . . . . . 81 Valuation Information Request (VIR) . . . . . . . . . . . . . . . . . . . . . . 83 Chapter 6: Fixed Assets and Capital Expenditures . . . . . . . . . . . . . . 87 What Happens on the Street . . . . . . . . . . . . . . . . . . . . . . . . . . 89 The Company Depreciation Schedule . . . . . . . . . . . . . . . . . . . . . 91 Tax Free Exchanges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Cost Segregation, All the Rage . . . . . . . . . . . . . . . . . . . . . . . . . 92 What Does It Cost New? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 Tax or Book Depreciation, Cross Your Fingers . . . . . . . . . . . . . . . . . 93 Are Depreciation Projections Necessary? . . . . . . . . . . . . . . . . . . . 94 Amortization, a Different Animal . . . . . . . . . . . . . . . . . . . . . . . . 95 Re-Investment in Restaurants, When and How Much? . . . . . . . . . . . . 100 Refresh or Renew Means What? . . . . . . . . . . . . . . . . . . . . . . . 101 Chapter 7: Franchised Restaurants, Are They Really So Different? . . . 145 Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 How to Read Franchise Documents . . . . . . . . . . . . . . . . . . . . . . 147 Can Franchisors Value a Franchise? . . . . . . . . . . . . . . . . . . . . . 150 Interaction with the Franchisor . . . . . . . . . . . . . . . . . . . . . . . . 151 UFOCs and More . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151 Reinvestment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152 Check out the Franchisor . . . . . . . . . . . . . . . . . . . . . . . . . . . 152 More Rules of Thumb Talking . . . . . . . . . . . . . . . . . . . . . . . . . 152 Lending to Franchisees . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152 Legal Disputes, Valuations, and Franchisees . . . . . . . . . . . . . . . . . 153 Risk of Renewal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154 Chapter 8: Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157 Types of Loans You Will See in this Industry . . . . . . . . . . . . . . . . . 159 Thoughts on Ratios and Financial Analysis . . . . . . . . . . . . . . . . . . 160 Here is What I See . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162 Here is What a Restaurant Banker Sees . . . . . . . . . . . . . . . . . . . 163 What Happens if Something Goes Wrong? . . . . . . . . . . . . . . . . . . 166 Example of Financial Analysis . . . . . . . . . . . . . . . . . . . . . . . . . 168 Summary of the Financial Condition of the Company . . . . . . . . . . . . . 172 Restaurant Loan Packages . . . . . . . . . . . . . . . . . . . . . . . . . . 173 What a Top Financial Restaurant Executive and Editor See . . . . . . . . . 174 Good Advice from a Man That Knows . . . . . . . . . . . . . . . . . . . . . 176
  • 5. Chapter 9: Smorgasbord . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177 Entity Structure Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . 179 Property and Sales Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 180 Loser Store . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181 Asset Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181 Value Each Store or All Stores . . . . . . . . . . . . . . . . . . . . . . . . . 183 Lease Problems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184 S-Corporations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 187 Shady Dealings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189 Excellent Owners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190 Regional Differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191 Marketability Discounts on Minority Interests . . . . . . . . . . . . . . . . . 192 Marketability Discounts on Control Interests . . . . . . . . . . . . . . . . . 193 Lack of Control Discounts on Minority Positions . . . . . . . . . . . . . . . 194 Drive- Thru Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 Subjective Risk Premiums for the Subject Restaurants . . . . . . . . . . . . 196 Is There A Value to Knowing Potential Future Restaurants’ Locations? . . . . 