Essential Questions When Buying A Restaurant

According to BizBuySell.com, and numerous other business sale indexes, restaurant sales are the most frequent business sold in America. The opportunity to own a successful restaurant is appealing to novices and experienced business owners as well as immigrants and multi-generation Americans. With a wide array of cuisines, concepts, locations and menus, the creative entrepreneurial opportunities are endless.

For many restaurant buyers, the risks of starting from scratch are prohibitive given the high failure rate for new restaurants. Of the 43,000 new restaurants that open each year in the United States, 25% fail the first year. Another 50% will fail within the next 2 years which means that only 14% of new restaurants survive. 

Given these new restaurant risks, buying an established restaurant is a much safer proposition. Particularly valuable is a restaurant that has been in business for at least 5 years with an established pattern of consistent earnings. To increase your odds of buying a restaurant for sustained profitability and growth,, it is critical to prepare the right questions regarding the key elements of the restaurant’s performance.

Buying an established restaurant is less risky and more affordable than many other businesses.  In general a restaurant listed at $400,000 should indicate cash flow of about $200,000.  With a Small Business Administration SBA loan and 20% down, or $80,000, a restaurant buyer can enjoy good earnings even while making debt payments on the $120,000 loan. This affordability is one of the reasons that restaurants are the most frequently sold small business in the United States.

The following are the essential questions when buying a restaurant that we think every restaurant buyer should be asking to properly understand and evaluate the restaurant business opportunity. These questions form the bedrock of how most restaurants function.

Essential Questions When Buying A Restaurant To Ask The Restaurant Seller

1. Does the lease transfer? Location. Location. Location. A restaurant’s success is based on good traffic flow which hinges on the best location possible with minimum conflict with other eateries that have a similar concept. When pursuing a restaurant opportunity, study the lease carefully and find out about transferability. Restaurant sale usually involve a lease transfer known as a “lease assignment”.  The language governing the lease assignment is in the lease and often indicates that the landlord will not unreasonably withhold approval. Landlords may hesitate assigning the lease to new owners without prior restaurant or small business experience. The landlord will ask you for your financial records, credit score, business plan and other documents to determine whether you are qualified and creditworthy.  

2. What is the restaurant’s cash flow? Typically, restaurants are sold based on a valuation model known as the Sellers Discretionary Earnings (SDE). SDE involves figuring out what any owner who owns the business could expect to earn.  The SDE is then multiplied based on numerous factors. On average SDE is multiplied two times cash flow. So if SDE is $150,000, then the listing price will be $300,000 or 2x $150,000 SDE cashflow. Suffice to say that it is important to verify the Seller’s actual cash flow and not their estimated earnings.  

3. What is the condition of the equipment? Restaurant buyers have numerous initial costs with the sale and assuring sufficient working capital. Therefore, it is imperative to assure that the equipment has been properly maintained and that no major repairs or replacements are warranted. As a restaurant buyer, you do not want all the expenses of buying a restaurant and then having to replace equipment as well. To avoid this negative consequence, have the equipment and building inspected to assure everything in good working order.  If there are issues with the equipment, you want to have the seller make the repairs before escrow closes. 

4. Is the liquor lease transferable? Alcohol is the key moneymaker in most restaurants. Verify that the restaurant’s liquor license transfers and is included in the sale through California’s Alcohol Beverage Control Board (ABC). The information is available online and the seller’s ABC documentation disclosure should indicate transferability. Be sure to check whether there are any infractions on the seller’s liquor license and how that will be handled prior to the sale of the restaurant. Learn more about transferring California liquor licenses.

5. Any pending liabilities? The due diligence process should root out liabilities attached to the business. Insist that the Seller provide written, signed disclosures confirming no: unpaid overtime, unpaid sales tax, health code violations or other liabilities. It is imperative that you process the sale through a business escrow which will identify a number of these issues. Failing to use a business escrow could cause you needless liabilities that will jeopardize your ability to successfully operate the business.

6. What is the restaurant’s reputation? If the restaurant has a negative reputation, revenue will be affected. Be sure to study customer feedback on Yelp and other review sites regarding the restaurant’s reputation. Also, run a general search with the restaurant name to find out its history, community involvement, negative press, etc.  

7. Will the Seller sign a non-compete clause? Where you have a popular chef and/or restaurateur, it will be essential to insert a non-compete clause into the restaurant contract in order to prevent the  Seller from opening a another restaurant nearby and risking the Seller siphoning your customer base. 

These essential questions when buying a restaurant are beneficial to start a conversation with the seller to help you determine the desirability of the restaurant for your investment. Enlisting a restaurant broker who knows the right questions to ask the restaurant sellers is fundamental to a successful outcome.

If you are interested in discussing these essential questions before buying a restaurant with an experienced restaurant broker? Contact us for your complimentary consultation.