How to Value a Franchised Restaurant Company

By Rick Ormsby
Managing Director
502-252-6422
[email protected]

Recently a young analyst approached me surprised at the perceived simplicity of valuing franchise restaurants. This inspired me to share a general overview of how to think about restaurant valuations.

Restaurants are unique in that they have very little inventory and accounts receivable, making the valuation techniques oftentimes different in practice to discounted cash flow calculations learned in business school or on Wall Street.

Restaurant valuations have 5 key drivers: EBITDA multiples, general and administrative (G&A) expense assumptions, cap rates, future remodeling obligations, and other considerations. Each is discussed below, though expounding upon their dynamic relationship with one another is beyond the scope of this discussion.

Please keep in mind that making incorrect assumptions about these drivers will yield drastically skewed valuations. Big or small, most restaurant owners I know do not apply these drivers correctly and thus are poorly informed about the value of their companies.

EBITDA Multiples

EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. For any franchised restaurant, this figure can be simply calculated from the most recent P&L (on a by-store basis).

Adjustments then need to be made. If not allocated at the store-level, beverage rebates should be added back, while credit card fees and bank charges need be subtracted. Further add back all actual above-store G&A before ultimately subtracting an implied G&A as a percentage of sales (see below). If valuing fee-owned real estate, an implied rent assumption should be subtracted as well. Lastly, there are usually other adjustments and add backs; these will vary from franchisee to franchisee.

Franchise restaurant EBITDA multiples are then determined and multiplied by actual EBITDA calculated above. These EBITDA multiples are generally in the range of 3.0X – 8.0X. For smaller, unproven, legacy or struggling brands, the lower range is warranted. Many brands are valued in the 4.0X – 5.5X range, including legacy brands with consistent performance, second tier franchise brands, and growth-oriented fast-casual concepts.

Any brand trading above 5.5X will likely have high-growth appeal or attractive EBITDA and development opportunities. At the highest end, there is a feeding frenzy for a few select brands, most notably Taco Bell – where EBITDA multiples have eclipsed 8.0X.

Finally, EBITDA multiples are sensitive to interest rates, general availability of capital, overall business climate, brand performance, buyer demand, yields in other asset categories, and many other factors.

G&A%

Once actual G&A is added back and other adjustments are made to the store-level P&Ls, an assumed G&A is deducted from EBITDA before the multiple is applied. It is typical to assume a percentage of sales ranging from 3.0% – 5.0% or higher, based on the size, brand, geography, and actual expenses associated with existing operations.

G&A% is generally lower for larger businesses than those smaller. G&A% is also typically less for a high Average Unit Volume (AUV) business than for a low AUV business with the same number of units. G&A assumptions might change based on in-line vs. standalone restaurants. If a franchise business has a large geographical reach, standard G&A assumptions might be too low.

Cap Rates

If you are a restaurant operator, you probably get frequent phone calls from sale-leaseback brokers. As such, you have likely heard of cap rates and their application in ascertaining value for fee-owned restaurant real estate.

Cap rates vary based on several factors: brand, geography, financial performance of the restaurant business, and number of restaurants sold. However, the biggest factor in cap rate variability is the rise and fall of interest rates. Due to the current low rate environment, cap rates are near historical lows and conversely, real estate valuations are approaching unprecedented highs.

In order to value a fee-owned real estate property, first assume an implied rent (generally as a percentage of sales not to exceed about 8% of sales) and assign a cap rate. The implied rent then must be subtracted from EBITDA so that business and real estate values are not double counted. Finally, multiply net sales by the implied rent to cap rate ratio.

Future Remodeling Obligations

This is perhaps the most widely variable aspect of a restaurant valuation. Franchise brands have routine remodeling programs – every 5, 10, 20, or 25 years. One must first understand what remodeling action is needed on a by-store basis, when it is required by the franchisor, and the expected expense.

From our experience, buyers treat these future remodeling expenses differently by brand depending largely on the expected increase in sales and profits thereafter (or lack thereof). For poor performing legacy brands, a buyer might deduct the present value of 5-10 years of future remodeling expenses from the final valuation before making an offer.

For high-growth brands with strong appeal, this deduction might instead account for the present value of 3-4 years of future remodeling expenses where there is ample evidence to support the thesis that remodeling produces higher sales and profits.

When determining deductions for remodeling expenses, two valuation experts might reach very different conclusions; therefore, it is inherently subjective.

Other Considerations

Here is a non-comprehensive list of other considerations:

  1. Poorly performing fee-owned restaurants with near-term remodels might have a higher valuation if closed and sold for a different use.
  2. Restaurants with short-term leases and no extensions have questionable value.
  3. Restaurants with near-term remodeling obligations without longer-term lease lives are also questionable.
  4. Will the franchisor allow for renewal upon expiration of the franchise? This is particularly pertinent for multi-brand restaurants.
  5. What is the impact on remodeling a restaurant and then selling it vs. selling before a remodel is due?
  6. How do we assess high-growth DMAs vs. saturated ones? For example, cities such as Dallas, Los Angeles, and Atlanta may have heavy QSR penetration. This might not be the case for smaller cities or in different regional areas of the US.

As you can see, restaurant valuations are a complicated topic. There is no easy formula for how to calculate a franchise restaurant company, and it normally requires an expert to help.

If you have found this overview insightful or if it has peaked your curiosity, please feel free to reach out to me for a deeper discussion. I’d be honored to talk with you anytime on a personal and confidential basis.

Rick Ormsby
Managing Director
502-252-6422
[email protected]