here’s a breakdown of the three main methods of valuing a restaurant or any business:
Income-Based Valuation Approach
The income-based valuation approach is based on projected future earnings. This method is recommended for businesses that have significant potential for growth. There are two variants of this approach: capitalization of earnings and discounted cash flow (DCF).
With the capitalization of earnings method, you take the historical cash flow of a company and divide it by its capitalization rate. The capitalization rate is expressed as a percentage and represents the rate of return on the capital, including equity components and debt. This method helps to identify risks and quantify the potential return on investment. This calculation is especially useful for valuing service-oriented businesses.
The discounted cash flow method takes the company’s projected cash flow and then discounts that amount for risk using the weighted average cost of capital. This projection is usually calculated for one year and then assumes perpetual and constant growth. Because of that assumption, this method of valuation is best used when an analyst is confident about the assumptions being made.
Asset-Based Valuation
The asset-based valuation approach focuses on the book value of a business and deducts liabilities. It is often used in conjunction with other methods of valuation and may be required as part of the due diligence process for private companies. Struggling businesses with little to no profit may often sell at this value in an asset sale.
To determine the value of the business using the asset-based approach, you’ll need to calculate the net asset value (NAV). The NAV is the sum of the fair market value of all the business’s assets minus the fair market value of all its liabilities. This method is most appropriate for businesses with a lot of tangible assets, such as manufacturing companies.
Market-Based Valuation
The market-based valuation approach is one of the simpler business valuation methods, and arguably the most relevant. By comparing a business to other, similar companies that have sold recently, you can determine the market value of the business at issue. You will want to find companies with similar financials within your sector and then calculate the pricing multiples. The multiples frequently used in this approach are revenue, and cashflow (SDE or EBITDA).
To use the market-based approach, you’ll need to identify comparable companies and look at what they sold for. Then, you’ll need to calculate a pricing multiple based on the company’s financials. For example, you might divide the sale price by the annual revenue to get a revenue multiple, or divide the earnings by the sale price to get an EBITDA multiple.
When it comes to an asset sale, you might simply divide the asset value by the sale price. For example, if a business’s assets are worth $200,000 and you sell the business for $400,000, the asset multiple would be 2.
It’s important to work with a professional, such as a business appraiser or broker, to determine the best method and multiple for your business. They can help you evaluate the specific factors that affect the value of your business and provide an accurate valuation.
As for Listing Ledge, it is a platform that helps restaurant sellers connect with buyers and sell their businesses.
1. A small family-owned restaurant located in a busy tourist area has been in business for 10 years. The owner is looking to retire and sell the business. The restaurant generates an average annual revenue of $500,000 and has an SDE of $100,000. Based on market data and industry analysis, similar restaurants in the area have been selling for a multiple of 2.5 to 3 times SDE. Using the income approach and a multiple of 2.5, the estimated value of the restaurant would be $250,000.
2. A franchise restaurant with multiple locations is looking to expand and acquire a new location in a different state. The franchise has a strong brand presence and has been in business for 20 years. The owner of a local restaurant in the area is looking to sell their business, which generates an annual revenue of $2 million and has an SDE of $500,000. Using the market approach and analyzing recent sales of similar franchise restaurants, it is determined that a multiple of 3.5 times SDE is reasonable for this transaction. The estimated value of the restaurant would be $1.75 million.
3. A struggling independent restaurant in a suburban area has been in business for five years and has been losing money for the past two years. The owner is looking to sell the business and move on. The restaurant generates an annual revenue of $300,000 but has a negative SDE of -$50,000 due to high operating costs and low profitability. Based on the asset approach, the value of the restaurant would be calculated by deducting liabilities from assets. The owner has equipment and furniture worth $100,000, but also has outstanding debts of $75,000. The estimated value of the restaurant would be $25,000.
These examples show how different business valuation methods can be applied to restaurants based on their unique characteristics, financials, and market conditions. It is important for restaurant owners to carefully analyze their business and consult with professionals to determine a fair and competitive selling price.