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When a prospective buyer is trying to establish whether he or she will purchase a particular business for sale, there are many buy business elements to take into consideration. When prospects arise, quite apart from the question of suitability, location and longevity, the issue of real-world business valuation is front and center. The seller will present a series of financial documents and it is, of course, in their best interests to portray the business for sale in a shining light. As such, the issue of “add backs” is likely to represent one of the thorniest problems.

In most instances, add backs are included in an effort to present the business from a real world point of view. When compiling traditional accounting reports, it’s essential to adhere to a set of very rigid standards - there may also be additional footnotes to consider, and depending on your point of view, these can be either positive or negative. When you’re thinking about buying a business, it’s crucial that you carefully scrutinize each and every add back, as they can often make a significant difference in your final valuation figure.

When performing the process of due diligence, checking recorded sales and purchases against ledgers and reconciled bank accounts is usually a fairly straightforward task. Far more often than you might think however, the current owner will strive to draw your attention to points which may be “one-time” instances, or to extra income which might not actually appear anywhere in the books at all. You should be open to all suggestions of course but maintain a degree of skepticism at all times until you are able to validate the claims, or otherwise.

Don’t forget that for an item to be claimed as a “one off,” it must not have occurred during any of the previous years. Seller could argue that a particular expense is much larger than it should be due to a particular incident or requirement, but if you see a pattern of any kind, then the add back must be discounted.

One of the most common add backs, especially when the business can be owner operated, is to suggest the value of a manager’s salary. You need to establish that the outgoing owner was not actively involved in the operation of the business in this case and this figure is only of interest to you if you intend to assume the role of the redundant manager.

Add backs may not be asserted whenever they represent intangibles, such as the prospect of additional revenues due to a new marketing initiative that the outgoing owner has just put in place, for example. Nor should you believe an owner claim that you can reduce a certain category of expenses through renegotiation or other initiatives. After all, if the outgoing owner has not being able to do so to this point it seems reasonable to assume that an incoming “newbie” is likely to have even less ability to affect short-term change in this regard.

Be particularly wary when you are told that a business retains a lot of cash sales. You must essentially discount this notion from a strict valuation perspective, even though such a claim made, after review, may be seen as reasonable. If the owner has not entered the cash sales on the books, he or she will not have accounted for taxes correctly and it’s not fair for them to expect to receive a double benefit in this way, a net tax saving and enhanced business value.

When you have reviewed the complete list of business financials, treat each claim for add back on an individual case basis and never roll them into an inflated value. At this stage you must be particularly diligent to enable you to arrive at a real world price for this prospect.

Richard Parker is the author of the How to Buy a Good Business at a Great Price series. As President and founder of Diomo Corporation - The Business Buyer Resource Center, his materials, seminars and consulting have helped thousands of business buyers realize their dream to buy a business.

Everyone needs to eat to live, and over time we’ve established a habit of making this process a social one. As such, a restaurant for sale is one of the most popular businesses to buy, and one which may represent an even more attractive purchase proposition if you have a particular taste for a certain type of food!

Perform due diligence carefully when looking to buy restaurant business, even though your intuition - and your stomach, might be telling you that it’s the right decision for you. This particular industry is extremely competitive, and there are an array of factors you’ll need to consider. Allocate a period of time, experts recommend four weeks, to observe the operation of the business. This should enable you to get a good feel and to smooth out any peaks or troughs before you make your final decision.

You have several key areas to investigate including the premises, the financials, the equipment, lease, the operations and the employees. Do not be afraid to bring in experts, including an accountant experienced in the food business to help you, but as you go through your observation period, use your general business sense and a good portion of common sense to observe how everything works, especially from a client point of view.

For your paper and number crunching chores, expect to review the tax returns, profit and loss statements, cash flow worksheets, inventory records, employee records, equipment agreements, maintenance schedules, all necessary licenses, health inspections certificates and a history and copy of the lease.

