Valuation Multiples for a Restaurant

In the dynamic world of food service investments, understanding restaurant valuation multiples is crucial for both buyers and sellers. This comprehensive guide delves into the intricacies of restaurant valuations, providing insights into current trends, methodologies, and factors influencing these crucial metrics.

Introduction to Restaurant Valuation Multiples

Restaurant valuation multiples are essential tools used by investors, business owners, and financial analysts to determine the worth of a restaurant business. These multiples serve as benchmarks, allowing for comparisons between different restaurants and helping to establish fair market values.

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As the foodservice sector continues to evolve, particularly with the rise of Private Equity activity, restaurant valuation multiples have been on an upward trajectory. Even in periods when deal volumes drop, valuations for high-quality restaurant investments have reached impressive heights, notably in 2019 and again in 2023.

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The Importance of Restaurant Valuations

Whether you're looking to enter or exit the restaurant business, a clear understanding of valuation principles is indispensable. For buyers, it aids in mastering negotiation tactics and determining a just purchase price. Sellers benefit from valuations by finding an equitable listing price and learning strategies to enhance their restaurant's value.

Current State of Restaurant Valuations (2023)

The global M&A landscape experienced a cooling period in 2022 and the first half of 2023. Factors such as inflation, rising interest rates, and banking sector instability eroded investor confidence. Across various segments, the number of deals declined by more than 15% globally since 2021, with the most significant drop observed in the Asia-Pacific region and substantial reductions in EMEA and the Americas.

Interestingly, during the pandemic, valuation ratios were maintained at artificially high levels. In 2022, they began to return to pre-pandemic levels. However, valuations for public companies in the U.S. have shown an upward trend in the first half of 2023.

It's crucial to note that valuation ratios are not the sole determining factor in restaurant chain acquisitions. The concept of Normalized EBITDA was significantly impacted by the pandemic, affecting enterprise value as much as the valuation ratio itself. Moreover, post-pandemic trends influencing sales and costs, which in turn affect margins, have a different dynamic that requires thorough due diligence to mitigate risks inherent in valuation model assumptions.

Factors Influencing Restaurant Valuation Multiples

Several key factors contribute to the determination of restaurant valuation multiples:

1. Perceived Growth: Companies with high growth potential often command higher multiples.
2. Risk and Uncertainties: Lower risk profiles generally lead to higher valuations.
3. Investors' Willingness to Pay: Market conditions and investor sentiment play a significant role.
4. Company Size: Larger companies tend to receive higher valuations.
5. Public vs. Private Status: Publicly traded companies often enjoy a premium over private entities.
6. Restaurant Category: Quick service restaurants (QSRs) typically receive higher multiples compared to fast-casual and casual dining establishments.
7. Franchisor vs. Franchisee Status: Franchisors generally command higher multiples than franchisees.
8. Technology Integration: Food delivery and tech-focused companies often receive higher valuations than traditional restaurant chains.

Types of Restaurant Valuation Multiples

1. SDE (Seller's Discretionary Earnings) Multiples

SDE multiples are particularly relevant for smaller, owner-operated restaurants. They account for the owner's salary and benefits, providing a clearer picture of the business's true earning potential.

Average SDE Multiple Range: 2.14x – 2.96x

For example, a restaurant with $376,000 in discretionary earnings and a 2.58x multiple would be valued at approximately $970,080.

2. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) Multiples

EBITDA multiples are widely used for larger restaurant chains and provide insights into a restaurant's investment return potential.

Average EBITDA Multiple Range: 2.80x – 3.65x

For instance, a restaurant with $301,000 EBITDA and a 3.21x multiple would be valued around $966,210.

3. Revenue (REV) Multiples

While less commonly used, revenue multiples offer a perspective on a restaurant's total revenue generation capabilities.

Average REV Multiple Range: 0.32x – 0.48x

As an example, a restaurant earning $2,200,000 in revenue and trading at a 0.41x multiple would have an approximate value of $902,000.

Historical Trends in Restaurant Valuation Multiples

Over the past decade, restaurant valuation multiples have shown a significant upward trend:

• From 2009 to 2019, valuations measured in EV/EBITDA multiples increased by 44% for U.S. publicly traded companies.
• In terms of EV/Sales, there was a 40% increase from 2016 to 2019, including both public and private foodservice companies in the U.S.
• QSR and fast-casual restaurant chains have seen the most substantial increases in valuation, while casual dining chains have grown at a more modest pace.