198 Canned Software Packages . . . . . . . . . . . . . . . . . . . . . . . . . . 201 What Makes a Great Restaurant? . . . . . . . . . . . . . . . . . . . . . . . 202 Alcohol, Sports Bars, Bars, and Taverns . . . . . . . . . . . . . . . . . . . 202 Mid-Year Convention on Discounting . . . . . . . . . . . . . . . . . . . . . 203 Accounting Periods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203 Gift Certificates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 Chapter 10: Market Approaches in the Restaurant Industry . . . . . . . . 205 The Public Guideline Company Method . . . . . . . . . . . . . . . . . . . . 207 The Private Transaction Market Method . . . . . . . . . . . . . . . . . . . . 216 Chapter 10 Attachment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 218 Chapter 11: Restaurant Projections . . . . . . . . . . . . . . . . . . . . . . . .239 Restaurant Financial Statements . . . . . . . . . . . . . . . . . . . . . . . 241 Why Are They All Different? . . . . . . . . . . . . . . . . . . . . . . . . . . 242 One Order of Projections to Go, Please . . . . . . . . . . . . . . . . . . . . 244 BREAKEVEN From the Restaurant Point of View . . . . . . . . . . . . . . . 244 Industry Peer Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246 Industry Binoculars or Where to Look . . . . . . . . . . . . . . . . . . . . . 250 Let’s Go to Monaco! . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259 Why Use Crystal Ball Software? . . . . . . . . . . . . . . . . . . . . . . . . 262 Restaurant Example Using Crystal Ball . . . . . . . . . . . . . . . . . . . . 262 Chapter 12: Determination of Value for Restaurants . . . . . . . . . . . . . 287 Review of Where We Are . . . . . . . . . . . . . . . . . . . . . . . . . . . 289 Depreciation, Cap Ex, and Amortization . . . . . . . . . . . . . . . . . . . . 289
  • 6. Next Year’s Projection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 289 Working Capital Adjustments . . . . . . . . . . . . . . . . . . . . . . . . . 289 Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291 What Debt Should We Use? . . . . . . . . . . . . . . . . . . . . . . . . . . 293 Determine a Cost of Capital . . . . . . . . . . . . . . . . . . . . . . . . . . 295 Simple or Complex, Is that the Question? . . . . . . . . . . . . . . . . . . . 299 What Approach To Use? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300 The Discounted Cash Flow Method . . . . . . . . . . . . . . . . . . . . . . 302 APV (Adjusted Present Value) method. . . . . . . . . . . . . . . . . . . . . 304 Chapter 13: Justification of Purchase Price . . . . . . . . . . . . . . . . . . 315 Business ValueXpress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 317 Calculations of Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 319 Example of Input and Output . . . . . . . . . . . . . . . . . . . . . . . . . 319 Chapter 14: Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 337
  • 7. Valuation Report Cross-Reference Guide A quick reference guide to help with the creation of valuation reports, containing a list of report sections referenced to their respective chapters and pages in the book. Opening Letter from Valuators Table of Contents Valuation Summary Disclosures and Description of the Assignment Introduction Overview of the Valuation Sources of Information . . . . . . . . . . . . . . . . . . . Chapter 2, Chapter 4 Basis and Standard of Value Valuation Considerations Economic and Industry Factors Affecting the Company . . . . . . . . Chapter 2 National Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 29 Regional & Local Economy . . . . . . . . . . . . . . . . . . . . . . . . . . p. 30 Industry Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . p. 32 Survey of the Subject Restaurants . . . . . . . . . . . . . Chapter 3, Chapter 7 Financial Analysis of the Company . . . . . . . . . . . . . Chapter 8 pp. 168–170 Valuation of the Subject Interest Methods Considered, Selected and Rejected Asset Approach . . . . . . . . . . . . . . . . . . . . . . . Chapter 