When reviewing the financial documents, it’s essential to keep in mind that the restaurant business has a large volume of cash sales. Surprisingly often, many business owners decide to siphon off some of this cash for themselves, not reporting it to save on taxes. In the long run this isn’t a good idea, as this money could have been applied toward a marketing budget or buying new business assets, and if siphoning is going on, it can be quite hard to prove income.

When you are inspecting the property, look at it from an overall perspective as well as in detail. Can it be adequately seen from nearby major roads, is signage appropriate, well-maintained and presentable? Are there any other major competitors and are they overbearing? What is your first impression when arriving in the parking lot? Take a look at external dumpsters and trash removal areas to make sure that these are as well-maintained as possible and are unobtrusive.

Moving inside, what is your first impression of the decor. Is the waiting area pleasant and contributory to the overall ambience? Is there adequate signage for bathrooms, emergency exits? Pay close attention to the bathrooms. They should be in perfect working order, comfortable and impeccably clean and well-maintained. In a restaurant, everything, repeat everything should be clean, presentable and in full working order.

Most of the equipment contained in a restaurant and specifically within its kitchen is subject to certification, inspection and permitting. Check to see that this is all up-to-date and timely. While every element of the equipment should be operated according to the letter of the law, you must also ensure that regular maintenance and cleaning schedules are top-notch. For major items and appliances, see whether contractor warranties are available and can be transferred to you.

Very often a lease can be a potential stumbling block when looking at a restaurant for sale. The landlord will want to ensure that the business is being operated as efficiently as possible and may be wary of transferring or issuing a new lease to someone who does not have much experience. Look for terminology within the lease stating that transfers will “not be unreasonably withheld,” and aim to ensure that you get at least as favorable terms during your tenancy. This would be a good time to assess the overall viability of the environment within which the business operates. If in a strip mall of some kind, are the anchor stores in good shape and do the majority of other businesses also appear sound? You do not want to see an anchor store disappear and the overall visitor level to the area decline.

When you analyze the operations of the business, you want to learn how the current owner operates and whether there are any immediate issues or challenges that you will have to take into account. Look closely at any “special arrangements” or unique selling points that involve a particular individual, a style or presentation of food. You want to be sure that these elements are transferable or will be present when you take over.

A restaurant will likely rise and fall on the strength of its employees. While you can expect a high turnover in any kind of restaurant, if you see some loyal staff and a good “team spirit” this can be a definite plus. Check to see how people are hired, the terms and conditions offered to them and exactly how they are paid.

While you should insist on an observation period, before you are involved in formal discussions with the seller why not kill two birds with one stone and visit the restaurant for a few nice dinners or lunches with other companions? You don’t have to show your hand at this stage and can get a really good feeling by observing how the staff come and go, the operation within the kitchen ideally and in general get an opinion of whether everything is orderly and well-structured during the busiest times.

Richard Parker is the author of the How to Buy a Good Business at a Great Price series. As President and founder of Diomo Corporation - The Business Buyer Resource Center, his materials, seminars and consulting have helped thousands of business buyers realize their dream to buy a business.

When looking to buy liquor store business, the process of due diligence goes way beyond just an assessment of the presented financials. You need to be able to access all the files and records, review information and research personnel as you review what you’re being told. It is recommended that you allocate at least four weeks for this process and do not be tempted to rush to judgement. There are a surprising number of issues which may only become apparent over a span of time, so always keep this in mind and proceed cautiously.

There are some decisions that you can make about buying a liquor store business before you immerse yourself fully in the due diligence process. While you’re likely going to have to do a great deal of number crunching and leg work as you press on ahead, is there anything at this point which you have come to understand about the industry, about this business in particular, its owners or its location so far that has given you pause, causing you to second guess yourself? If for example you already know that financial records are incomplete for reasons given by the seller, or the condition of the store or its assets are not as you had hoped or expected, inventories are incomplete, inspections, certificates or licenses are compromised for one reason or another – all may be reasons for you to turn around and bid good day.

