What To Consider Before Making An Offer To Buy That Restaurant
QUESTION From: Danie in Idaho Falls
“The owner of the business I run wants to just ‘walk away’ from it and wants to sign it over to me while he keeps the debt from any loans. However I'm not really sure how all of that works? Are there any ways you might recommend structuring an arrangement like that?”
Whether the Buyer / new owner is buying out the Previous Owner outright or the Buyer is going to be gradually receiving ownership (as I imagine might be the situation in your particular case); four basic questions need to be answered before considering possible deal structures:
How many sellers/partners are there in total (who are they) and how is the value of the business being established? and Who is doing the valuation? (i.e., the current owner or their accountant, an independent MAI appraiser, a formula that averages the owner’s appraiser’s assessment and the buyer’s appraiser’s assessment? An accounting method that essentially equates to 10 times the net net profit?
There are so many methods, means and formulas...and to complicate matters even more - sometimes multiple formulas need to be employed since multiple assets (like real estate) are often involved.
If the property is owned, an appraisal of value would be needed as well. Keep in mind however that the appraisal of real estate is NOT a science and rife with both subjectivity and ulterior motives. Any appraisal or broker opinion of value needs should not only be supported by comparable sales (within the last 12months) but also tale into consideration the aspects of the property that make it unique. For example: I was recently helping a family who owned a building and was trying to decide whether to sell their restaurant or lease it. Two local brokers gave this family an opinion of value (and suggested asking price) based on the average cost per square foot of a few smaller buildings that sold within the last few months directly across the street.
Whether it was their interest in a quick commission, incompetence or their acting in the interest of existing clients who were interested parties - I don’t know - but I was quick to point out the following facts to these owners who weren’t looking at their asset from a more “global perspective” :
The properties that sold and the one that was listed were “ACROSS THE STREET”. That might make those properties seem close and relevant… and they are, but not totally. Traffic going one way doesn’t necessarily provide the same value as traffic going the other way. To underscore that point I reminded my clients that they were proximal to a turning lane which meant people traveling in EITHER DIRECTION could easily access and depart their location. The other side of the street was lower in elevation as well offering my clients’ property far greater visibility.
The commercial properties these brokers used as direct comparisons took up most of the lots which meant 2 things: #1. Less parking and #2. No ability to expand if desired.
The properties across the street were not built to support additional stories whereas my clients’ building was (once HVAC was relocated)... which meant there was also a possibility for a buyer to expand vertically as well (a great opportunity for a developer who might want residential or office above the retail component below).
If the real estate is Leased, (see “The Anatomy Of A Restaurant Lease”) the term, rate, use, exclusivity, co-tenancy and restrictions all need to be carefully considered.
Most often (unless a business is being transferred over to an existing employee or management team) the Lease is the only thing of any real value so the seller should hope at least two things are in place (or try negotiating them into their Lease before attempting to sell or transfer their business).
Below current market rates.
At least 10 years (straight or with options to renew)
Ability to assign / sublet and/or change specific use.
There are ways around these but all require some delicate negotiating and creative operational structuring to propose a win/win for both Landlord and Tenant.
Will the Concept / Menu / Name remain the same?
If the Buyer is not going to be featuring the same or very similar menu and/or same concept, it is unlikely that the decor, furniture, fixtures, equipment, social pages, website or line set up will be appropriate for the new concept and/or menu.
Often times, forcing the old set up to work for a new use becomes awkward and flow or thru-put (or both) proves inefficient to the point where it ends up costing the new owner even more money because they’ve not only paid for a build out that is less than ideal for them but then they need to remodel … and, in essence, end up paying twice.
Even if you are going to keep the name, the build-out and/or menu; every concept should be refreshed in 5–7 year intervals. That means the original equipment, fixtures and furnishings are probably not worth what the previous owner paid for them. I’ve seen a lot of transfers that took place with the seller justifying the price on used equipment with the fact that the transferee or “Buyer “doesn’t have the funds necessary to buy their own equipment or get credit.
The bottom line is this – any other savvy buyer / experienced operator would most likely reconfigure the space anyway. And Im not just talking about flattops and grills on the line.
And there’s a ripple effect to even the smallest changes. For example, in some states, the hood and ansul system’s placement is crucial in order to pass inspection and therefore requires careful examination as well. Often times, every single ansul head must line up precisely over each piece of equipment - so unless you’re getting the exact same size equipment with heating elements in the same exact same location; you’re likely going to be looking at a new hood and ansul.
If you DO like the equipment / line set up for your concept be sure that the equipment, hood and ansul, electric, plumbing, HVAC, compressors, grease trap, line to the street, everything has been properly maintained and serviced. Also note: the lifespan on most equipment is 10-15 years. If the business is 13yrs old - you should consider it as a car for sale with 120,000miles on it - not saying it doesn’t have another 100,000 miles to go but you better make sure that timing belt has been changed.
What does the Debt look like & have they paid their taxes?
