Avoid Derailing Your Restaurant Business Sale By Spotting These Common Pitfalls
Not surprisingly, not all restaurant sales successfully close. Issues arise from a variety of sources. More often, conflicts occur by either the buyer or seller that derails the restaurant sale. For the most part, many of these pitfalls are avoidable either by timing, full disclosure or proper preparation. Unfortunately, too many transactions fall apart in escrow after considerable effort, time and resources are wasted.
If you see yourself in any of these predicaments, review your concerns with your business sale team to help you determine how to avoid derailing your restaurant business sale.
How Buyers Derail Restaurant Business Sales
- Failing to raise sufficient funds. To avoid derailing your restaurant sale based on this issue, the seller and broker should sufficiently vet the buyer early. Either the seller should insist on proof of funds with the buyer’s offer or during the seller’s due diligence of the buyer within the transaction process. Some brokers won’t even speak to a prospective buyer until they receive proof of funds along with their Non-Disclosure Agreement (NDA). The seller and broker can decide on how best to screen buyers and how soon they should screen for financial ability. Usually, the earlier the better to avoid wasting time on dreamers and tire kickers. A restaurant broker will request from the buyer their financial statements including reviewing their sources of cash (i.e. current bank statements, investment statements, equity in real property, etc.). Some buyers draw the money from equity lines of credit from real property or obtain it from investors. The broker will examine these additional sources to assure that they will produce sufficient funds for the deposit or full purchase.
- The buyer backs out of the transaction. Restaurant deals fall apart and a buyer getting cold feet occurs often. We have a saying that if a deal is going to fail, we hope that it “fails fast” meaning that it’s better for everyone involved if the deal falls apart earlier rather than after considerable time, money and effort are invested. Early in the transaction, the buyer examines the financial performance of the business. This phase is known as “due diligence” (this includes reviewing the restaurant’s books and records, performing physical inspections and securing the landlord’s approval for lease assignment on the existing lease or negotiating a new lease). The buyer can walk away for any reason during due diligence. After the buyer completes the due diligence process, the buyer removes the contingency for sale and makes additional deposits. If the buyer develops reservations about buying the restaurant after due diligence, the buyer may find themselves in breach of contract and risk losing their deposit. The typical outcome is the parties get together and negotiate an exit for the buyer so that the seller can move forward to sell the business to someone else.
- Buyer’s relationship issues impede the sale. Whether it’s family members, partners or investors, relationship issues can impede the sale of the restaurant when there is conflict. With respect to family members, money or lifestyle priorities may prevent the buyer from completing the restaurant sale. Owning a restaurant is often a family affair and involves long hours and becomes like another family member. It can be hard to balance family obligations with restaurant business demands. If family members are not supportive, then the buyer may find themselves in a high conflict family scenario that will feel as if they have to back out to keep the peace at home. Other times, the family may be supportive but crises, such as divorce, illness, death, will impede the buyers’ ability to close the deal. As to partners and investors, as the buyers start formalizing the process and take concrete steps towards their acquisition, they may find they disagree on money, operations, etc. and their partnership starts to unravel. Early in the transaction, it is helpful for the seller and broker to find out more information from the buyer as to the cooperation and commitment by family, partners and investors. It is particularly helpful to speak to the additional individuals as well to gauge their motivation.
- License Issues. If an eatery has a liquor license to transfer, buyers may have problems qualifying for alcohol licenses due to prior felonies and/or DUI convictions. Some buyers will have the licenses put in family member’s names. Vetting for these issues early on is important to screen prospective buyers.
How Sellers Derail Restaurant Business Sales
- Seller Gets Cold Feet. A seller may decide against selling their restaurant in the middle of a transaction. Sellers may want to back out of restaurant sales for a variety of reasons. Most of the time, however, sellers will balk at closing the deal because: 1). they think that they are not getting a sufficient amount for their restaurant, or 2). they believe the timing is off and they will get a better deal if they wait a little longer, or 3). they won’t know what to do without being a business owner or a family, or 4). The sale proceeds after tax and expenses is insufficient to fund their retirement. To avoid derailing your restaurant sale based on this issue, Sellers should consult with their restaurant broker regarding the most likely sales price and then share that information with their accountant as to what their actual net proceeds will be after taxes before listing the business and going to market.
- Seller Bankruptcy. In a distress sale situation, the seller may go into bankruptcy during the transaction. Should this occur, then the restaurant is no longer available for sale because it now comes under the jurisdiction of the bankruptcy court. If restaurant operations cease and the Seller is unable to continue paying the lease, then the landlord will reclaim the premises.
- Seller Eviction. If the Seller has been delinquent on rent, or failed to pay back rent, and continues to do so during the restaurant sale transaction, the landlord can file a notice requiring that the landlord pay or quit the premises. If this occurs during the transaction, and the landlord takes back the premises through an eviction process, then there is no lease to assign and restaurant to sell.
- Seller’s Financial Statements Cannot Be Verified. Sellers who create fictional financial statements will face negative consequences in the sale process where they cannot verify the claims they make about the the financial condition of their restaurant. Buyers will hire accountants to analyze the Sellers financial records during due diligence and will ask for receipts. In the situation where a Seller cannot provide proof for their representations, they will lose the Buyer’s trust and likely cause the Buyer to withdraw from the restaurant purchase.
- Unreasonable Deferred Maintenance. During due diligence, Buyers will inspect the premises and equipment. If a Buyer discovers through their inspections that the premises or equipment have not been maintained, need extensive repair or replacement, and that increases the cost to a prohibitive level, the Buyer may withdraw from the transaction unless a price reduction can be worked out. Alternatively, if the Buyer wants to proceed with the sale, the parties may work out a credit for the Buyer to complete the work after escrow closes or that the Seller will make all the necessary repairs prior to the close of escrow to Buyer’s satisfaction.
- Legal Issues. Prior to the restaurant transaction commencing, the seller is obligated to fully disclose any pending legal claims. On a very rare occasion a lawsuit may arise during the transaction. Where there is an asset sale, it may be possible to proceed with the sale. Oftentimes, however, buyers will be very leery of proceeding with the sale regardless of protections against successor liability just on the off chance there is an exception that will sweep them into the lawsuit too.
- Seller’s Back Taxes. Where a Seller has failed to pay their taxes a tax lien will be imposed and escrow cannot close until the tax lien is addressed. Where the value of the tax lien exceeds the value of the equity in the business, the Seller will be relieved of their debt but they will not receive any proceeds from the sale. The Seller may choose to not sell the business at that point. The Buyer may also want to avoid the sale since if the sale proceeds are actually insufficient, the taxing authorities might also be able to foreclose on the furniture, fixtures and equipment of the restaurant to cover the cost of the remaining debt unless the parties are able to negotiate a settlement in full based just on the cash proceeds. Regardless, a tax attorney should be included in any tax lien negotiations.
Avoid Derailing Your Restaurant Business Sale by Working With A Restaurant Broker
Working with a restaurant broker helps minimize these occurrences to avoid derailing your restaurant business sale. A good restaurant broker will be able to spot risks and issues before they become a problem. Moreover, with experience, a restaurant broker can come up with remedies to some of these issues to help prevent your restaurant business sale transaction from derailing.
Working with a Restaurant Broker will help you avoid derailing your restaurant sale. If you would like a consultation to get started on selling your restaurant, contact us for your complimentary consultation and valuation.