For a process of due diligence to be complete, you will need to concentrate on seven different areas:

1. The Premises.

We’ve already covered the crucial importance of allocating not less than four weeks to this endeavour, and you should reach an agreement with the seller for this set period of time so that you can personally observe the day-to-day operations of the business. First of all, you’re going to need to assess the inside and outside of the place of business and figure out a rough estimate of what you might need to pay out to replace, repair or upgrade. Remember that the attitude of the staff is very important in the retail business and you should immediately assess how the existing staff interact with clients. Are they generally friendly, attentive, and prompt as well? Personal issues or conversations should not be apparent. Ask yourself whether the store looks good, has a good ambience, appears fresh and clean, has well-maintained restrooms and break areas and is generally spick and span.

You must also ensure that you are happy with the general location of the business, the surrounding stores, the type of people who frequent the area, the accessibility and especially beware of any pending major road construction in the area as this often has a significant bearing.

2. The Financials.

As a minimum, you will need to review the profit and loss statements, the balance sheets and tax returns. You would do well to employ the services of an accountant who is experienced in the liquor business to help you here. Look at all the supplier invoices and reconcile them to revenues. This may be a time intensive process but you will be able to determine your margins this way. Be very aware of any transactions that involve cash, especially if it involves your suppliers. You will need to get written confirmation from the suppliers of their ongoing terms.

Remember some of these industry benchmarks:

• gross margin should be between 24 and 28%.

• rent should be 7% of revenue maximum.

• product mix should be up to 70% liquor or up to 40% wine.

• labor should represent 5 to 7% of revenue.

• net profit should be 8 to 12% of revenue.

• inventory should be turned over between eight and 10 times per year.

3. The Equipment.

All equipment and furnishings should be in adequate working order and not in immediate need of repair or replacement. As such you should review all the maintenance and service records and look for yourself to see if all refrigeration cases are clean and well-maintained and all other equipment is well looked after.

4. Vendor Agreements.

Your wholesalers and suppliers are absolutely essential when you purchase liquor store business assets and you must get to know them well during your due diligence. Can arrangements be transferred to you or will you have to make new ones? You do not have to be prepared to settle with the existing suppliers or vendors and you should really investigate as many options or opportunities as you can. You may, for example, see better terms elsewhere and this knowledge will be great ammunition when you come to negotiations and peace of mind.

5. Lease Contracts.

Always be sure the lease is transferable or that there are no obstacles ahead of you. You must be able to assume or acquire a long-term lease before proceeding.

6. Operations.

It is likely that you will need a number of licenses and this should be a particular area of concern when it comes to a liquor license. Sometimes these may not be assigned or transferred or other onerous terms may be set by jurisdictions.

Go through the daily procedures from opening time to closing time; who has access to keys and alarm settings? Does the business have a procedure for emergencies of any kind? Ask the seller to provide you with an optimal inventory level. Ensure that you review all insurance certificates and be adequately covered for all eventualities. You will need to talk with credit card processors and merchant banks and be prepared to move to access better rates if necessary.

7. The Employees.

As this can be a significant cost and liability area, be focused here. Check each member’s compensation, especially if there’s any possibility of cash being paid “under the table.” If you see that there is a high turnover of employees, ask yourself why. Is there a procedure in place for training? While the seller will often be wary about letting his employees know that the sale is in process, you nevertheless need to analyze each employee individually, assess their loyalty and competence and adjust your plans accordingly. Understand that certain procedures may be quite traditional to them and you should ask yourself how you feel they will react if you need to make significant changes. If one or more employees are absolutely critical to your success, you will need to meet with them prior to consummating a contract.

When you find a liquor store for sale, if you conduct your due diligence correctly you will have the opportunity to see exactly how the business ticks, and you won’t be in for any surprises when you take over.

Richard Parker is the President and founder of the Diomo Corporation - The Business Buyer Resource Center. His inspiring materials, seminars and consulting have assisted thousands of business buyers with achieving their life long dream to buy a business.

