The Covid Effect on Restaurant Sale Prices
In a previous blog post, I spoke about restaurant prices on the open market and why they vary so greatly. I detailed three basic reasons.
- Restaurants that have enjoyed years of successful operations are priced based on a multiple of strong cash flow—these are the higher priced restaurants.
- Restaurants that have not achieved profitability and are being sold as an “assets in place sale” are the restaurants priced at or below $100K.
- There are the restaurants that have been priced by the seller usually based on a combination of debt that needs to be repaid and the cash the seller would like to walk away with. These are the restaurants with wildly varying prices.
Today, I’m going to focus the discussion on restaurants that have enjoyed years of successful operations with strong cashflow until the past year. Again, as I discussed in Episode III, list prices for successful restaurants are generally established by calculating a weighted average of the last three years of cashflow and applying a multiple. This way if sales are trending up, then the weighted average will account for that. If sales are trending down, the weighted average will reflect that as well.
The multiple is generally two, although it can be higher or lower depending on occupancy costs, condition of the restaurant, the market and lease terms. So, let’s say the weighted average of a restaurant annual cashflow is $125K with a multiple of two, that restaurant should be listed for sale at $250K.
But how does this calculation work with COVID? For most of my clients, not all, but most, the last year of cashflow has been devastated by the closures mandated by COVID. So, if we use a weighted average, remember, the weighted average accounts for the cashflow trend. For most of my clients who have enjoyed years of profitability, their trends might look like this: trending up and then falling off a cliff.
How should these restaurants be priced? That is the question. And although I have a few answers, I don’t necessarily have a definitive answer.
One other thing that determines restaurant sale prices (not list prices, but sale prices) is access to capital. Meaning, how is the buyer funding the purchase? And this brings us to a discussion of SBA loans—even if the buyer isn’t going to need SBA funding, the funding protocols of the SBA will have a bearing on restaurant sale prices. Although I’m going to be discussing SBA loans today, this is not the focus of today’s episode. I will cover this topic (probably with a guest speaker) in a later episode.
The purchase of a restaurant is the purchase of personal not real property. Those are funded by a specific SBA 7a loans. For the most part, if the list price for a restaurant has been determined by the industry norm I’ve discussed, then the SBA will generally lend to that price.
There are other factors like the experience of the buyer and the current market. But for the most part, matching an SBA 7a loan to the purchase of a restaurant has everything to do with the restaurant being priced properly. So how is a restaurant priced properly if the last year’s cashflow is awful?
There are multiple answers to this question. The first is to ignore the last year. This is fine if the buyer is purchasing with cash and has confidence the restaurant will rebound to its pre-COVID cash flow. But what about buyer who needs funding? In this case, it is super important to note that this depends on the institution issuing the loan. Which is to say, the requirements for SBA 7a loans vary from institution to institution. There are basic federal requirements for all 7a loans, but the issuing institution layers on other requirements.
And nobody knows this better than Matt, the owner of our host restaurant today. As a matter of fact, we met because Matt was denied an SBA 7a loan for a restaurant he was going to purchase prior to this one. There were two reasons why Matt wasn’t successful in purchasing the first restaurant. He applied for the loan through a national bank that set unreasonable lending requirements that were above and beyond the federal requirements that most borrowers couldn’t meet, and he wasn’t working with an experienced restaurant broker. I’m not adding this story as a shameless marketing plug to use my services, but because an experienced broker would have known that Matt was denied the loan due to unreasonable strict lending requirements of the institution. When I met Matt, he thought he wouldn’t qualify for an ABA 7a loan, when, in fact, he very much qualified for the loan, just not at that institution.
I relate the story about Matt because access to SBA funding for restaurant purchases has EVERYTHING to do with the institution issuing the loan. For my clients, I recommend one of three lenders; two of them are local NorthBay banks, and the third is a bank out of Sacramento that is very experienced with restaurant funding. Why do we choose local banks? In this case, the restaurant itself will be known to the lending institution. They are committed to the financial well-being of the community. They will look at the qualitative as well as quantitative.
As of the middle of 2021, funding can happen once the current operator gets back to pre-COVID numbers for a designated period of time. Here is the most current information I have. The local lending institutions will perform an analysis of the last year, but more than likely those numbers will not be taken into account. The buyer will produce 2-3 years proforma, and the lenders will use that information against the 2017, 2018 and 2019 cashflow assessment of the restaurant. And then they’ll use that data to make a lending decision.
But why am I talking about SBA lending if the buyer is going to purchase the restaurant with cash? The SBA is protocols for valuing businesses is the same, or very nearly the same, as what is used, or should be used, by business brokers.
Think of the SBA protocols as the gold standards for business valuations. And these standards change. For instance, many SBA lenders are not taking into account 2020 financials for restaurants that did not perform as well as they had prior to the COVID restrictions for reasons such as reduced access to employees or no outdoor seating. Most business brokers are doing the same.
As you can see, there are a variety of complexities associated with restaurant sales prices right now. We will update you as the pricing landscape impacted by COVID—19 continues to change. In the meantime, feel free to contact me with any questions.
Ryn Longmaid is a restaurant broker and consultant at Santa Rosa Business & Commercial in the San Francisco NorthBay and the host and founder of the Facebook Live Series, Deep Dish: discussions on the business of restaurants for restaurateurs, restaurant buyers and sellers and the restaurant curious.
As well as being a licensed real estate broker, Ryn is a CBB with the California Association of Business Brokers (CABB), a CBI with the IBBA and she holds an MBA in Sustainable Business Management. In addition to being a proficient business broker, Ryn has over 20 years’ experience in the restaurant, hospitality, and food industries. She has served as the executive chef for Amy’s Kitchen, personal chef to actor Don Johnson, and she founded and operated a successful and longstanding restaurant. She has also held teaching posts in restaurant management at the Art Institute-San Francisco and The Culinary Institute of America-Greystone.