What’s my business worth? It’s a question any restaurant owner asks—and why not? Everyone wants to know how much his or her home is worth, right?
Unlike real estate, a business is worth the income it generates multiplied by a factor of usually two to three times the income.
Two parts determine the value of a business: income and multiple.
Income: In small business, the important number is working owner cash flow, sometimes called seller’s discretionary cash flow (SDCF). In a nutshell, this is the amount of money a working owner puts in his pocket before paying himself a dime.
A tax return with a detailed profit statement next to it is the best source for this number. A good accountant ought to be able to identify the “add-backs” to obtain the true SDCF.
Multiple: Determining this number requires thought and involves some subjectivity. But there is a science behind deriving a solid multiple.
In small business, the multiples range from 1 to 3. Five factors affect the multiple. Scoring each factor between 1 and 6 gives one a rational multiple that’s defendable.
1. Lease and location: The longer the lease, the higher the score. The higher the rent in terms of percentage of sales, the lower the factor. The stronger the location the higher the factor. Long lease with rent factor in the 6% range, score it a 6.
2. Condition of facility and equipment: The better the condition the higher the factor. A restaurant in great condition gets a 6.
3. Revenue growth: Flat revenue growth scores a 3, while declining scores a 1. Revenue increasing year-over-year at a good growth rate of 10 percent or more scores a 6.
4. Cost management: If the restaurant is keeping its costs in line with industry standards year after year, give it a 6. If costs are significantly higher, give it a 1.
5. Regional risks and desirability: This factor tends to fluctuate around the nation. Rural areas tend to get lower scores, while larger popular metro areas get higher numbers. California tends to have the highest factors in the nation, driving multiples closer to 3 on most of the business sales. For example, in Phoenix the summer variability creates greater risks for the restaurant owner, lowering the multiple, while in California the great weather causes less variability in sales.
Add the results of the factors together and divide this result by 6. The box below shows what multiple should be used:
For example, if the SDCF is $100,000 and the factor is 3.0, it derives a multiple of between 1.51 and 2.0; hence, then the value is about $150,000.
Each restaurant’s value is unique and a professional should do a proper valuation analysis, analyzing each of these factors to determine what your restaurant is worth.