The restaurant business can be very volatile and this will often be reflected in the number of restaurants for sale at any one time. As the rate restaurants close their doors permanently can be so overwhelming, you should really find out the reasons for the sale, and then make up your mind whether you think you’ll be more successful than the previous owner.

One of the first points that you should think about when going over the documentation is the lease terms. Location is all-important when it comes to a restaurant, and most of the time its proximity to a large number of potential and repeat clients can make or break its chances of success. In this day and age landlords are searching for security, and in most instances they’ll question the credibility of a potential new owner intensively. Communication with the landlord should happen early on in your due diligence process, to make sure that there are alternatives available in case something unforeseen arises.

Placing a value on a restaurant can be quite a challenge. Basically, there are two methods that can be used: cash flow multiple or asset-based. If the business you’re thinking about purchasing has been inactive, or you’re just buying the equipment, then it’s quite reasonable to utilize the asset-based method where you just set a value to the assets, and then that’s the figure you pay. If, however, the business is ongoing you can get a good idea of its value by calculating a multiple of the owners benefit. Ordinarily, the benefit can be calculated by adding any owner salary or other benefits to depreciation and interest expenses, combined with the business net income. Self-service restaurants can specify two times the owner benefit for consideration, while full service restaurants can specify two to three times this figure.

Bear in mind that the hours of operation of a restaurant have a great impact on the owner benefit. Carefully consider the incredible number of work hours involved, and then compare this to the benefit figures to make up your mind on whether the deal is actually worth your while. Many analysts like to use a fairly general rule of thumb, depending on the number of meals and/or the number of days the restaurant is open for business each week. If the restaurant is open five days a week, specify 70% of gross annual revenue; six days a week: 60%; seven days a week: 50%.

You might find it frustrating trying to value revenues as the industry is well known for not reporting income. Sellers will expect to be paid for the total profit, but often cannot prove it. The devil’s advocate could easily say that if they’ve been taking money “under the table”, and benefiting with their taxes, they shouldn’t have any expectation of reaping the benefits yet again upon completion of the sale. It may be possible to re-create the financial picture, but you should ask yourself whether you’re willing to believe the final outcome of this exercise, whether the process is realistic and whether you want to go through with it, anyway.

The two major costs in a restaurant operation are food and labor. While costs will vary greatly depending on the type of restaurant and whether liquor sales are involved, as a general rule of thumb the combined total of labor, rent and food costs should not exceed 65% of total revenue. Pay close attention to this rule as you do not want to operate in the red.

Many believe the typical breakdown of costs should be as follows:

Food Costs: 30 to 33%

Labor: 20 to 25%

Rent: 6 to 10%

Again, you should not exceed approximately 65% when combining these items.

The exercise of due diligence is important whenever you buy a business and is especially true when you are considering a restaurant. This critical stage can lead to a review of 125 separate items and you should maintain a critical checklist as you proceed.

When reviewing equipment, bring in an expert. A nearby restaurant supply store can provide you with names to choose from and remember that there is a very large market for used equipment so you should be able to replace any faulty products at reasonable cost.

When you are checking out the reputation of a business, turn to public records to see if the business has performed to health department regulations. You should also include a “representations and warranties” section within the purchase agreement, to document that there were no previous health violations resulting in a fine, closure and so on. Health concerns are paramount when it comes to your restaurant’s reputation and there’s no faster way to put yourself on the street than by enduring a public report in the paper that the establishment has serious bug problems or is not complying with regulations.

You should educate yourself well when it comes to buying a restaurant, especially if the business is new to you. Don’t become one of those negative statistics and make sure that you buy well and build a successful restaurant in this highly competitive environment.

Richard Parker is the President and founder of the Diomo Corporation - The Business Buyer Resource Center. His inspiring materials, seminars and consulting have assisted thousands of business buyers with achieving their life long dream of buying a business.