7 Critical Factors to Maximize Brand Value
Restaurant businesses can be valued between zero times and 100 times their annual EBITDA. When potential investors or buyers perform due diligence they zoom in on the factors below. Every year, hundreds of deals are made in the restaurant industry, and these factors are what will drive shareholder value.
Use these concepts as cornerstones for your company's strategic planning process. Set guidelines that will define your path. When considering a new opportunity, you will either check all the boxes or move on to the next one. Saying "no" to a project that only gets through 60% of the stress test will add value to your business. Directing your resources and time only towards the opportunities that add maximum value is a key element of success.
1. HIGH CASH ON CASH RETURN
Buyers will look at total cash invested (hard cost and soft cost) and how quickly it is returned. If your cash-on-cash return exceeds 33%, meaning that it would take less than three years for capital to be paid back, your business will command a high multiple.
An example: If the total investment in one unit is $300,000 and your annual free cash flow is $100,000, then your cash on cash return is 33%.
Hard cost + soft cost (including pre-opening expenses) = total cash invested (including debt).
Operating yearly profit - yearly capex = yearly free cash flow.
Free cash flow / total cash invested = cash on cash return %.
2. PROOF OF CONCEPT
The market wants to know that the business model has been successful in multiple locations. The more successful locations, the stronger the concept. More than five states and multiple applications will increase the multiple.
- Has the concept been successful in multiple states?
- Has the concept been successful in multiple settings, such as urban, suburban, transportation hubs, hotels/resorts, entertainment venues, etc.?
3. GROWTH POTENTIAL
When looking at growth, the buyer will be looking at the pipeline of newly secured locations, as well as the "white space".
Pipeline: The acquirer will be looking at the quality of the leases, a realistic development plan, and projections that reflect existing stores.
White space: This is an evaluation of how much the brand can grow considering how crowded the segment is with competition. If you are competing in the fast food hamburger space, there isn't a lot of "white space".
This would also include how easy it would be to replicate the same business model. The cupcake and frozen yogurt industries were highly prized for a short period, but the price of entry and ease of growth made many brands worthless, as competition increased quickly.
4. REAL ESTATE
A potential buyer will evaluate the real estate assets based upon the term left on each lease, as well as the value of the lease compared to the market. National real estate brokerage firms will typically assist in evaluating the leases against a market specific competitive set.
Term: The term left on the lease, including the options, will be very critical in the multiple. For example, in order to validate a multiple of 8 or 10, the average term left on the leases should be higher than 10 years. "Core" leading stores that generate significant cash-flow will certainly be an important focus. If 5 stores out of 20 generate 60% of the company's cash flow, the term of these leases is going to play a significant role in the valuation of the business.
Market: Each lease will be evaluated against market rent. The variance between current rent and market rent, multiplied by the years left on the lease, will determine the value of the lease. For example, if market rent is $20 higher per foot than current rent, and there are 10 years left on the lease, and the property is 10,000 square feet, then the lease would be considered having a value added of $2,000,000. If market rent is lower by $10 per foot, the same property would have a negative value of $1,000,000.
The real estate portfolio will play a significant role in the validation and valuation of the business.
5. EFFECTIVE MANAGEMENT TEAM
While potential buyers will value the management team differently from one another, a strong team with a successful track record will play an important role in the valuation of the company.
A pure financial buyer will value a team who can keep the business running and can execute the contemplated growth plan. Businesses that depend upon one particular person, chef, or restaurateur, may be deemed less valuable, because of the risk of losing that key person.
A strategic buyer may plan on acquiring the business and creating economy of scale by eliminating senior positions, then merging companies together. In this case, the strategic buyer will focus upon store level talent and operational middle management. Showing low turnover and retention will be key to keeping the valuation high.
6. SAME STORE PERFORMANCE
The market will analyze year over year store performances that are a year or older. Sales and bottom line results of same stores will be one of the most important factors in valuing a business. These are a reflection of brand loyalty, competitive landscape, and operational performance.
When Chipotle experienced health safety issues and traffic to their stores softened, the valuation of the business took a significant hit, based on lower same store sales performance. As soon as same store performance showed improvement, Chipotle's market cap steadily grew back.
7. BRAND LOYALTY
Buyers will evaluate “raving fans” and in some cases “cult following”. Database, repeat customers, digital presence, and demographics will be analyzed to evaluate how strong the brand is and how likely it is for the brand to continue to perform at that level. Who is your customer? How well-known is your brand? Is your brand memorable?
When Shake Shack went public, it was valued at over 100 times EBITDA. The brand awareness and reputation played a significant role in Wall Street’s valuation of the company. The association of Shake Shack's founder and acclaimed restauranteur, Danny Meyer, brought a new level of recognition for the Brand.