Ultimate Guide to Buying a Restaurant: Research, Costs, and Due Diligence Checklist
For aspiring entrepreneurs and food enthusiasts, buying a restaurant presents an exciting opportunity to enter the culinary industry. With a fully functioning establishment, complete with lease, furnishings, and kitchen equipment, buying an existing restaurant can be a cost-effective path to success.
In this comprehensive guide, we delve into the intricacies of buying a restaurant, equipping you with ex tips, invaluable research insights, and a thorough due diligence checklist. Get ready to embark on your restaurant ownership journey with confidence and clarity.
Advantages of Buying an Existing Restaurant
Established customer base
When you buy an existing restaurant, you also acquire its customer base. Locals already associate the commercial space with a place where they can grab a bite.
The restaurant likely has regulars who have developed a relationship with the establishment over time. This means you can benefit from a stable revenue stream from day one rather than spending months or even years building up your customer base.
Buying an existing restaurant is generally less risky because there are historical data and financial records to analyze. You can also assess the restaurant's profitability data and make changes to improve it.
The previous owners would have likely done their due diligence to study the market, including surveys and focus groups, to test the area prior to purchasing the commercial space for a restaurant.
Financing your new restaurant premises with a bank loan? Need to balance the books to budget for your future restaurant expenses, wages and tax? You'll be a restaurant financial wizard by the time you've read this.
WHAT YOU'LL LEARN...
- Restaurant Grants and Loans: Guide to Restaurant Funding
- Complete Guide to Increase Restaurant Profit Margins
- Buying a Restaurant: Research, Costs and Due Diligence
- Restaurant Bookkeeping: Guide for New Restaurant Owners
- Restaurant Business Loans: 7 Tips Before You Apply
- Restaurant Menu Pricing: How to Price a Menu (+ Examples)
- Restaurant Budgeting: Guide to Create & Balance a Budget
Advantages of Buying an Existing Restaurant
Consult a Trustworthy Broker
If you lack experience or connections in the restaurant industry, enlist the help of a broker. The best choice tends to be a business broker who specializes in the restaurant industry. Alternatively, you could find a commercial real estate broker who has access to more relevant databases.
There are several advantages to working with either a commercial real estate or business broker. They typically have knowledge of available businesses that have not yet been publicly listed.
Additionally, brokers understand the market and may be able to provide advice on lease terms, governmental regulations, and permitting issues. To locate a commercial real estate or business broker, a simple internet search for "restaurant broker" and your location should suffice. Below are some trusted brokerage firms that specialize in restaurant leasing:
- CBRE Group
- JLL (Jones Lang LaSalle)
- Colliers International
- Marcus & Millichap
- Cushman & Wakefield
- NAI Global
Use online listings
Look for online marketplaces which specialize in listing businesses for sale, such as:
Rather than rely solely on real estate or business brokers, you have the option to explore the aforementioned listing sites. These sites provide basic information to begin your search, but to evaluate the business and complete a purchase agreement, it's recommended to hire a specialized attorney with expertise in business transactions.
Do Due Diligence on Your Potential Candidates
On each potencial commercial space that has made it to your wish-list, do your due diligence in 3 steps:
Step 1: Consider each potential space
One way to evaluate potential restaurants for purchase is to visit each one as an anonymous customer first. This allows you to get the full authentic dining experience and identify the restaurant’s strengths and weaknesses.
While dining, pay attention to general features, such as the ambiance and overall cleanliness. Observing the flow of service is also important.
Are the employees able to navigate the space around the customers seamlessly? Are there sufficient spaces available at the bar, entryway, and guest restrooms? Additional queries can assist you in determining if a particular restaurant space is suitable for your needs.
Step 2: Check the restaurant’s performance metrics
Restaurants often become available for one of two reasons: poor performance or owners selling for personal reasons. It is important to verify the reason for the sale by assessing the restaurant's performance metrics.
Key performance indicators to ask about include labor costs, food costs, prime costs, profit margins, and cash flow.
Another useful metric is the seller's discretionary earnings (SDE). The SDE of a restaurant is its net income after deducting costs and taxes, including the owner's salary and certain expenses.
The revenue of a business is its gross earnings before any costs or taxes are deducted. By multiplying the SDE or the revenue of a restaurant by the respective industry gives you a ballpark estimate of the restaurant's selling price that can be obtained.
The SDE multiplier is typically around 1.96, while the revenue multiplier is around 0.39. Using either method can give a range of what a restaurant should cost, but the expected prices may not always be the same.