Well placed (and/or rotating) debt can not only provide an owner with a time buffer that makes operating possible - it can also create a distorted view of a business’ profitability.
Even if the previous owner agrees to assume all the debt - you have to have full disclosure as to what that debt is (and a competent lawyer to assist in determining it) so that you can accurately assess what the profitability of the business is/ has been over the long haul.
The Timeline is always a serious consideration due to several reasons;
The first of which being that a quick and/or sudden change of ownership presents both challenges to principles and staff alike.
The staff will undoubtedly be concerned (if not anxious) regarding how easily they will be able to work with new ownership and the uncertainty of whether things will be better, the same or worse for them.
Transfers that have a shorter tail also deprive the new owner of feeling their way around the facility and staff as an owner (which, no matter how you slice it- is different than how one experiences it as a: guest, relative, investor or manager.
There are nuances to every establishment that take years to fully comprehend. Im not suggesting that every transfer take quite that long - but I will say that having at least a few months (unless the current owner is a toxic ingredient to the mix) is prudent so that the existing owner can walk the new proprietor through everything they touch in a quarter (from food vendors and cleaning contracts to human resources and service techs).
Not only does the incoming Chief benefit from sufficient time to try the restaurant on and take it for a test drive - additional time also provides both parties with a certain level of comfort / peace of mind in knowing that the arrangement is going to work...which should be especially important for the Seller if they are going to have a re-capture clause in the agreement or want/need to maintain even the smallest percentage of interest.
Be weary of any owner who is looking to get out quickly and execute a deal by next month. These things take time and as much as you might think common sense and Spidey senses would prevail - I’ve received more than a few calls from Buyers AND Sellers who assure me that their particular “situation is different” or that moving quickly makes sense for a “very good reason”.
If, after these 4 key points have been addressed satisfactorily, you feel it’s prudent to proceed; you’ll want to then
ALSO CONSIDER THE FOLLOWING:
5. Does the purchase price include real estate? And if not, how much term is left on the lease? And at what cost?
6. What are the going rental rates in the area for similar space? (i.e., have you compared purchasing to leasing? or have you considered how much you could get from a new tenant should things go south?
7. Are you confident that you have seen all accounts payable?
8. What is the condition and age of the: facility, roof, HVAC, plumbing, sewer, trap, mechanicals, furniture, fixtures and all equipment?
9. What is the city/neighborhood’s short and long term plan for the area?
10. What competition exists (or will exist) in the immediate area?
11. What planned roadwork, expansion or development is planned over the next 1,3,5?
12. Is there any debt on the building or business?
13. What are the terms/conditions and guarantees that accompany all financing / any seller financing?
14. What’s the avg cost/sqft for purchasing AND leasing commercial space in the area?
15. What does parking & co-tenancy look like?
16. When was the property last inspected? Any grandfathered issues (from fire code to actual use) upon changing hands?
17. Employee make-up?
18. Keeping name and concept and all rights? Exclusivity?
19. Gift cards ever sold / tracked (how will you handle if keeping the name?)
20. Who’s your consultant / third party advocate?
TAKE IT SLOW
Let me be clear. There is NO GOOD REASON to move quickly. I don’t care if it’s because the owner has an amazing and fleeting opportunity they want to capitalize on....or because of a family member relocating....or a terminal illness...or even a death.
NO situation that the seller or seller’s family is experiencing justifies you diving head-first into a lake when you aren’t 100% sure how deep it is.
There are too many variables / moving parts to address in one post here and every deal is as unique as the parties involved but I hope I have given you enough to get started with your own preliminary evaluation. Just be sure to have an experienced business broker and/or restaurant consultant evaluate the deal structure AS IT IS BEING DISCUSSED / NEGOTIATED not afterwards.
THERE IS NO SUCH THING AS A “STANDARD” OR “BOILER PLATE AGREEMENT”.
Unless you’re renting an apartment in a building with 200 units, anyone who presents you with an offer and describes it as “standard” should be scrutinized very carefully.
Any lawyer can tell you whether or not an agreement is legal and binding but only an experienced operator who is familiar with the the operational challenges of a restaurant and the vagaries of economy that affect it can accurately assess whether or not the terms of a deal are able to be realistically met and how each requirement / term might affect the others.
I’m not a lawyer but I’ve seen enough deals to glean that, generally speaking, it seems that if the agreement has
-specific performance - this for that
-specific term and clear payment schedule outlined
…anything the two parties agree to is legally binding... unless one of the parties is doing something criminal / illegal or is in violation of the law- but even then- most contracts have what they call a “Severability Clause” with seems to specify that if any part of the contract or it’s terms are unenforceable and/or violate local law; the rest of the contract’s terms remain in full force and effect.
Read every single word when reviewing ANY agreement.
When you get to a word (or a phrase) that you don’t know- Google it. Have an experienced lawyer that you trust peruse the contract with you as well and if you’re relatively new to the industry, have a qualified restaurant consultant / adviser review it in detail with you as well.