9 pp. 181 Income Approach . . . . . . . . . . . . . Chapter 12 pp. 295–288, Chapter 6 Market Approach . . . . . . . . . . . . . . . . . . . Chapter 10 pp. 205–215 Indication of Value Discount for Lack of Control . . . . . . . . . . . . . . . . . . . Chapter 9 p. 194 Discount for Marketability . . . . . . . . . . . . . . . . . . . . Chapter 9 p. 192 Reconciliation of Indicated Values Conclusion of Value Justification of Potential Financing . . . . . . . . . . . . Chapter 13 pp. 181–303 Appendix A – Financial and Other Information Appendix B – Sources of Information Appendix C – Statement of Assumptions and Limiting Conditions Appendix D – Qualifications of Appraisers Appendix E – Glossary of Terms Appendix F – Glossary of AICPA Additional Terms Appendix G – The National Economy
  • 8. Introduction
  • 9. BVR’s Guide to Restaurant Valuation 3 Introduction Please indulge me while I spend a few short paragraphs describing my background so that you can see the evolution of my interest in restaurant valuation. My undergraduate degree in economics from Georgetown University and my Masters degree in businessadministrationfromtheUniversityofPittsburghwerekeptinthebriefcaseuntilIfinished my four year obligation as an Officer in the United States Air Force. My service fulfilled, I went to work for General Electric and their Medical Systems Division in the San Francisco Bay area. After several years I decided to go into business for myself, and Nancy and I returned to Tucson, Arizona. I took a job at a local CPA firm while I completed accounting coursework at the University of Arizona, which was preparatory to taking the CPA exam. Transferring credits and completing these accounting requirements awarded me another degree, which was in accounting. So, you see, I really cheated on this third degree. Several years later in 1978, I opened my own firm, and shortly afterward I acquired the account- ing and tax work for my first four restaurants, which were local franchise McDonald’s restaurants. In high school I worked at Gino’s in Baltimore, Maryland. Gino’s (named for Gino Marchetti, a player who helped win the Championship for the Baltimore Colts in 1958 and 1959) was an exact copy of the early McDonald’s restaurants, which were not yet established in Maryland at that time. In these early years, my CPA clients were a combination of various local businesses. The Jimmy Carter years with the 20% interest rates eliminated my construction clients, so I decided my future emphasis would be the acquisition of additional restaurant clients. In 1985, Jeff Quick (who had been an auditor and a regional controller for McDonald’s) and I formed Moran & Quick, which grewrapidlyyearbyyearuntilwefinallymergedwithHorneLLP,alargeregionalCPAfirm,in2006. At the time of this merger, our combined offices were producing approximately 3,000 financial statements per month in the restaurant and franchise industry. From sports bars and fast food restaurants to fine dining establishments, we advised the owners on all aspects of their business. On any given month, restaurant purchases or restaurant sales occurred. Owners often turned to us to help them determine pricing. As you will learn in this workbook, rules of thumb prevail in this industry. Originally, I had relied on spreadsheet programs to help me simulate profit and loss statements under various pricing options. It seemed odd to me that a restaurateur would work his or her entire life and then determine the value of this life’s work with a simple multiple. There had to be a better solution. In the mid-1990s, I signed up for an intensive week in Las Vegas with Kevin Yeanoplos, CPA/ ABV, ASA, and NACVA (National Association of Certified Valuation Analysts) to obtain the designation, Certified Valuation Analyst. A big thank you goes to all my friends at NACVA. From this point on, I began a quest to read, attend, and acquire every article, lecture, conference, or reference book that dealt with the restaurant industry and its science (art??) of valuation.