Lastly, the value of a business can further be estimated using two methods: applying a multiple of the discretionary earnings or applying a percentage to the annual gross revenue. The more accurate method is the first one, which calculates the cash available to the owner after necessary expenses.
The second method assumes that the business earns the average profit for its peer group and applies a percentage to the revenue. Bars are typically valued using a multiple of their discretionary earnings or a percentage of their revenue plus inventory.
Step 3: Review the seller’s listing package
When buying an existing restaurant, a listing package or offering memorandum is important to accurately determine the value of what you are attempting to acquire.
The package should contain key financial information about the business including:
- Gross sales
- Cost of goods sold
- Labor costs
- Net income
However, tax returns and profit and loss statements are often not included and are only released by a confirmed third-party source.
The due diligence period is a crucial step in the buying process, where meticulous review of financial records can be conducted. It is essential to establish mutual trust with the broker and understand the process of buying a restaurant.
The seller has a brick-and-mortar operation and has employees that depend on its continued operation, so it is crucial to avoid scam artists in the buying process.
Secure a Lawyer to Evaluate The Business
Sort out the legal formalities in 3 steps:
Step 1: Find a lawyer
When buying a restaurant, it's important to secure a business attorney to handle the necessary legal paperwork. Buying a business involves assuming permits and relationships with tax authorities, making it essential to ensure that your interests are protected.
A business attorney will help with drafting or assessing critical documents such as the letter of intent, lease agreements, and purchase agreements. To find a business attorney, contact the local branch of the American Bar Association or search online directories like these:
- Martindale-Hubbell: Martindale-Hubbell is a long-standing directory of lawyers and law firms worldwide. The website provides peer and client reviews of attorneys.
- Avvo: Avvo is a legal directory that provides ratings and reviews of attorneys. It also contains information about an attorney's experience, education, and disciplinary history.
- FindLaw: FindLaw is a legal directory that provides listings of attorneys and law firms by location and practice area. You can also find articles and resources about various legal topics, including buying and selling a business.
Step 2: Prepare a letter of intent
Put together a bid for the seller. Your offer should be both fair and reasonable. Next, prepare a letter of intent (or a purchase agreement), which can be done by the buyer's attorney or a certified restaurant broker.
Using a standard agreement for restaurants is crucial at this stage since it will cover specific aspects of restaurant transactions, such as inventory, cash on hand, and transfer fees, assignment fees for the landlord, repairs or refreshes required by the brand, security deposits, and equipment that transfers with the sale.
A standard agreement ensures that all parties are aware of the expectations and requirements of the sale, which helps to avoid any conflicts in the future.
If you're using a certified restaurant broker, they will likely have standard documents ready to go that are filled in, so the process will be relatively quick and straightforward. If you're working with an attorney, they'll draft a purchase agreement that is specific to your transaction.
Once the letter of intent has been prepared, it will be presented to the seller (or their lawyer) for consideration. The seller can accept the offer, reject it, or counter with a different offer.
Step 3: Do your last stretch of market research
Performing a comprehensive investigation is a more involved process compared to the previous analysis of performance metrics you conducted.
While the latter primarily focused on managing costs and considering cash flow, the due diligence process delves deeper into examining the legal, structural, and operational aspects of the business.
The objective is to acquire a thorough understanding of the overall health of the business, not just its cash flow. This step is critical prior to finalizing the sale.
It enables you to uncover significant issues that could potentially influence your decision to purchase the business, such as unpaid sales tax or unresolved workers' compensation claims.
One vital area that requires diligent examination is the scrutiny of zoning laws and regulations in your state or city. Comprehending these laws and regulations is of utmost importance for restaurant owners and operators, as they govern the permissible utilization of land in specific areas and can impact the location and offerings of a restaurant.
Each city or municipality possesses its own distinct set of zoning regulations; thus, it is crucial to research and understand the rules that apply to the intended restaurant location. Failure to comply can result in penalties, closure, or legal repercussions.
Secure Funding for Your Restaurant Purchase
Get the funds you need to purchase your new restaurant by tapping into these 3 resources:
1. Personal Investment
To obtain financing for a restaurant purchase, be prepared to pay at least 20% of the purchase price as a down payment. However, certain small business loans may ask you to pay up to 30%.
Alongside conventional financing options, one can also contemplate utilizing funds from a 401(k) or retirement account to invest in the business.
