Valuations are based on several key metrics, some of which include EBITDA, cap rates, G&A expenses and remodeling costs. Find out how they inter-relate by watching Rick Ormsby’s views from Unbridled Capital.
The topic of this episode is, how do buyers and sellers think about valuation when considering a transaction? The restaurant industry has a very particular way to think about valuations, and this is different from what most people learn in business school. The methodology is simple, but like everything in restaurants, from financing to marketing to operations, it is difficult to execute correctly and easy to mishandle. Restaurant valuations are determined based on several criteria on a trailing 12-month rolling 13-period basis, net sales, real estate owned versus leased, pre-G&A EBITDA, implied or actual G&A expenses, the famously known EBITDA multiple, remodeling dates, and remodeling costs. If the real estate is owned, important factors are implied rent, cap rates and rent coverage ratios. For a simple example, evaluation for a restaurant that is not fee owned would essentially take pre-G&A EBITDA less a G&A allocation, then multiply by an EBITDA multiple, and finally, reduce the result by a discounted value of several years of future remodeling obligations.
Real estate would be valued at implied rents and prevailing cap rates, subject to rent coverage ratios in term of remaining franchise agreements. From a high-level perspective, post G&A EBITDA multiples generally range from four and a half to eight times, and cap rates are generally between 5.75 and 7.5%. However, it takes much experience to correctly apply these various criteria, based on brand geography, size, performance, tenure, operational track record, and other factors. For example, a two-unit Taco Bell business in Montana with no real estate and long remaining franchise lives has an entirely different valuation methodology than a 50-unit Pizza Hut business in Atlanta with 20 pieces of real estate and 15 remodels due in the next three years.
The iterations can expand infinitely and there are three problems that happened when franchisees throw around valuation metrics with their friends. Number one, most of them have no idea what their true post G&A EBITDA is. Number two, most will misapply an EBITDA multiple or cap rate to their assets. And number three, all of them think their business is worth more than it's actually worth. If you have any questions on valuation or M&A, and would like to talk further, please feel free to reach out any time. Thanks so much.