  • 10. BVR’s Guide to Restaurant Valuation4 Introduction My first formal valuation (a sports bar), which I had valued at $100,000, undershot the eventual sales price by $250,000. The owner later confessed to me that there were some things he had not told me about. Welcome to my world! Along the way I acquired other valuation certifications (Certified Business Appraiser and, very recently, Accredited in Business Appraisal Review from the Institute of Business Appraisers. I was Accredited in Business Valuation, from the American Institute of Certified Public Accountants untilmyrecentAICPAretirement).AnotherhugethankyougoesouttomyfriendsattheInstitute of Business Appraisers and the Financial Consulting Group. Perhapsyouhaveheardoneofmylecturesonrestaurantvaluation?Ifyouhave,youprobablyremember the Billy Joel song quote I always reference—“Listen, this is good information from a man who has made mistakes.” And I’d like to begin this restaurant valuation workbook with the same quote. As I makeupdatestothisworkbook,pleaseemailmewithfriendlysuggestionsatGuides@bvresources.com. While this workbook is intended for valuation professionals, I realize that bankers, controllers, restaurant owners, financial consultants, and other industry experts may read it as well. I will attempt to be sensitive to this. In the offenses I make, I try to offend everyone evenly, although I very sincerely intend no disrespect. I dragged my guest authors one by one through my focused interview approach. I tried to be sensi- tive to their time constraints and busy schedules. As this book goes to press, each co-author has seen only their piece of the puzzle. It might be fair to state that not everyone will agree with the information in my chapters, or my logic, historic experience, or statements. However, my overall feeling is that these guest authors have really “kicked it up a notch” and, in some cases, they have even corrected my direction. I am so thankful to them. When I first discussed this book with the editors at Business Valuation Resources, they encouraged me to go outside of my Horne partners in order to fire test my experience. I think this was good advice. However, I want to pay sincere respect to the Horne Restaurant and Franchise Partners: Jeff Quick, Dee Boykin, Mike Roberts, Vera Reed, and SuzAnne Eubanks. This gang eats, breathes, and sleeps restaurants twenty-four hours a day. You can reach any of them through the Horne website: www.horne-llp.com. Here is Jeff ’s cell phone number…Just Kidding, Jeff! Actually, I want to thank everybody at Horne, but especially those poor souls who, over the years, had to work directly with me, by typing, proofing, correcting, re-correcting, assembling, polishing, and suggesting changes. For this, I thank Carla Diaz, Jayna Woods, Nick Trent, Doug Letkeman, Cindy Chaney, Tanya Eskue, Karen Osborne, and Bita Abrams. You will also be pleased to know that Don Wisehart, ASA, CPA/ABV/CFF, CVA, MST (Master in Tax),afriendandmostrespectedValuatorfromtheFinancialConsultingGroup,proofedthemanuscript withme,and,alongwithAndiNashfromBVR,walkedmethrougheveryscrambledsentenceandlogic point.Donhasextensivefoodindustryexperience,aswehavesharedsomebestpracticesovertheyears.
  • 11. BVR’s Guide to Restaurant Valuation 5 Introduction Thanks, Don! We had some exciting ideology battles, with Don winning most. Needless to say, any divergencefromthevaluationbodyofknowledgeconceptsliessquarelyonmyshoulders,notonDon’s. It is my intent, in this workbook, to share my experiences with you so that you benefit from them. It is notmyintentiontoaskyoutochangethestyles,approaches,ormethodsthatyoucurrentlyuseinyour valuationreports.Andofcourse,thisworkbookisnotintendedtoreplacethe“standalone”textbooks of valuation that you rely upon for formulas and reference. It would be helpful to have Jim Hitchner’s Financial Valuation, Second Edition (Third Edition early 2010) handy to supplement my references. Finally,Icanbealittleirreverentfromtimetotime,andnocriticismofanyactualrestaurantowneris intended—you know I love you! You deserve the best valuation possible and that is my challenge. About the Author Edward F. Moran, Jr., MBA, CVA, CBA, ABAR Mr.Moran’sareasofspecialtyarevaluations,mergersandpurchases for franchise and restaurant clients throughout the United States. Ed has been advising small businesses and franchises on account- ing and valuation issues for more than 35 years. He has been quotedinTheWallStreetJournalandispublishedintheValuation Examiner, CPA Expert, Valuation Strategies and Franchise News, among others. He is author of Special Industry Valuations: Restaurants, Bars and Nightclubs, Financial Valuation, Second Edition and Third Edition, edited by James Hitchner, CPA/ABV, ASA. Ed has valued, or participated in hundreds of industry sales, mergers, purchases, exchanges, estate planning and gift engagements. He is currently a Certified Valuation Analyst (CVA) from the National Association of Certified Valuation Analysts as well as a Certified Business Appraiser (CBA) and Accredited in Business Appraisal Review (ABAR) from The Institute of Business Appraisers. Ed recently retired as a Certified Public Accountant (CPA), Accredited in Business Valuation (ABV), from the AICPA. InadditiontoaMasterofBusinessAdministration(MBA)fromtheUniversityofPittsburgh,heholdsa BachelorofArtsinEconomics(withaminorinStatistics)fromGeorgetownUniversityandaBachelor of Science in Business Administration (with a major in Accounting) from the University of Arizona. Mr. Moran is a member of the American Institute of CPA’s and the Arizona Society of CPA’s as well as other professional, Air Force, and civic groups. He is a member of several organizations including the FinancialConsultingGroup,anorganizationoftheleadingappraisalfirmsacrossthecountrythatshares knowledgeandthelatestdevelopmentsonbusinessvaluationandlitigationengagements.Mr.Moranwas also a member of National Franchise Consultants Alliance, a nationwide alliance of accounting firms.
