Caveat emptor

It looks good now, but that business you’re about to buy may be harbouring dark and terrible secrets ...

It looks good now, but that business you’re about to buy may be harbouring dark and terrible secrets …

With the economy on shaky ground, it’s a buyer’s market out there for people wishing to pick up a new hospitality business—but it would be rash to go buying willy-nilly. Michelle Starr gets the lowdown on where the buyer should beware.

So you’ve decided to take advantage of the current bust and pick up a restaurant or cafe business. If you’re reading this magazine, presumably this isn’t your first time starting out on a food service venture; therefore, you should be aware that it’s never as simple as merely taking over the reins of an established—or successful—concept. There are quite a few pitfalls waiting to trip the unwary buyer—especially in these times, when current sellers are feeling the pinch.

In fact, Tony Eldred of Eldred Hospitality advises extreme caution. “It’s a total buyer’s  market—we reckon there are about 15,000 hospitality businesses for sale in Australia at the moment—everyone wants to get out,” he says. But it’s for that reason that you should be careful—if everyone wants to get out, there is a reason for it. “It’s not the time to buy a restaurant, that’s probably my overall advice—unless you really know what you’re doing,” Eldred continues. “It’s probably the worst beginner’s market that I’ve ever seen.”

Proprietors are selling up because the food service industry is suffering under the weight of the global financial crisis. With the average spend of eating out dropping quite considerably, many operators are struggling. If you buy in the current economic climate without knowing what you’re doing, chances are you’ll be belly-up yourself before you can turn around.

But there are ways you can turn the market glut to your advantage. “You can be very choosy,”  Eldred says. This means you can afford to take your time to thoroughly check out a business before purchase—a crucial process, since you need to be absolutely certain that you’re getting value for money.

“There are a lot of people who are trying to get out and will do anything to take some money with them,” Eldred cautions. “We’re commonly seeing people asking $500,000 for a business that is worth maybe $50,000.” Such proprietors try to sneak the higher sale price through by getting creative with the accounting—leaving out costs that the business should be incurring in order to plump up the bottom line.

So, Eldred advises, the first thing to check is that the books are clean. “A common trick is an owner who hasn’t paid himself a salary. He’s worked 80 hours a week, lived off the restaurant, eaten late at the restaurant, pulled cash out and paid the rent, etc., but he’s not paying himself a salary,” he says.

“Another thing to be careful of is that if they own more than one hospitality business. It’s very easy to doctor the figures by purchasing, say, your food stock or part of your food stock and charging it to one of your other restaurants and using that to show low costs in the business you’re trying to sell. Or they may charge management salaries to a different restaurant. You have to be very careful.”

Jonn Close from restaurant consultancy and brokerage Close Encounters agrees. “Do your due diligence very carefully,” he says. “Don’t rely on anybody else. Then have it verified by a third party just to make sure.” He advises that, instead of relying on information provided by the seller, who has a vested interest in making things look good, you should perform your own calculations. Work out your own budgets for expenses such as staff, food and beverage costs, rent, and general operational expenses.

If you do all this yourself, he says, you’ll have a much clearer understanding of where the business is, where you could take it and whether it is worth your time and money.

Close also recommends you carefully examine the Development Approval. “The DA advises the permitted trading hours; the restaurant capacity; and terms, conditions and restrictions that the council may have placed upon the premises,” he says. “It is imperative to ensure a DA exists; the business you are planning to purchase must have approval to trade as its intended use.”

For example, you may not have approval to cook on the site, or to use the footpath for outside dining—or you may be required to have a certain number of parking spaces available that just aren’t available.

You also need to examine the lease. “Look for lease terms, the rent, any special conditions—could there be a demolition clause or other clause that restricts the permitted use?” says Close. “There could be all sorts of tricky things, such as percentage rents, strata plan considerations and outside seating restrictions—you have to look at all those things and try to understand it. If you don’t understand it, get it checked out by someone who does.”

This goes for pretty much everything, says Eldred. “Get advice,” he says. “You really need someone to come in and check what the restaurant has been purchasing under the previous owner, and just to know what to look for. It’s not something that a person who doesn’t understand what they’re doing would be capable of doing, and an average accountant wouldn’t be able to do it either.”

Michael Gonsalves of Five O’s Bar Restaurant in Coogee, New South Wales, said that finding someone to help him with his buying process, though, wasn’t that easy. “It took approximately 12-18 months from when I initially started looking for a business until I found one that I eventually bought,” he says. “During that process, I dealt with a number of brokers who weren’t very helpful or completely forthcoming with all the information that I needed in order to make a decision.”

When he finally hooked up with Close, Gonsalves found the process a lot easier, but he was still stymied by prospective sellers who wouldn’t meet his requests for information. “Some of the owners would not let me have a trial period, and this made my decision to buy a lot more difficult,” he says. “There is always a risk involved when purchasing a business, especially without a trial; however, in the absence of a trial, complete and accurate records are a must. Have a qualified accountant go through these with you. But try to spend as much time in the business as possible. I spent months visiting for hours at a time at different times of the day.”

You may feel that you don’t have months to spend deliberating, but doing it this way may be the best way to make sure you’re not having the wool pulled over your eyes. “A lot of restaurants are sold on the basis of, ‘The figures aren’t what we’re showing initially, come in and do a trial’,” says Eldred. “In other words, come and camp out in the restaurant for two weeks and have a look for yourself. But it’s very easy to rig that—you know, tell all your friends to come and dine for a fortnight, that sort of thing.”

It’s important, therefore, to try to see the restaurant at different times of the day and on different days of the week. If you just show up on Thursday, Friday and Saturday nights, which are typically the times restaurants are busiest, you’re only going to see it when trade is at its peak, which won’t give you an accurate picture of the sort of revenue the business can pull in.

Close advises that you also look carefully at the liquor licence—and make sure you cross-reference it with the DA. “There has often been a disparity between the DA and the liquor licence in the past,” he says. “Now, whatever the
DA says, the liquor licence adopts. So if your premises
are able to open at 7am and close at midnight, you’re
able to serve alcohol in those hours. If your liquor licence
says you can have so many people on the premises and your DA says something else, the rules default back to the DA now.”

Making sure that the lease, DA and liquor licence all add up, and checking to see what you are actually allowed to do on the premises, is just as crucial as checking the revenue of the business. You can’t just assume that because the venue does something a certain way that you can do it that way too; or that, because your concept idea doesn’t involve fancy kitchen equipment, you’ll be allowed to run with it.

Your seller may be in a hurry to cut and run, but that doesn’t mean you should let them or their broker push you into a purchase you’re not ready to make. Take your time. Check everything. And “the most important thing, I think,” says Close, “is to make sure the business does what it says it does.” ≤

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