The most common question we hear as industry specialists is “what’s my restaurant worth?” Truth is, it’s not such a simple formula but rather a blended number of analysis based off multiple factors that can change day-to-day. The best way to determine the most accurate value of your business is by hiring professional, such as the restaurant realtor 🙂 Anyone can look up “how to value my business” online and get a list of different approaches. But to truly understand how us professionals come to our final conclusions, you first have to determine these ever-changing factors.
Perhaps the most common approach to valuing a business is the market approach. Professionals will value a business based off top-line sales numbers or net profits and multiply by a calculated number. This is where you’ve probably heard “it’s x% of gross sales” or “it’s y% of net”. In this case, the x and y are determined by factors like interest rates, the economy the state of our industry, and (if you reside in NJ) liquor license values just to name a few.
THE INTEREST RATE EFFECT
Lower interest rates typically mean it’s not as expensive to borrow money. It’s where you’ve heard the coined term “cheap money”. When “money is cheap”, consumer spending typically increases. Conversely a higher interest rate typically slows consumer spending. To understand how the interest rate can affect restaurants, let’s look at the prime rate over time.
In 2019, the prime rate was dropping slowly but consistently until 2021 where it had remained at 3.25% for the whole year. At this time the government was rolling out all kinds of “cheap money” loans like the EIDL and SBA loans to try to stimulate the economy after Covid. Many restaurant owners took advantage of these low rates while they were available. Things got interesting in 2022. The year started off with prime at 3.50% and ended in December at 7.50%. Interest rates increased 4 points in just one year! Even though interest rates were high in the late 80’s/early 90’s, we hadn’t seen that type of exaggerated rate change since 2001 – when rates dropped 4.25 points. As of early November 2024 the prime rate sits at 8.00%, dropping half a point since September just two months prior.
What most people may not know is commercial loans are typically a percentage above prime (depending on your qualifiers). Specifically, SBA loans can charge up to 3% over prime (for loans greater than $350,000) and are considered quarterly adjustable. The result – when prime climbed 4 points in 2022, so did some owners monthly payments. Owners went from $6,000 a month to almost $9,000 a month in what felt like a blink.
Fast forward to 2024, although prime rate has dropped, it is still considered “expensive” to borrow money. One of the latest restaurant deals we managed included a $1,000,000 SBA loan at 10.5%. That’s a lot of money for buyers to pay back.
THE ECONOMY EFFECT
The economy kind of goes hand in hand with interest rates. When consumers are confident and incentivized, typically we see high consumer spend. When rates increased in 2022, we didn’t necessarily see the lower spending in revenues. Restaurant costs were going up. This meant increased prices – which does NOT always equate to increased profits; and in this case, it did not. We saw inflationary increases for costs of goods as well as annual payroll increases due to Governor Murphy’s minimum wage plan enacted in 2019. So your restaurant was grossing the same amount of money as it was in ’22 maybe slightly lower, but in ’23 you’re showing a net zero, or in some cases a net loss. This was a difficult time for restaurants. These challenges would carry into 2024 leaving very little breathing room for operators.
THE STATE OF THE INDUSTRY EFFECT
The state of the industry also affects the value of your business. We’ve all heard the horror stories about how Covid completely decimated some businesses and stopped our worlds in 2020. There were still residual business effects that spilled into 2021. No one really talks about the success stories that came out it. I am lucky to have met a lot of these owners.
In a way, business owners became smarter as a result from the constant “pivoting” during Covid. It forced owners to get creative and make it work. Cocktails to-go, increased delivery, expansion of seats due to covid permitted outdoor dining…Owners were and are servicing the same or more consumers at less hours, all while increasing revenues. This post-covid state (2022) made an albeit brief, but healthy industry, which positively affected business values during that time. The YOLO mantra was in full effect and restaurants were making the most they ever have.
The beginning of this year (2024) started off slower than usual. Normally we start to see an uptick in revenues around the end of January/beginning of February. For most, this didn’t come until March. May not sound so bad, but then the summer that everyone was expecting just never hit. If it wasn’t 99 degrees, it was pouring rain, resulting in empty dining rooms. Talking to owners across all sectors of the industry – byo’s, full-service restaurants (with liquor), fast casual/quick service, even some catering companies – business is almost 20% down YTD for 2024. For some, this could mean the difference of $1,000,000 gross sales. To say the industry is relying on Q4 is an understatement.
How does this affect the value of your business? Typically, when sales drop, the first thing cut is the owner’s paycheck. This is especially true for absentee owners. And if you aren’t making any money, how do you expect to get top dollar for your business?
THE LIQUOR LICENSE EFFECT (NJ SPECIFIC)
The threat of liquor license reform is a very real problem for New Jersey restaurant owners. This is a unique challenge to NJ that no matter which side you stand on, is affecting your business. Yes, the law has “changed a bit” (see my understanding liquor license article), but it’s more like we put a band aid on a bullet hole wound. We are still kicking the can down the road. The idea that your investment in a license may be devalued if laws change to a NY-like model, is not only affecting the market, also the value of businesses with expensive liquor licenses. This threat puts buying a restaurant with a high-valued license at a higher risk. For example, a town where liquor licenses are valued around $1,000,000, sold a license for $850,000 because the threat of another license entering that town drove the price down.
There are many other factors that can affect value like location, the lease or mortgage amount, land values (if real estate is included), use-type, and general market conditions – but that’s an article for another day. The main take away is that it’s not a “one size fits all” model for valuing a restaurant. Call me today to see what your business is worth.