  • 12. BVR’s Guide to Restaurant Valuation6 Introduction Contributors The following individuals provide their expertise in portions of this book: Thomas Bates Thomas Bates is an Associate Professor of Finance at Arizona State University. He has a Ph.D. from the University of Pittsburgh, and a B.A. from Guilford College. His research areas include: corporate finance, valuation, corporate governance and executive compensation, financial state- ment analysis, mergers and acquisitions, law and finance. He is a Dean’s Council of 100 Scholar, a McCoy-Rogers Fellow, Eller College of Management, 2008, and a Scrivner Teaching and Service Award recipient, 2008. Michael L. Bradnan, FCSI, CSI Michael L. Bradnan began his career managing a full service foodservice equipment dealership. In 1977, Mike founded his own consulting firm which provides planning, design and manage- ment services to the foodservice industry. Michael L. Bradnan & Associates, Ltd.’s clients include architects, hospitals, schools and universities, private foodservice clients, correctional institu- tions, country clubs and national restaurant chains. Mike is a Lifetime Professional Member of the Foodservice Consultants Society International (FCSI) and a Professional Member of the Construction Specifications Institute (CSI). John T. Hall John has been in the restaurant business for 36 years on both the operational and the finance sides of the business. John spent 30 years with McDonald’s Corporation in positions ranging from crew person to Vice President. He was Regional Manager for a 300 restaurant territory, Division Controller for a $4 billion division, and held numerous other operational and financial positions. He also worked on new concept and new restaurant development. During his time with McDonald’s, John was involved in the pricing, sale, or purchase of over 1,000 restaurants. John was also a partner in a CPA firm servicing the restaurant industry for 5 years, and is currently the CFO of a $90 million restaurant company and an oil and gas exploration company. John Hamburger John Hamburger is the founder and president of Franchise Times Corp., a national publisher of business trade journals in franchising and finance. He publishes Franchise Times Magazine, a national franchise industry trade journal; the Restaurant Finance Monitor, a monthly financial newsletter which covers the capital markets in the restaurant industry; and Foodservice News, a monthly newspaper for independent foodservice and restaurant operators in the Upper Midwest. John also produces a number of industry executive conferences including The Restaurant Finance & Development Conference and the Franchise Finance & Development Conference.