The COVID-19 pandemic caused a temporary shift in the market:

• Global M&A activity quickly shifted from a sellers' market to a buyers' market in just a few weeks, before reverting back.
• In the U.S., restaurant EV/EBITDA ratios dropped by more than 20% in 2020. However, this decline was less severe than the drop seen after the Great Recession.

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Valuation Methodologies for Restaurants

When it comes to valuing a restaurant, three primary methodologies are employed:

1. Cost Approach

This method is less commonly used in the restaurant industry but can be relevant in specific scenarios, such as bankruptcy acquisitions. It considers the replacement cost of building the business from scratch, including:

• Market value of assets (e.g., restaurant locations, warehousing, commissaries)
• Intellectual property and intangible assets (brand value, standard operating procedures)
• Minus any debt

2. Market Approach

The market approach is a relative valuation methodology that derives a restaurant's value by comparing it to similar companies or transactions. It includes two main techniques:

a) Comparable Analysis: This involves comparing the restaurant to similar chains and applying valuation multiples such as EV/EBITDA, EV/Sales, or P/E (price-to-earnings). Public restaurant chains are often used as peers for this analysis.

b) Precedent Transactions: This method compares the restaurant to similar foodservice operations that have been sold recently, considering both public and private companies.

For independent restaurants, it's common to use a percentage of the annual operating income (typically 25–40%). In cases with a single, full-time owner, the operating income is considered the seller's discretionary earnings (SDE), which includes profit after the owner's salary and certain other expenses.

3. Discounted Cash Flow (DCF) Approach

The DCF method involves projecting the unlevered free cash flow of the business and discounting it using a weighted average cost of capital (WACC) rate to obtain the present value. The financial model used for projections should consider various factors, including:

• Openings and closings
• Same-store sales growth projections
• Probable labor cost increases
• Future earnings
• Other top and bottom-line projections

Each valuation model will yield a range of values for the restaurant chain. The expected valuation for the business will likely be agreed upon at the intersection of these results.

Variations in Restaurant Valuation Multiples

Differences Based on Company Size

Among public foodservice companies in the U.S., larger companies (those with more than $1 billion in enterprise value) tend to have higher valuations. The median multiple for large companies is about 13.5x, while core middle-market restaurants have a 38% lower valuation on average.

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Variations by Restaurant Category

For over a decade, quick-service restaurants (QSRs) and fast-casual restaurants have commanded higher multiples than casual dining chains. As of 2019:

• QSR multiples were more than a third higher than the fast-casual median
• QSR multiples were about 60% higher than those for casual dining restaurants

Within the QSR category, there's significant variability:

• Pizza chains (like Domino's) and coffee/snacks restaurants (like Starbucks) tend to have higher valuations than the average fast food chain.
• For example, Domino's had a multiple of 20.0x, while the lowest was 5.8x for the Burger King franchisee Carrols.

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Franchisor vs. Franchisee Valuations

Among publicly traded foodservice companies in the U.S., highly franchised chains are reaching valuations that more than double (as a median) the EV/EBITDA multiple for lightly franchised chains. Many of these heavily franchised businesses operate in international markets via agreements with master franchisees.

This trend suggests a strong case for buying American restaurant chains and becoming the franchisor, rather than operating as a franchisee.

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Technology and Delivery Companies

Food delivery companies and restaurant-tech companies tend to be valued comparatively higher than traditional restaurants. This trend is consistent across markets:

• In the U.S., companies like Grubhub would be in the top-quartile valuation among publicly traded companies.
• In the UK, Just Eat was trading at 3.7 times the average EV/Sales for foodservice companies.

Factors Contributing to High Restaurant Valuations

Top-quartile performers can be valued many times higher than the average market valuation. In the U.S. and Canada, the top-quartile is valued at a 176% higher multiple than the median. Several factors contribute to these high valuations:

1. Alignment with Consumer Demand and Purpose: Companies that align closely with current consumer trends and have a strong sense of purpose often command higher valuations. For example, Sweetgreen's $1.6 billion valuation in 2019 put its enterprise value per unit at about $16.5 million per store — 81% higher than Chipotle and more than three times the value per unit of McDonald's.
2. Brand Story: Valuation multiples are partially generated through a brand's narrative. Shake Shack, for instance, trades at a valuation of 22 times enterprise value to 2019 EBITDA.
3. Public Image: Among U.S. publicly traded restaurants, companies with the best public image are often in the top quartile of valuations. Purpose-driven brands like Chipotle, Shake Shack, and Starbucks, as well as technology leaders like Domino's, benefit from positive public perception and earned media.
4. Consistent Growth: Restaurant companies that demonstrate fast and consistent growth are rewarded with favorable valuations. Growth CAGRs higher than 11% (over a 3-year period) typically result in a median EV/EBITDA multiple almost 5x higher than the median for companies growing below that pace.

