Restaurant Acquisitions, Current Concerns
<p>Watching some restaurant franchisee network acquisition efforts underway currently, a number of common issues seem to be emerging. The need to obtain the right price is enormous. Buying more restaurants is as final of a decision as is picking a site, signing a franchise agreement or building a new unit. You have only one chance to get it right.</p>
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<p>All five of the points below have been noted in restaurant acquisition efforts underway currently.</p>
<p><strong>Compose cross checks on the sales and cash flow projections.</strong> Sometimes franchisors do provide market sales and profit guidance to use in your business plan. Don't use their numbers exclusively. After all, they want to sell new units. Come up with a best case and a worst case scenario on your own. A lot of restaurant sales and profit expansion is about geography and driving brand awareness over time and the time to build to profitability and positive free cash flow takes time.</p>
<p><strong>Honeymoon period distortion to sales.</strong> In buying a restaurant enterprise that has new units and units that just opened, be very aware of the “honeymoon and trail off period”. Your challenge is to see beyond the initial sales pop and the next year resulting sales fall off, to determine the base case. There is more restaurant year one to year two sales variability, and honeymoon distortion problem got worse in 2012 and 2013. In thinking about <a href="http://www.investopedia.com/video/play/earnings-before-interest-taxes-d…; target="_blank">EBITDA </a>price multiples, always try to restate the numbers into a current year base projection value, and not use the last year annual value or even a 12 month trailing twelve months number.</p>
<p><strong>Factor in general and administrative costs.</strong> Franchisees do have costs below the store level that must be considered. Interest and repayment of principal, principally. (repayment of principal is not an GAAP expense, but is a cash outflow). Most of the cocktail circuit banter about restaurants is geared to store level EBITDA numbers, so beware accordingly.</p>
<p><strong>Is the enterprise struggling because the debt is too high? </strong> For struggling brands or franchise networks, it is often said that the underlying concept is fine but that the debt is too high. We all know of situations where the debt is too high, but businesses need the capacity to tolerate some debt. One restaurant brand is currently hurdling towards Chapter-11, the debt is too high but the store economics doesn’t work either.</p>
<p><strong>Insufficiency of EBITDA as the main metric.</strong> As I’ve noted many times, EBITDA as the basis for a purchase price multiple is very insufficient. It is true everyone keeps records this way, but it’s up to you to get to the right economic base so you don’t over pay. There are eight separate additional subtractions from store level EBITDA, to get to the right <u>economic profit value</u> to evaluate an investment. Call me and I'll discuss this in greater detail.</p>