  • 13. BVR’s Guide to Restaurant Valuation 7 Introduction John has almost 30 years of experience in franchising and finance and during that time served as chief financial officer of a public restaurant chain. He is frequently quoted about financial matters concerning restaurant, franchise and hospitality businesses in national business publications including The Wall Street Journal and USA Today. John serves as a board member of Park Midway Bank in St. Paul, Minnesota and is director of the Western Golf Association, which administers the Evan’s Scholarship Program. He attended St. John’s University in Collegeville, Minnesota and the University of St. Thomas in St. Paul, Minnesota where he graduated with a B.A. in accounting in 1977. Cindi Roney Cindi Roney has 22 years experience in banking for commercial lending, specializing in franchise lendingforthelast8years.SheiscurrentlytheVPCommercialLenderofAllianceBankofArizona. Prior to this, she was the SVP Manager Franchise & Specialty Lending/Regional Credit Manager for the National Bank of Arizona. Bruce S. Schaeffer Bruce S. Schaeffer, co-author of CCH Franchise Regulations and Damages and author of the BNA Tax Management Portfolio on Franchising, is an attorney in private practice with over 30 years’ experience and offices in New York City. Mr. Schaeffer holds a Master of Laws (in Taxation) from New York University School of Law and a Juris Doctor degree from Brooklyn Law School. He is the founder and president of Franchise Valuations, Ltd. (www.FranchiseValuations.com), which provides expert testimony on damages and valuations in franchise disputes, performs lender due diligence, and resolves succession and estate planning problems for the franchise community. Mr. Schaeffer has been named a “Legal Eagle” by Franchise Times magazine. He can be reached at 212.689.0400 or Bruce@FranchiseValuations.com. Claudia Straw Claudia’s accounting career began with the McDonald’s Corporation in 1979. After gaining valuable experience with this Fortune 500 company. In 1985, she began her career at the firm of Foelgner &Ronz, P.A. As the Managing Partner since 1992, she has helped the firm achieve astronomical growth and still maintains a strong niche with McDonald’s franchisees as well as other restaurants. Foelgner, Ronz & Straw, P.A. also gives back to the community by supporting the Ronald McDonald House Charities and other non-profit organizations. Kevin Yeanoplos Kevin R. Yeanoplos, CPA/ABV, ASA is the Director of Valuation Services for Brueggeman and Johnson Yeanoplos, P.C., a firm with offices in Seattle, Washington, Tucson, Arizona and Salt Lake City, Utah that specializes in the areas of business valuation, financial analysis and litigation
  • 14. BVR’s Guide to Restaurant Valuation8 Introduction support. Mr. Yeanoplos has extensive experience, having valued over 900 businesses for a variety of purposes, including divorce and other litigation, gift and estate taxes, mergers and acquisitions, and ESOP’s. He has valued businesses for a broad spectrum of companies in various industries, includingaircraftpartsmanufacturers,constructioncompanies,automobiledealerships,restaurants, and various retailers. He has also valued various professional practices, including accounting firms, law firms, and medical and dental practices. Mr. Yeanoplos has evaluated economic loss suffered by parties in cases involving contract disputes, medical malpractice and wrongful termination. He has been recognized as a leading expert in accounting/valuation by attorneys listed in The Best Lawyers in America as part of Best Lawyers Preferred. Mr. Yeanoplos is currently serving as Chair of the AICPA’s ABV Credential Committee and a memberoftheirVirtualGrassrootsPanel.HewasnamedtheAICPA’sBusinessValuationVolunteer of the Year in 2006. He served as a member of the AICPA’s Consulting Services Business Valuation Committee, Chaired the AICPA’s 2000 Annual Business Valuation Conference, is Chair of the ASCPA’s Business Valuation Committee and was the founding Chair of the UACPA’s Business Valuation Committee. Mr. Yeanoplos is a Certified Public Accountant Accredited in Business Valuation and was in the charter class of those earning the ABV credential. In addition, he is an Accredited Senior Appraiser in the Business Valuation discipline for the American Society of Appraisers. He is a member of the American Arbitration Association’s Commercial Panel. He is currently a member of the ASA’s International Board of Examiners.