Global Perspectives on Restaurant Valuation Multiples

Restaurant valuation multiples vary significantly across different global markets:

• U.S. multiples are 5.5% above the global average.
• India has valuations 21% higher than the U.S., despite only 2% of the world's restaurant & dining public companies being located there.
• Japanese foodservice companies have an EV/EBITDA ratio 30% higher than their market average.
• Chinese foodservice companies have a valuation ratio 35% lower than their market average.

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Middle East Valuations

Valuation multiples for hospitality and related public companies in the MENA region show significant variation:

• Companies like Etiler (Turkey fast food operator) and Saudi Airlines Catering have EV/sales multiples considerably higher than the median.
• DO & CO (Turkey — restaurant, cafes, airports, gastronomy) and Al-Tajamouat (Jordan — catering and other services) are well below the median valuation for their respective markets.

For EV/Sales, valuation multiples in the Middle East are close to four times those of the U.S. when comparing the median.

European Valuations

Among foodservice public companies in major European markets:

• American-based companies (like Yum! Brands, McDonald's, and Domino's Pizza) generally have some of the highest EV/EBITDA multiples.
• Companies like Restaurant Group, Bravo Brio, and Punch Tavern have the lowest valuation ratios.

The Future of Restaurant Valuation Multiples

The average restaurant valuation multiple has slowly increased over the years, with some notable shifts in recent times:

• Valuation ratios for emerging markets went from being the highest in 2013 to the lowest of all regions considered by the end of 2016.
• In the last two years, the rank of EV/EBITDA has remained stable, with U.S. restaurant companies on the high end and emerging markets on the low end of valuations.

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Looking ahead, the future appears favorable for specific segments:

1. Foodservice platforms with high-growth potential
2. Purpose-driven brands investing in both mature and emerging markets
3. Companies that continue to innovate and focus on convenience engineering
4. Businesses that align with consumer trends on multiple fronts

Considerations for Restaurant Valuation

When calculating restaurant valuations, it's crucial to remember that the process is more complex than simply multiplying last year's EBITDA by an average multiple. Key considerations include:

1. Comparability: When using multiples of EBITDA or sales, the comparison needs to be as similar as possible. Finding the right comparables depends on various factors:
   1. Geography
   2. Category
   3. Size
   4. Franchisee vs. franchisor status
   5. Public vs. private company status
   6. Growth rate (fast-growing vs. stagnant)
2. Normalized EBITDA: The key often lies in determining the Normalized EBITDA for the operations. This calculation may reveal hidden value or unaccounted risks if opportunity costs and non-obvious P&L lines are studied closely by an industry expert.
3. Due Diligence: Thorough due diligence is crucial to understand the true financial health of a restaurant. For example, a lower spend on repairs and maintenance in the year before a target comes to market can artificially inflate margins, but the new owner may end up paying for this in the mid-term.

Opportunities in the Restaurant Industry

Despite economic fluctuations, opportunities in the foodservice space persist:

• In a liquidity crisis, M&A opportunities may arise through consolidation and distressed asset investments.
• In a booming economy, emerging brands and markets can reveal new growth acquisition targets.

Currently, 38.6% of global M&A activity across all sectors involves cross-border transactions, indicating significant international opportunities.

For Sellers

Valuations remain high, making it a potentially good time to evaluate an exit strategy. Restaurant owners considering selling should focus on:

1. Optimizing their operations to maximize EBITDA
2. Demonstrating consistent growth
3. Investing in technology and delivery capabilities
4. Building a strong brand story and public image

For Buyers

While valuations are high, it may be worth paying a premium for the right platform, especially in high-growth geographies and segments. Key strategies for buyers include:

1. Developing a creative and modernized investment thesis
2. Conducting thorough due diligence
3. Obtaining custom market landscape insights
4. Focusing on acquisition and expansion strategies that can leapfrog the competition

Conclusion

Understanding restaurant valuation multiples is crucial for anyone involved in the foodservice industry, whether as an investor, owner, or potential buyer. While these multiples provide valuable benchmarks, it's important to remember that each restaurant is unique, and a personalized business valuation is often necessary to determine the most appropriate valuation approach.

As the industry continues to evolve, particularly in the wake of the COVID-19 pandemic and ongoing technological disruption, staying informed about valuation trends and methodologies will be key to making sound business decisions. Whether you're looking to optimize your restaurant's value for a potential sale or seeking the right investment opportunity, a deep understanding of these valuation principles will serve you well in navigating the complex and dynamic world of restaurant finance.

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