There can be many pitfalls when buying a hospitality business, and just as many selling one. Mark Abernethy shows you what to look out for.
It seemed like such a good idea at the time: buy a little café somewhere up the coast, bring in some good staff and then settle into the new lifestyle. But when the dream turns into a nightmare, it could well be that the problems started before the first espresso was poured.
“The restaurant business can be hard even for seasoned operators,” says accountant to the restaurant trade, Peter Sheehan. “So you don’t want to make things impossible for yourself by the decisions you make when buying a business.”
Sheehan, a partner at BDO Kendalls in Brisbane, says the restaurant and café industry holds a romantic allure for both newcomers and owners who have had a dream run with their first hospitality business and expect easy pickings second time around.
But there are basic pitfalls that everyone should watch for when buying a hospitality business, especially if they decide to forego independent advice. “The first thing to work out is, what exactly are you buying? What are you paying for? If you’re buying a successful restaurant, you want to make sure you’re buying the components of that success,” he says.
The price being asked will typically include goodwill, stock, plant and equipment, says Sheehan. Then the task is to make sure that what is being offered actually exists. “Once you’ve seen a few business sales you realise that vendors can tell you anything. You don’t want to get into a negotiation to buy any business unless you have already decided what your own valuation is.”
The pitfalls are many: plant and equipment that is actually leased, not owned; earnings that allegedly have a cash component, but with no proof; stock that doesn’t exist; costs that seem too light or costs that include the current owner’s car; wages bills that don’t include the owner’s time, etc.
What are you really buying?
Having established bona fides in the books, Sheehan says prospective buyers should look at the lease attached to the business.
“If the lease includes bad terms, this is something that should be negotiated before you take on the business. If there’s a steep rent, then perhaps the business case won’t stack up. A big problem is generous ‘review’ clauses that give too much power to the landlord—it may be the case that the vendor is selling because of the rent situation,” he adds.
Sheehan says newcomers to the hospitality business should be aware that restaurants and cafés should never pay more than 10 per cent of turnover in rent—eight per cent is considered an optimal ratio. There are also clauses in commercial leases that give parameters to what the restaurateur can do to the building; the current owner may have made alterations that are not allowed.
Which brings in another question for the buyer: is the quoted turnover in the books the real turnover? This sets off a due diligence process in which people like Sheehan go looking for not only the physical assets that have been claimed, but an examination of the earnings and expenses. The goodwill component of the sale price is usually calculated on a multiple of earnings (e.g. 1.5 or 2 x earnings), so having an independent appraisal of actual earnings is crucial.
“Even if you want to dive into this without independent advice you still need to have an accountant look at the books,” says Sheehan. “The turnover figures are what the goodwill is calculated on and what you’ll build your own business case on—you have to have an objective opinion about how much money this business has been making. Sometimes there’s more trade than recorded in the books, sometimes there’s less.”
Sheehan says his firm usually uses a times-earnings multiple of earnings to find a goodwill component for the business, and he advises that buyers not pay more than it would take three years to repay the investment.
Sheehan says buyers should have financial and business due diligence done by accountants and due diligence on leases, permits and town planning issues by a solicitor.
When it comes to selling a restaurant or café, Sheehan says vendors should have their books ‘normalised’ to reflect the actual workings of the business.
Sydney-based restaurant broker David Wallace of Feszt & Feszt, says the lease and rent are the main things that vendors in the restaurant trade get caught on.
“Buyers are so focused on the dream and the business case that they can leap into situations where the landlord has an unfair advantage. My advice to people who haven’t done this before is to get independent professional advice before you sign, or you’ll spend twice as much getting yourself out of it at the other end.”
Wallace says it’s not unusual for tenancy leases to contain five per cent per annum increases.
“You may miss that when you buy the place, but after eight or nine years it’s ruining your business.”
He also advises to make realistic revenue budgets when making a business case for the restaurant.
“The hospitality game goes up and down—don’t just look at how many seats the place has and then do your sums on 100 per cent patronage all the time. Not even the top restaurants do their budgets on a capacity house, 100 per cent of the time. You have
to be realistic.”
Wallace says many of the smaller café businesses will do a certain amount of cash sales, and a clear picture of actual revenues is not always easy.
“If you know a place is for sale, spend a few hours in there and count how many coffees per hour. It’s often the only way to work out exactly what they’re making.”
Getting the right staff
Wallace’s big warning centres on staff. He says in a jobs market where even big name restaurants are struggling to fill mid-level kitchen positions and good floor staff, the novice café owner has to have an employee plan before taking possession.
It’s a theme that hospitality management consultant Ken Burgin is also big on. The managing director of Profitable Hospitality is wary of the low morale in restaurants and cafés that are for sale, and he says a prospective buyer has to have a core team ready to
go into a business. “It’s inconvenient and it’s hard to get a team together before you go in,” says Burgin. “But taking on the staff will cause more problems than it’s worth.”
He urges potential buyers of hospitality businesses to have an accountant and solicitor ready to look over the business. “People buy into this industry for return on investment and lifestyle, so you have to approach a purchase from these two perspectives.”
He says that to prove a business case for a restaurant, café or catering company, a buyer must get access to business activity statements, tax returns, and the profit and loss statements going back as far as is possible.
Burgin says buyers sometimes have to use their guile to find the true earnings and costs of a hospitality business.
For instance, ask for power bills and look at the usage graph that tells you if business is up or down on a year ago. Do the same for water usage. Half of all water used in a café or restaurant is flushed in the lavatory, so historical water usage tells you how business has been travelling. Burgin also suggests Wallace’s DIY audit tip: sit in the business and note how many coffees, mains, deserts, etc are delivered in an hour.
On the lifestyle front, Burgin says a buyer should make a business case that includes his or her own days off. “You don’t want to sink all this money into your lifestyle business and find yourself working seven days a week. You have to develop your most important skill: managing a team of staff,” he says.
Burgin—who has sold three businesses himself—says vendors usually do better with a broker, even after the commissions and fees. “I use a broker because they reach more people and the right people. They’re like a real estate agent: you may think they cost
too much but their business is in getting the best price that the market will allow.”
His tips for selling are to have an accountant and solicitor help construct the books, the sale contract and the lease. “Have all this stuff ready to go. How many times do you hear that someone wants to buy a restaurant but the owner doesn’t have a contract ready to go?”
Burgin also says that because of the number of ‘life changers’ who want to buy into the hospitality industry, a seller gains an advantage by documenting recipes and supply systems, putting business systems into manuals and standardising as much of the business as possible. “Make it a turnkey proposition and you’ll widen your market,” he says.