Personal savings, direct investment from investors, or crowdfunding with small contributions from family and friends are also viable means of gathering funds for the purchase.
Having a personal credit score of at least 680, strong letters of recommendation, and a compelling business plan can enhance your chances of securing favorable financing.
Securing financing for a restaurant can pose challenges as lenders perceive the industry as particularly volatile. Nonetheless, Small Business Administration (SBA)-backed loans can offer a solution.
Traditional banks provide SBA loans, but they're guaranteed by the SBA, which reduces the risk for lenders. To apply for an SBA loan, you can approach a local bank.
Alternatively, you can explore the option of utilizing a lending marketplace, which enables small businesses to complete a single application and potentially connect with numerous lenders.
You'll need to rely on personal resources or seek funding from investors if you don't have the credit to qualify for an SBA loan.
Collaborating with investors will require legal expertise to create an investor agreement that outlines the terms of the association between the investors and your business.
This agreement should specify the repayment timeline for the investors and any additional benefits they may receive, such as dining discounts.
Prepare for completion
Check off these 4 boxes to complete the purchase of your new restaurant premises:
1. Closing Checklist
Your restaurant broker will provide you with a closing checklist to ensure that all necessary tasks are completed before closing the deal. This list will include:
- Changing over the point of sale (POS) system
- Conducting training for employees and management
- Contacting vendors and updating account information
- Acquiring or transferring the necessary alcohol license (if applicable)
- Obtaining or transferring the food service permit
- Updating and transferring restaurant insurance policies to the new owner
2. Transition and Closing Date
Closing Date and Transition Process:
- It is crucial to arrange an initial meeting with the seller to discuss the specifics of the transition process.
- Typically, the closing date for a restaurant is set at least two months after both parties have agreed to the sale.
Collaboration and Operations Shifting:
- During this period, the purchaser and seller must collaborate to shift all restaurant operations.
- Administrative tasks such as revising licenses and vendor accounts need to be addressed.
- Licenses and vendor accounts should be updated with the purchaser's contact information.
- The new proprietor must be formally introduced to the employees.
Training and Advantages:
- In certain situations, the seller may offer training for a few weeks.
- This can be beneficial if the buyer is taking over an established restaurant with a loyal customer base.
- The seller can provide insights into payroll systems, procurement arrangements, and the utilization of the POS system.
- The seller can also introduce the buyer to regular customers, facilitating a smooth transfer of ownership.
3. Draft the Final Contracts
It falls under your lawyer’s responsibilities to formulate the purchase agreement, which represents a legally binding contract elucidating the terms of the sale.
Ordinarily, this document incorporates the purchase price and closing date, along with any warranties or transactions that necessitate completion prior to the closing.
Moreover, it outlines any pending costs linked to the sale, including closing costs, transfer fees, and renovation expenses, and designates the party accountable for bearing these expenses.
4. Sign the purchase agreement
The contract, drafted by your attorney, should be sent to the seller for review before signing. It's customary for the buyer's lawyer to include a non-compete clause in the purchase agreement to prohibit the seller from opening a similar restaurant in the same market.
This would prevent competition with the restaurant you just acquired. On the day of closing, you will release the money to the seller, and the seller will relinquish ownership of the restaurant to you.
FREE Resources for Restaurant Owners
- Decide whether buying an existing restaurant better meets your needs than starting one from scratch.
- Work with a business or commercial real estate broker, use online listings, and search for restaurants that are not yet listed publicly.
- Understand the three primary assets that you can purchase when buying a restaurant: the business, the land, and the inventory, machinery, and supplies.
- Visit potential restaurants as an anonymous customer to evaluate the space and its strengths and weaknesses.
- Assess key performance metrics, including labor cost, food cost, prime cost, profit margin, cash flow, and seller's discretionary earnings (SDE).
- Secure a business attorney to handle legal paperwork and drafting or assessing critical documents such as the letter of intent, lease agreements, and purchase agreement.
- Prepare a fair and reasonable offer for the seller by using a standard agreement for restaurants or drafting a specific purchase agreement with an attorney.
- During the due diligence period, review financial records to establish mutual trust with the broker and understand the buying process.
- Carefully review the purchase agreement, as it’s a legally binding contract that outlines the terms of the sale of. The purchase agreement is also reviewed by the seller before signing.
- On the day of closing, release the money to the seller, and the seller will relinquish ownership of the restaurant to you, the buyer.