  • 15. Chapter 1 Rules of Thumb
  • 16. BVR’s Guide to Restaurant Valuation 11 Chapter 1: Rules of Thumb Why do you think my first chapter is about restaurant rules of thumb (ROT)? I cannot think of another industry where the use of primitive rules of thumb is more prevalent. Rules of thumb vary even among different types of restaurants. Talk to a Wendy’s owner operator and he will have a different metric than a McDonald’s owner operator. I suspect you probably already sense that a simplistic rule of thumb in a restaurant valuation setting would ignore many of the detailed observations that we will be discussing in this book. In performing a restaurant valuation, the valuator should ask the owner what simple multiples he or she might use to determine a restaurant’s value. Remember, after you submit your valu- ation, the owner will use these ROTs to question, criticize, or evaluate your results. Knowing what these ROTs are from the start will allow you to convincingly explain why you think your valuation resulted in a higher or lower estimate of value. At one point in my career I decided to correlate the sales price of restaurants with the dollars in the expense account labeled “operating supplies.” Of course, this was my “camp” answer to the use of ROTs. The premise was that a store with more sales would use more operating supplies. A restaurant with more sales very likely would be worth more money. A good old regression analysis could possibly supply me with a formula that I could use to fool disbelievers. I had a lot of fun with this silly premise. You should have seen some of the looks that I was given when I announced a restaurant’s value using this bizarre method! The point of my madness was to show the owner how crazy the use of simplistic formulas was. Why would an owner work an entire lifetime to build up a restaurant empire, only to value it at the conclusion with a simple rule of thumb? If you don’t think this happens, you are wrong. I have seen it time and again—hundreds of thousands of dollars either taken from the table or left on the table because of this stupid practice. Examples of Rules of Thumbs Here are some examples that are often bandied about1 : • 1.5 to 2.0 times the seller’s discretionary earnings (the cash flow of the owner), plus fixtures, equipment, and inventory. • 25 to 35% of the independent’s annual sales. 1 Council of International Restaurant Brokers; North Palm Beach, FL 33408; Valuing Restaurants: Handbook of Business Valuation, West and Jones, First and Second Edition, John Wiley & Sons; National Restaurant Association, Washington, DC 20036-3097; Inc. Magazine, various annual issues Ultimate Valuation Guide.
  • 17. BVR’s Guide to Restaurant Valuation12 Chapter 1: Rules of Thumb • 40 to 50% of franchise annual sales. • 2.5 To 5.0 times the monthly net revenue (should this be annual?), which has been stabilized. Fixed assets, lease, and intangibles are included in the indicated value. • 1.0 to 3.0 times the owner’s cash flow, which has been stabilized. Fixed assets, lease, and intangibles are included in the indicated value. • Net equity value is determined by adding the net of current assets less liabilities to the value of formula assets determined above. • Inc. Magazine had a variety of reports, including the following: • 1.94 times net income; and • .38 times net sales. • Full-service—33% of annual sales. • Fast food—40 to 50% of annual sales. • Franchised fast food—50 to 60% of annual sales. • Casual style restaurant—33% of annual sales. • Fine dining—20 to 30% of annual sales. • Full-service tablecloth restaurant—2.5 to 3.0 times annual net (SDC), depending on the condition of the premises. • Family restaurant—30% of annual sales. • Restaurant (no alcohol)—44% of annual gross sales. • Restaurants overall—20 to 30% (doesn’t say of what? Assume sales). • Bagels—30% of annual sales. • Barbecue—150 % of annual sales. • Barbecue—just kidding on that last statistic, 30% of annual sales. • Bistro—30% of annual sales.
  • 18. BVR’s Guide to Restaurant Valuation 13 Chapter 1: Rules of Thumb • Brewpubs—25 to 30% of annual sales. • Billiard parlors—45% of annual sales. • Cajun—30% annual sales. • Caribbean—30% of annual sales. • Chicken—30% of annual sales. • Chinese—33% of annual sales. • Coffee house—40% of annual sales. • Continental—30% of annual sales. • Deli—30 to 40% of annual sales. • Diners—30% of annual sales. • Fine dining—30% of annual sales. • French—30% of annual sales. • Gourmet shops—40% of annual sales. • Hamburgers—35% of annual sales. • Ice cream—35 to 40% of annual sales. • Irish—40% of annual sales (should be more!!). • Italian—30% of annual sales. • Mexican—30% of annual sales. • Nightclubs—25% of annual sales. • Pancake House—30% of annual sales. • Pizza—30% of annual sales. • Sandwiches—40% of annual sales.
