HOW TO EVALUATE THE TRUE WORTH OF A BUSINESS
PART 7 of 21
“What are the Major Things to look for in Purchasing a Restaurant?”
by Willard Michlin
It was a normal day in Los Angeles and I got a phone call from London. George has found a profitable restaurant in San Diego that he is very interested in buying. He requests that I determine the value of the business and the validity of the reported sales and profit.
The seller owns a chain of Italian restaurants and wants to sell just one location. This business sounds to good too be true. Sales are $800,000 a year. Profit is $300,000 per year. A manager runs it, since the owners own multiple locations. The asking price is $750,000.
I spend hours getting all the financial reports, from the seller that I requested, plus I had to talk the seller into telling me about the cash, over the phone. He wanted to meet me face to face in Orange County. My client hadn’t even made an offer yet and I felt the price was too high even if it was making $300,000, which I didn’t believe for one minute. My problem was that I had to prove it was not making $300,000 rather then believe it wasn’t making that profit. My client wanted to immigrate to the USA and this business qualified for what he needed to please immigration.
What did I look for to determine that it was not making a $300,000 profit. The books only showed $750,000 in (Gross Income) GI. I was given Point of Sale documentation to prove the $850,000 sales (reported orally). Lets take the plus points first. The rent was only $2,500 month and that is worth another $30,000 extra profit. Another plus was that the food was mostly pasta, which is one of the lowest food cost categories, and the company got bulk prices because they were a chain of locations. Now lets take the minuses.
The labor costs as reported on the financial just didn’t appear big enough, especially since the location is manager run. I determined, but did not prove, that some of the wages were paid out of the cash income. There were no advertising costs in the financials; these were probably paid from the headquarters. The buyer would not get the advantage of the bulk-buying rate that the seller got and there was no liquor license to drive up the profit margin. Another thing that bothered me was that they only wanted to sell this location, which tells me it was the least profitable. With five locations you can easily switch income and expenses between stores, especially when you have $850,000 at stake. The biggest most obvious negative was the profit itself. 37% net profit is impossible in the restaurant business unless a whole family is 100% of all the total labor. 25% in a very busy family controlled location is the best one can do if there are employees. This didn’t fit any of those situations. I never did prove the actual profit, but I did convince the buyer that the price had to come down, even if the profit was true, which I knew in my heart, it wasn’t.
Willard Michlin is a Due Diligence and Business Evaluation Advisor. He is also a California Business Broker and a California Real Estate Broker. He has published many articles and is in demand as a public speaker in the Southern California business community.See other articles and information about his services at: