2012 was an eventful year for restaurant mergers and acquisitions, with financial and strategic investors snapping up fast food chains, family dining, fine dining and quick service restaurant (QSR) concepts, franchises and more at near-record pace.
Some business owners hastened sales in 2012, anticipating a 5 percent capital gains tax increase and a 3.8 percent tax on investment income in 2013. However, with the fiscal cliff avoided, and capital available to deploy, we expect another robust year in 2013 for this sector.
Strategic buyers are looking to grow, often through acquisitions. They have record amounts of capital surplus and the low cost of debt makes financing attractive. Private equity continues to invest billions in restaurant holdings.
It adds up to a strong M&A market for sellers.
Whether you want to monetize your restaurant investment or grow your organization by integrating with a larger one, to maximize value in your restaurant sale, you’ll need to get your house (and books) in order.
Here are tips to arm yourself with knowledge of where a buyer may try to poke holes, uncover opportunities you may have missed, and generally improve the speed and certainty of a closing.
1. Talk frankly about revenue.
How’s business? Has revenue moved due to pricing or foot traffic? Have any units been recently opened, closed or remodeled? Buyers will question the reliability of revenue and profit projections and need to understand what the revenue looks like on a normalized basis. Start with proof of revenue by linking revenue to cash deposits.
2. Understand vendor relationships and business costs.
According to the National Restaurant Association, one-third of sales in a restaurant go to food and beverage purchases. Wholesale prices rose drastically last year, and drought conditions reduced supply. Use third-party vendors’ reports to document these business expenses so buyers see that the costs align, and also make note of suppliers who are paid in cash. Because restaurants turn their inventory so quickly, food and beverage purchases will often be close to the cost of sales. Another third of a restaurant’s sales goes toward labor costs, an expense that will increase under the Affordable Care Act. Third-party payroll reports should correspond with labor costs. Similarly, facility costs should be reconciled to lease agreements.
Sellers should be prepared to explain any significant discrepancies. Buyers will look for red flags, such as expenses or payments unrelated to running the operation. You need to have a full understanding of how your business operates to anticipate and answer these questions.
The next steps to take
3. It’s time to be the numbers person.
You may tout a persuasive economic model, but sellers need to know what revenue and cost numbers really represent. What’s the impact of seasonality? Were there sales spikes from online daily deal participation, such as Groupon and LivingSocial, or are these offers scheduled? Internet coupons are treated as gift cards under some state laws, meaning that restaurants may be required to redeem the coupons long after their expiration date. Are a handful of units or certain locations driving high or low margins? Buyers will want to see same-store sales analyses, year over year.
As a seller, you need to understand why some units consistently outperform others. A nearby, newly built corporate campus may help sustain new sales levels. Did/will a lengthy road construction project impact business? Does the management or some other factor play a role?
4. What’s new or improved can be vital to pricing.
Resets, openings and closings play a significant role in restaurant negotiations and accurate cash flow projections. This is where a good deal of money is left on the table. If a new unit earned only $100,000 in its first year, but is on its way to earning $200,000 annually, you may request credit for that higher run-rate. A remodeled restaurant may have a history of strong sales, but earned no profit for several months due to construction. Sellers will want to add back that profit and normalize revenue and earnings for it.
Buyers will not give the seller credit for closed restaurants’ earnings. Historical profits from units that no longer exist should be excluded from normalized earnings.
Reset, remodel, refresh: All crucial steps to remain competitive and grow guest traffic and sales volume, especially in the quick-service and fast-casual sectors. Updating units may require major capital expenditures and remodels, betterments and restorations can have different tax implications. Buyers will want to know the projected cost of repairs or remodels, the sales impact during the work and the remodel schedule. Has the seller updated restaurants as expected? How much will have to be spent to keep up post-acquisition?
5. Get started on the paperwork.
Every restaurant needs to keep current and accurate financial and legal records. A surprising number of small business transactions fail because the financial statements do not support owner income, operating expenses and future earnings potential. Organizing the following information for a would-be buyer will make the sale process go much smoother (this is not a comprehensive list):
• Monthly P&Ls and balance sheets (preferably downloaded in Microsoft Excel),
• Detailed trial balances,
• Bank statements to support revenue,
• Reconciled vendor reports to confirm food, beverage and labor costs, and
• Leases to account for any control provision changes that may have been triggered
A note on franchise agreements: A buyer will compare franchise, royalty and advertising expenses to the franchise agreements, so make sure all costs are reconciled. In addition, large multiunit franchisee systems require consent from the franchisor prior to sale, so plan for that process.
Communication is an important prerequisite for a successful transaction. It’s critical that there be transparent communication between the buyer and the seller. Provide information on an ongoing basis and handle important issues in a timely manner to reduce any uncertainty.
You need a thorough understanding of how your business operates to anticipate and answer questions. By following these tips, you’ll approach a sale with an independent eye, fully prepared for a buyer’s scrutiny. With this information at hand, you’ll be better able to connect the dots for would-be buyers, outlining growth potential, identifying synergies and closing the deal.
Wade Kruse is partner, transaction advisory services, at Grant Thornton LLC. He can be reached at 704-632-6881 or [email protected].