Ask the Small Biz Adviser By Stephen Windhaus • Bankrate.com

Valuing a business you want to buy

Dear Small Biz Adviser
My boyfriend Mike has been in the restaurant business since he was 16. He is now 32 years old, and "owns," with his brother, a successful restaurant. It is open for lunch and dinner and provides corporate lunches.

Mike's brother has three other restaurants under which this particular one was incorporated. The restaurant has been in business for two years and is continually growing, both in clientele and financially.

My boyfriend wants to buy the restaurant from his brother, but I feel as if the brother and his partner are asking too much. When the business was first established, Mike put in $24,000 and his brother and his partner put in $36,000. Mike is not documented as an official owner of this business even though he put in money to start the business.

His brother and partner want $45,000 to buy out their portion. How do you determine the worth of a restaurant when you have already placed money into the business? I would think Mike's brother and partner should be happy to just get back what they invested.

Also, Mike has been told that it will be very difficult to get a loan for a restaurant. What are your thoughts on whether or not he would be able to get a loan, and what type of bank would provide a loan for a restaurant?
Thank you.
Mike's Girlfriend

Dear Mike's Girlfriend:
Let me start with a contradiction in your inquiry. You begin by noting your boyfriend, Mike, is a co-owner in a restaurant with his brother (whom we'll call Tony for ease of reference) and Tony's friend. Then you later note Mike is not "documented" as an owner of the restaurant although he invested $24,000 in the startup of the venture. Can you explain how that occurred?

Furthermore, historically I have been very leery of providing advice to one family member when he or she is involved in a dispute with other family members. Not surprisingly, an entire family group can join together when an outside observer appears to pick one over the other.

However, I am going to go as far as to suggest your boyfriend seek some legal advice regarding his claims to ownership in the business. I hope he retained some form of documents that prove the $24,000 investment. This is crucial to the entire negotiation to buy out the restaurant.

Additionally, I question how serious Tony is about selling since he throws in the discouraging words about the difficulty of getting a loan for a restaurant. This generally is true. Experience and feedback from banker friends have led me to believe food-and-beverage loans are not easy to obtain. I have had bankers tell me the failure rates of restaurants can be as high as 85 percent. However, that does not mean the banker will not consider such a loan application. Despite the generally high risk, 15 percent are successful.

Did Tony bring up this financing hurdle to ensure that Mike is fully aware of what he would be getting into? Or are Tony and his friend simply "going through the motions" to placate your boyfriend's interest in full ownership? The process of attempting to place value on a business, negotiate terms of sale and then seek funding for the buyout can be long and tedious. Before you begin this process, Mike needs to be sure of their intentions.

Now let us consider the process for determining the value of a business. That is the starting point from which to negotiate a sale price. The following is a list of items required to begin the valuation process:

• The income tax returns from the business for the two years it has been operational.
• The profit-and-loss statements and year-end balance sheets for the restaurant since it has been operational.
• A copy of all loans, notes and any other payables for which the company is liable. An evaluation of the value must include a detailed review of these documents to confirm any extraordinary conditions related to the purchase conditions, including interest rates, terms of the loans and notes, and the existence of any balloon payments.
• A detailed list of all fixed, tangible assets to be included in the sale. You must include the original purchase price, date of purchase, depreciation formulas and adjusted values of those assets at present.
• Any other documentation that may further confirm the present dollar value of the business.

If a commercial lender is involved, there may be other documents requested. I also strongly urge your boyfriend to begin preparing a business plan. A commercial loan of this nature will require that document. Likewise, it must be substantive.

After evaluating all these documents, the matter then comes down to deciding how many years of net profit the sellers want in return for selling the business. In simple terms, the sellers want to sell off all liabilities, be compensated for the present value of all fixed assets, and then seek a margin above that total dollar value that reflects net profit for a certain period. Consider the simplified example below:

In this example, the present adjusted value of all fixed, tangible assets is $60,000, and the seller wants to be compensated for $20,000 he estimates the business will produce in the next two years. Assets plus projected profits equals $80,000. Subtract the liabilities the buyer will assume, and the adjusted selling price is $68,000. However, let us also consider the example in which the buyer previously invested $24,000. That should reduce the selling price to $44,000.

Remember this is a simplified example. Other conditions could alter the valuation process of the restaurant. Again, I strongly urge Mike to begin collecting all documentation of his investment and seek legal advice regarding that investment and ownership interest.

I wish both of you the best.

-- Posted:Oct. 9, 2001