Updated: May 20, 2021
What you think your hospitality business is worth and what the other party thinks the business is worth are rarely the same.
There are multiple valuation methods which can be applied and each method has its advantages and disadvantages; and in most instances the valuation of a business is based on a combination of methods.
However, the sales contract defines the business and its components in simple language; and seeing as this is the common ground for both parties it is worth considering your business in this way to determine a ballpark value.
So what is the business?
The contract defines a business as ‘the chattels, fittings, fixtures and furniture, goodwill intellectual and industrial property, licences, permits, plant, quotas and software of the business, together with any other items forming part of the business’
The simple approach to a value then is to break down the business into two parts:
The Assets Value and The Earning Potential
These elements are common language for all businesses and both elements are also expressed on the front page of the contract under Asset and price apportionment = Equipment and Goodwill
As defined by the contract this figure is ‘the chattels, fittings, furniture, plant and vendor’s fixtures forming part of the business’
If you do not already have an asset register or depreciation schedule then make sure that you prepare a detailed inventory, listing all owned fittings, plant and equipment owned by the business and then put a value on that. Valuing equipment is pretty simple, it is the purchase price minus wear and tear (during negotiations it is always worth pointing out fair market value and replacement costs).
Goodwill is seldom fully understood and most people define goodwill as net profit. A more accurate depiction of goodwill is that its value is predominantly the true operating profit of the business. The profit from business operations (gross profit minus operating expenses) before deduction of interest and taxes = this figure is the Sellers Discretionary Earnings (SDE)
ie. the business’ true profit potential for the prospective purchaser.
When looking at your Profit and Loss statement typical add-back items are as follows:
- Non-operational owner wages and/or above market rate portion of operational owner wages
- Personal travel and/or personal vehicle payments
- Personal expenses, like the purchase of a personal vehicle
- Non-cash expenses such as depreciation and amortization
- Personal leisure expenses – gym/golf/yoga membership etc.
- Charitable donations
- Business travel (non-essential to running of the business)
- Legal costs that are not business specific
- Insurances that are not business specific
Ultimately the agreed goodwill figure must also allow for expected growth & sales prospects, brand identity; network of customers; good reputation amongst customers and good reputation in the market; but the SDE will give you a ballpark figure, and more goodwill factors will support a goodwill multiple.
So what is the business worth?
As long as the lease can be transferred to the other party and that the financial information supports an accurate figure for Seller’s Discretionary Earnings then you can work out the value of a business.
The earnings multiple method is the most accepted valuation method in the industry; how does it work?: Take your SDE value and simply multiply by your multiple to find the business value.
Cafe, Restaurant and Bar businesses typically have a multiplier between 1.5 and 2.5.
The longer the lease, strength of the brand, USP of the business, licenses attached to the business/premises, growth opportunities, lower the trading hours, customer base, position, web presence, reviews - the higher the multiple.
Lastly you add your business assets and subtract your business liabilities.
A Bar has an SDE value of $90,000 and an industry value of 2 = $180,000
The business assets (equipment) value is $55,000 and the liabilities are $20,000 = $35,000
The value of the business is $215,000
When you have arrived at an informed valuation which can be proven, make sure that you go to market with a realistic asking price. The most common reason for a protracted business sale is where the seller intentionally overprices a business to leave negotiation room, this tactic can often backfire and present a barrier in finding a buyer, and put many people off enquiring altogether.
If you have any questions then please contact Barn on firstname.lastname@example.org
We would also love to meet you to discuss the value of your business, you can book this online using the following link www.retailbusiness.com.au/book-online
We look forward to hearing from you.