How Much Would Buying a Local Restaurant Cost?

If you are thinking about buying a restaurant and wondering what it might cost, there are several methods you can use to arrive at a realistic ballpark price. While there are many variables to account for, the two simple calculations described here will get you off to a good start. Here is what you need to know.

What Restaurants Sell For

How much it might cost to buy an existing restaurant depends on a wide range of factors. What type of restaurant is it (fancy sit-down vs. casual pizza place, for example)? What furnishings and equipment are included? Does the restaurant own its property or rent it? And, as with any other kind of business or real estate, where is it located? The famous real estate saying "location, location, location" may be particularly apt for the restaurant business. Other variables might include the eagerness of the owner to sell or the state of the overall economy at the time.

Investopedia's recent perusal of business broker websites across the U.S. found restaurants available for well under $100,000, well over $1 million, and at every price point in between. 

Sales Prices Based on Gross Income

As a general rule, restaurant owners and investors often aim to sell a restaurant for 25% to 40% of its yearly sales or gross income. For example, if a restaurant has sales of $1 million a year the owner might set a price of $250,000 to $400,000. It's important to remember that sales and profits are two very different things—and in the case of restaurants, where operating expenses are high and profit margins thin, they will be very different numbers.

According to the National Restaurant Association, food and labor costs each consume about 33% of every dollar in sales for the typical independent restaurant. So there goes 66% right there. Other costs, including rent and utilities, add up to another 29%, the association says, bringing the total to 95%. That leaves 5% in potential pre-tax profit. In other words, a restaurant with $1 million in sales might reward its owner with a profit of $50,000, which would then be subject to taxes.

Sales Prices Based on Discretionary Earnings

Multiplying a restaurant's annual sales by 25% to 40%, as mentioned above, is just one way that a restaurant owner might set their sales price. Another way to calculate a reasonable selling price for a restaurant is by using what's known as seller's discretionary earnings (SDE).

SDE represents a business' net income—its remaining income after costs are deducted—plus the owner's salary and certain other expenses, such as depreciation, amortization, and interest expense.

If you know the SDE of a business, you can multiply it by a generally accepted multiple for that industry to get a ballpark estimate of what it is worth. Different types of businesses will have different multiples—a restaurant vs. a hardware store, for example.

SDE multiples for restaurants are generally between 1.5 and 3.0. Restaurants are often on the lower end of the multiples scale because the restaurant industry is relatively volatile (many go under within four to five years), and restaurants often have a lot of risk associated with them. The more assets, overall industry growth, and transfer viability (likelihood of successful transfer from one owner to another) a business has, the higher its multiple. Fewer assets, industry stagnation, volatility, and high owner risk can mean a lower sales multiple.

Based on a relatively common industry multiplier of 1.96, a restaurant with an SDE of $100,000 would be expected to sell for about $196,000.

Comparing and Combining the Two Pricing Methods

While a selling price calculated using the SDE multiplier method might be the same or relatively close to one based on multiplying the restaurant's sales income by an appropriate percentage, such as 40%, the two figures can also vary widely.

By calculating both and then comparing them, you can get a reasonable range for what a restaurant should cost.

Let's say you are interested in buying a small sit-down restaurant in your area called Sal's Steaks. The sales listing for Sal's Steaks gives you its annual revenue and SDE. Here are the numbers: 

• Gross sales = $624,000
• SDE = $150,000

With these numbers you can calculate an approximate price/value for Sal's, using the previously mentioned industry multiples:

• Sales Multiple Cost Estimate: $624,000 x 0.40 = $249,600
• SDE Multiple Cost Estimate: $150,000 x 1.96 = $294,000

Generally, the true value of the business—and a reasonable selling price—will fall somewhere in between the two estimates.

Of course, these are just estimates based on industry averages. If Sal's has a killer location or owns its building, the price will be higher. If there are lots of liabilities associated with the business, such as old equipment that needs replacing or a lease that is just about up, then the cost might be lower. Franchises almost always have a higher multiplier, because they are generally more likely to succeed due to the help and guidance provided by the parent corporation—although that is by no means guaranteed.

The Bottom Line

The restaurant business is characterized by thin profit margins. For that reason, it's especially important not to overpay when buying a restaurant. Remember, too, that the owner's asking price is not the final word, and it's worth trying to negotiate to make the deal more favorable to you.