Financing Tips to Purchase an Existing Restaurant

How do I Valuate an Existing Restaurant?

If you believe you found the right restaurant to purchase - a restaurant with good standing in the community, regular diners and consistently good social media reviews, it's important to take a deeper dive into the numbers. Every restaurant acquisition will be different, but many use the same basic metrics:

• Determine the Seller's Discretionary Earnings (SDE). For small- to midsize restaurants, this widely used metric represents the total annual financial benefit a full-time owner derives from the restaurant.

The SDE is typically calculated by adding the restaurant's pre-tax net income, the owner's salary and benefit, non-cash expenses such as depreciation or amortization, interest, non-recurring expenses and discretionary expenses (expenses that are not considered essential to the survival of the restaurant). A rough valuation of the restaurant is often calculated by 1.5x to 4x SDE, although every purchase price will be different.

• Determine the restaurant's earnings before interest, taxes, depreciation, and amortization (EBITDA). This valuation is usually used for large, established restaurants because their expenses are typically more in line with mid-sized companies. While every transaction will be different, rough valuations of large restaurants are often 2x to 5x EBIDTA.

Non-financial factors need to be considered when valuating, although these factors may have to be determined through non-traditional means. This includes searching social media and online reviews to determine what the local community thinks of the restaurant:

• Will your restaurant participate in community events or charities?

• Does your restaurant's menu prices match the conditions of the local economy?Will the restaurant match the cultural dynamics of the neighborhood?

• Will the restaurant owner take online reviews seriously and make improvements accordingly?

Operating a restaurant also requires multiple inspection certificates and licenses, and the application processes may be extremely time consuming. If the restaurant being purchased does not have all of the necessary inspection certificates (i.e., notice of occupancy or food safety certificates) or isn't up to date on licenses (such as a liquor license), that should also be factored into the price of the restaurant.

What Types of Financing are Available?

If you've never owned or operated a restaurant, your options for financing will be limited, as almost all banks and online lenders will not be willing to provide you with financing. There are, however, still some ways to obtain funding, especially if the seller also owns the building and real estate upon which the restaurant operates.

If you do have years of experience successfully operating a restaurant, the traditional routes include:

1. Seller financing. Seller financing is when the seller of the restaurant acts as the private lender. In such financing, the buyer typically provides a down payment for the restaurant and then makes monthly payments with interest to the seller until the restaurant is fully paid off. In this arrangement, the seller consults with an attorney and comes to terms with the buyer on payment and default terms and fees. This is the most popular option chosen when selling a restaurant.

Often used by: Buyers who have a good credit score but do not qualify for traditional financing, and sellers who are eager to sell quickly.

2. Second mortgage. Purchasing an existing restaurant will require a large amount of capital that many people don't have, so if the buyer owns property such as a home, taking out a second mortgage could be one of the only ways to raise that much capital quickly. This option takes on significant risk for the buyer.

Best Often used by: Buyers who have low credit scores and very few options on raising the capital needed to purchase the restaurant.

3. Personal loan. There are plenty of companies that specialize in high interest personal loans to individuals. If the restaurant buyer is seeking multiple lines of capital for the acquisition, this should be one of the last resort options since these personal loans often carry high interest rates. Additionally, personal loans often won't provide enough capital to purchase a restaurant outright. Personal loans may not be able to be used for business expenses depending on the agreement.

Often used for: Buyers that are looking for multiple lines of capital to purchase a restaurant and may not have a strong credit score.

If a buyer does have years of experience successfully operating a restaurant, there are strong options to raise enough liquidity to make the purchase:

1. SBA 7(a) loan. A 7(a) loan is often the most attractive loan for small business owners as it is partially backed by the U.S. Small Business Administration and therefore usually offers lower interest rates than other loans. The drawback is that obtaining a 7(a) loan can take several weeks and requires significant paperwork, including a detailed business plan. Since restaurants are considered especially high-risk businesses by lenders, the business plan will need to be significantly strong.

Often used for: Restaurateurs with high credit scores and a successful track record of owning and operating restaurants.

2. SBA 504/CDC loan. If a restaurant buyer can't get enough capital from a term loan or 7(a) loan, a 504 loan could come in handy. It's a loan that is also partially guaranteed by the SBA and can be for acquisitions, purchasing equipment and hiring employees. The amount ranges from $50,000 to $5 million and is granted by an SBA-backed community development corporation (CDC). Loans are given to small businesses that have strong ties to their local communities. Similar to a 7(a) loan, the application process requires significant paper work but the loan requirements are not as stringent as a 7(a) loan.

Often used for: Restaurant owners that help develop local economies by hiring locally, presenting attractive storefronts, etc.

3. Term loans. Term loans are not guaranteed by the SBA and therefore typically charge higher interest rates than 7(a) loans. However, there application process usually involves far less paperwork and the credit score requirement may be lesser than a 7(a) loan, especially when it comes to online lenders. Another advantage is that most term loan lenders offer short- and long-term durations for the loans. When it comes to restaurants, they will also require that the borrower has extensive experience in successfully operating a restaurant.

Can be used for: Experienced restaurateurs who don't qualify for an SBA 7(a) loan.

4. Commercial real estate (CRE) loan. A buyer can use a commercial real estate loan to buy a restaurant if the previous restaurant owner owns the property as well as the restaurant business. CRE loans are typically offered by both traditional banks and credit unions, but usually require a down payment on the property. The interest rate charged can be both variable or fixed.

Often used for: Restaurant owners who can afford the down payment and are comfortable maintaining the property as well as the business itself.

5. Business line of credit. A business line of credit may be a viable option if the price of the restaurant is relatively low. Every lender is different, but the maximum for most business lines of credit range between $100,000 and $500,000. A line of credit could be useful as a supplemental form of financing to a term loan or SBA 7(a) loan.

Often used for: Restaurant owner who needs a supplemental form of financing on top of a term loan or 7(a) loan to handle cash flow expenses, such as food inventory, restaurant furniture, etc.

Cover All Your Bases

Restaurants are considered risky for a reason, and as such, securing financing to purchase one can be difficult and tricky. Prospective owners need to carefully examine multiple facets of the business and may require several forms of financing. On top of that, owners need to perform a delicate balancing act between their culinary passion and ability to closely manage finances. While everyone loves the idea of a charming local eatery, the sustainability of the investment requires the owner to rigorously analyze finances and community reputation.