  • 19. BVR’s Guide to Restaurant Valuation14 Chapter 1: Rules of Thumb • Seafood—40% of annual sales. • Sports bars—40 to 45% of annual sales. • Steakhouse—40% of annual sales. I am sorry to report that some of the worst ROT offenders come from the valuation industry. I will later be discussing the contribution margin and its dramatic effect on profitability in the restaurant industry. If an industry ROT is developed from restaurants with lower levels of sales volumes, the ROT is worthless. If an industry ROT is developed from a wide average, the ROT may not be appropriate for the restaurant that you are valuing. Irish restaurants are worth 7% more than Chinese restaurants, and 10% more than Mexican restaurants. Does Guinness have a lower Cost of Goods Sold? This is crazy stuff. Don’t use any of these rules of thumb. The Internet to the Rescue Googling “restaurant valuation” returned 2,130,000 hits. This scary stuff has to be the equivalent of the TV series “Hell’s Kitchen” for restaurant valuations. I immediately saw a “Value a Restaurant $25,” “Restaurant Valuation $399,” and even better, “Value Your Restaurant—Find out in 10 Seconds for Free!”, “Fast Food Restaurant, Franchise Valuation Formula provides a general busi- ness valuation formula for fast food restaurants and franchises based on a percentage of annual gross revenues,”…and on. I spotted a PDF from the Cornell Hotel and Restaurant Administration Quarterly titled, “A Financial Approach.” This ancient article from 1991 touted the use of a weighted average cost of capital. I did not purchase it. I did order a $7.95 PDF from Harvard Business Publications, think- ing that “Valuation Ratios and the Restaurant Industry” might be an academic breakthrough I could use for my book. The PDF turned out to be a case study problem based on four restaurant groups. Sadly, no answers were offered in the PDF! What was I to do? According to my favorite blog, “I was told that restaurants sold for three times cash flow or two times cash flow, sales times the multiplier ( say 30% of gross) to arrive at a valuation…” I pictured some poor restaurant owner struggling to price his restaurant for sale using this madness. Don’t use any of these Internet restaurant valuation templates.
  • 20. BVR’s Guide to Restaurant Valuation 15 Chapter 1: Rules of Thumb Maybe there are one (or two) models buried somewhere in the 2,130,000 hits that might be useful. Good luck hunting! Don’t give up on me, however. I’ll demonstrate a much better solution in my chapter titled, Justification of Purchase Price with Mike Adhikari’s Business ValueXpress from the Merger & Acquisition Industry Segment. Where Do We Go from Here? Researchers often see a sales price to revenue factor of $.30 or $.40. Deliver a valuation report to a McDonald’sowneroperatorwith10storespricedat$.40onthedollarofsales,andseeswhathappens. 1 As Claudia Straw, Bruce Schaeffer, and I will later discuss, a multiple of cash flow or EBITDA seems to have the most value potential in the restaurant setting. Perhaps this multiple will get us somewhere on the correct playing field. However, it is shadowed with various grease traps that will catch the unaware analyst. Multiples of cash flow are related to their inverse—capitalization rates. A multiple of five times cash flow is equal to a capitalization rate of 20%. A multiple of four times cash flow is equal to a capital- ization rate of 25%. A multiple of six times cash flow is equal to a capitalization rate of about 17%. If the discount rate less the long-term growth rate equals the capitalization rate and the capi- talization rate is always 20%, doesn’t this imply that the growth rates will always be the same? Or does it make sense that discount rates might proportionally increase as growth rates increase such that the overall result for the capitalization rate is always 20%? Higher growth rates seem to be a factor in lower capitalization rates rather than higher capitalization rates. If there is one thing we can take from the Nielsen Claritas market studies you will examine later, it is that growth rates vary dramatically among restaurants. Restaurant Example We will value two restaurants, each with $200,000 in cash flow. A quick keystroke or two tells us that each of the restaurants is worth $1,000,000. It is that simple and you were stupid to purchase this book. Or were you? 1 (Now this is not to say that an unusual group of these stores might not be worth this calculation or even worth less.)