Written By:  Richard D. Williams & Matthew Williams

How often have you asked yourself this question?  Restaurant operators often need to know the approximate value of their restaurant business and/or real estate and personal property, even if they are not currently contemplating a sale of the business.  Knowledge of value becomes important for a variety of reasons.  Some of the reasons include refinancing of the real estate; dissolution of a partnership or sale of stock representing a majority or minority interest in the business; a divorce settlement; property tax protest; insurance settlement after a fire or natural disaster; and settlement of an estate upon the death of an owner.  The purpose of this two-part article is to provide the reader with an easy way to answer this question.

Restaurant value can be separated into at least three components, which include the value of the business (business enterprise value), the value of the personal property (furniture, fixtures, and equipment), and the value of the real estate.  Real estate value can be broken down further to leased fee value (value to the landlord of the lease encumbering the property), leasehold value (the value of the tenant’s interest in the lease), and the value of the fee simple ownership interest in the real estate.  In the United States, approximately one-half of the restaurants occupy a leased building and land, and slightly less than one-half own the building and land.  I will address the business value of the restaurant and the value of personal property in Part I of this article, and the value of the real estate interests in Part II. 

The following table shows a statement of income and expense for a hypothetical restaurant.

In this example, the value of the leasehold interest in the real estate has been removed by subtracting rent paid to the landlord from income.  The remaining earnings before income taxes, depreciation, and amortization (EBITDA) equal $290,500.  This is the cash flow available to cover a return of and on the investment in personal property, and a return to the business component of the going concern value of the restaurant.  The return requirements for the non-real property components are typically significantly higher than the return to the land and building.  As the net income allocated to the personal property and business is received by the business owner after all occupancy costs have been paid, including rental income attributable to the land and improvements, the risk of the operator is significantly higher than that of the landlord.

Capitalization rates for a restaurant operator’s invested capital typically fall into one of three ranges: for an efficient, profitable operation with new equipment, good location, and expectations of strong annual growth in revenue, a capitalization rate of 13% to 19% is appropriate.  Stable, mature restaurants with a track record of steady cash flows, but annual growth in sales attributable to inflationary menu price increases, may use cap rates ranging from 15% to 25%.  Capitalization rates for restaurant businesses with declining revenue may range from 20% to 30%.  The following table indicates the value range for the hypothetical restaurant business based on the three scenarios listed above.  The values shown include the depreciated value of personal property, which must be subtracted from the total capitalized value to isolate the business value.

The personal property within a restaurant consists of its furniture, fixtures, and equipment.  On average, restaurant equipment has a useful life of ten years.  In the example above, we will assume that the original value of the furniture, fixtures, and equipment was $800,000 and it is now seven years old, or 70% depreciated.  On a straight-line basis, the value in use of this personal property would be:

$800,000 x 70% = $560,000

$800,000 - $560,000 = $240,000 depreciated value in use

If the personal property were to be sold at auction or in a liquidation of the business, it might sell for $0.05 to $0.10 on the dollar of original cost. 

Subtracting the depreciated value in use of the furniture, fixtures, and equipment from the three values indicated in the table above, the value of the business ranges from $836,000 to $1,576,000. 

There are other variables to consider in the valuation of the restaurant business, such as the immediate need for capital improvements, which may also need to be deducted from the capitalized value of the business and personal property.  This approach uses only one year of cash flow, which does not account for future variation in cash flow.  However, the above method of valuing your restaurant business will give you a “ball park” indication of value.  Estimating the value of the land and restaurant improvements (real estate), will be covered in my next article.