What’s My Pizzeria Worth?

bOValuationUnlike automobiles or homes, assigning a value to any business, let alone a restaurant enterprise such as a pizzeria, can be a biased, meandering task filled with subjectivity, high emotion and figure-swaying details.
It’s anything but concrete. A.J. Edelstein of The Restaurant Brokers, a Tempe, Arizona-based commercial real estate firm that specializes in restaurant deals, calls the valuation process “multi-faceted” and quite often results in a slanted number based on market conditions and perspective.

“In reality, anybody can assign any amount of value to a business that they want, but, like virtually everything else in this world with a price tag, the business is only worth what you can sell it for. Market value is a big determining factor,” Edelstein says, adding that common sense must be applied to any valuation.

While a sale of the business remains the most common reason operators order a valuation, there exist various other instances in which an operator would need a credible valuation, such as refinancing, estate tax, a partnership split, the addition of new investors, insurance or divorce. Having a solid grasp of a pizzeria’s value would also arm an operator with key information to begin planning the right exit strategy –– even if that reality existed years down the road.

As a baseline, Edelstein says a restaurant valuation is typically anywhere from two to three times the adjusted cash flow, a number that rarely matches the cash flow number listed on the restaurant’s P&L since so many operators place various expenses on the business –– cars, cell phones, life insurance, and the like –– to maximize deductions.

“We’ll take away all of those discretionary expenses to reach the adjusted cash flow, which is a more honest representation of the restaurant’s success,” Edelstein says. “Then, we apply the multiplier.”

In Edelstein’s experience, the numbers get “twisted, twirled and contorted” to reach a final valuation figure that respects market conditions, operational ease, location, lease terms and an assortment of other factors.

For instance, a pizzeria might only receive a multiple of two if it sits in a crime-ridden neighborhood or only does delivery. By contrast, a pizzeria might receive a more favorable multiple, such as three or even 3.5, if it has an established catering business, a large dine-in space that boasts a highly profitable beverage program, or a direct, easy-to-execute menu.

True to the subjective nature of appraisals, other professionals tout different formulas.

Steve Mize, a partner with Tampa, Florida-based GCFValuation, one of the country’s leading independent business appraisal firms, says he typically sees restaurants sell for a multiple of the “seller’s discretionary earnings,” which is calculated as adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) plus the owner’s compensation plus the owner’s benefits, or “perks.”

William Bruce, a business broker, appraiser and Accredited Business Intermediary (ABI), takes a non-multiplier approach. He says the rule-of-thumb valuation guideline for valuing independent, non-franchised pizza shops is 35 percent of annual sales plus food and liquor inventory. Among franchised shops the guidelines range from 28 to 55 percent.

“However, and this is important as a reality check, the bottom line discretionary cash flow of the business must support the above valuation formula,” says Bruce, president of the American Business Brokers Association.

Subjective as the valuation can be, there remain a number of universally accepted guidelines for what appraisers will or will not include in the valuation.

Inventory and fixed assets, including equipment, are factored into the price because those components are required to run the business. In many cases, the pizzeria’s valuation will fall if the equipment is assessed to have an abundance of deferred maintenance.

In the event that the pizzeria owns its real estate, that physical asset is almost always evaluated separately from the business.

“A lot of it comes down to salvage value,” Edelstein says. “If a buyer closes the business upon his purchase, the real estate still has value.”

In some cases, potential earnings, sometimes referred to as “blue sky” by appraisers and brokers, will enter the valuation as well. For instance, if the current pizzeria business has three stores in a local area but the potential to have as many as seven to eight local units because of its brand strength, the valuation’s multiple might rise given those encouraging prospects.

“If the valuation process is subjective, so, too, is blue sky,” Edelstein says, adding that a single-unit restaurant will rarely see blue sky factored into the valuation.

Compared to other restaurant ventures, Edelstein says pizzerias stand in a favorable valuation position given that most pizzerias contain straightforward, simple operations with generally favorable margins and food costs.

How often should owners get a valuation?

The question of how often a pizzeria owner should order a professional valuation remains an issue of debate.

Steve Mize, a partner with GCFValuation, for example, says owners should get an appraisal every two to three years, if not on an annual basis.

“The business owner’s largest asset is typically going to be (his or her) ownership in the business; therefore it’s important to know the value of this asset and have it updated annually or every few years,” Mize contends.

Yet, A.J. Edelstein of the Restaurant Brokers isn’t convinced routine valuations are necessary and, moreover, practical for many operators, particularly the many mom-and-pop pizzerias humming along throughout the U.S.A. professional valuation might run $3,000 to $5,000, a sum many operators cannot justify spending.

“Unless you’re in a situation with bank covenants or you see something coming down the road, like the addition of new partners or a break with an existing partner, I’m not sure you need to have a valuation,” he says. “Most operators choose to spend that money on something that will help the business grow or operate more efficiently.”

Bruce says experienced business brokers can typically offer a quality valuation, while Edelstein urges operators to ask trusted advisors for references, particularly in the case of a divorce, one of the most common reasons — outside of a sale of the restaurant — that owners need a valuation.

“Unfortunately, divorce among a husband-wife business owner team is a common scenario, so that attorney should be able to offer some professional recommendations,” Edelstein says.

Chicago-based writer Daniel P. Smith has covered business issues and best practices for a variety of trade publications, newspapers, and magazines.