business valuation (Cafe)

[RichardinDorset]

Just interested to see what the general consensus is for valuing a cafe business.

On the assumption that it operates from a leasehold property and has fixed assets of say 10k. Turnover is 100k. Zero net profit with an owners salary of 10k, so in reality only just breaking even.

As a rule of thumb this would be worth maybe 30-40k?

'Goodwill' can't be worth that much if it's not translating to profit?

'Potential' can't really be valued either unless there is a real case (supported by evidence) for some form of easy expansion or refurb which could be guaranteed to increase profits over a short time-span.

Any thoughts?

 

[Deleted member 138423]

You're saying that the cafe t/o is £100k, the owner takes £10k and the rest goes to running the cafe?! That imo is a very poor business!!

I think I would not be alone in that thought so asking someone to buy it and make £10k per year would prolly be a very tough thing to achieve.

 

[RichardinDorset]

Well that seems to be what running a cafe is like these days!

Rents are very high, overheads keep going up, people have less to spend.

There are a number for sale which are either making losses or very small profits, but at the same time are asking for 30,40,50k...

I don't really see where they are getting these valuations from for businesses that are really liabilities!

I'd always thought that 3 to 4 times net profit was a reasonable value for a business plus fixed assets. If the owner runs the place and takes a salary you could take a view that that counts as part of the profit or that it's a normal running cost.

I'm looking at investment opportunities so, If I could buy a cafe business that cost me 50k and I could make 10k per annum profit, after all staff costs (I am making the assumption it would be fully staffed and managed), then it's a brilliant investment. If I had to work there 7 days a week, 10 hours a day for 10k a year then clearly it's a no go.

From what I can see such business do not exist. Anything that makes any kind of reasonable profit will be many hundreds of thousands and a break even business are priced at 30 to 50k based on 'goodwill' and 'potential' value of a business that is treading water or making a small loss.

 

[Mitchells Bristol]

From what I can see such business do not exist. Anything that makes any kind of reasonable profit will be many hundreds of thousands and a break even business are priced at 30 to 50k based on 'goodwill' and 'potential' value of a business that is treading water or making a small loss.

Hello there

You have probably answered your own question really - if someone has a business that makes £50k profit without them having to put in any work, then inevitably it will cost hundreds of thousands to buy such a business. By the same token, if you already had such a business, would you want to sell it? If so, you certainly wouldn't sell it for £50k.

Realistically, if you have £50,000 to invest in a ready-made business, then you should probably expect a profit/return of £10k-£15k per year depending upon the industry you enter into.

Ultimately, a cafe business will be worth what someone is willing to pay for it, and from the description you have provided the cafe is probably worth not much more than the value of the fixtures.

 

[Rohit]

Perhaps cash transactions are not reported fully to evade tax??? For example income tax on self assessment if sole trader and corporation tax if limited company.

I would be least suprised if their actual turnover turns out to be a lot higher than what they have reported on the SA or CT600. Lots of take aways, corner shops, car washes are the same.

From a valuations point on view, I would do some market research. May be spend some time outside the premises monitoring customer flows etc which perhaps may provide some insight on its true worth.

Also looking at the accounts in detail may uncover inconsistencies, errors etc for example overvaluation of stock which could increase margin. Compare the net profitability of this business to other businesses. It is easy to jump to conclusions but it is quite possible that the current owner does not have a handle on costs.

 

[ArcSine]

Rohit makes a good point which much be addressed first. You have to assess the source of your information about the cafe's current performance, and then get inside the numbers for a thorough breakdown of the cafe's cash flows and economics. There may be a significant gulf between the current owner's accounting numbers and the numbers that really matter in terms of pricing the biz.

Not just to parrot Rohit here, but the second (related) point bears repeating as well: In the exercise of deriving the numbers that matter, you might identify certain improvements you could bring to the equation, post-purchase. If so, then of course it's those "as if" numbers that count in terms of deriving an appropriate investment value, from your perspective.

All that said, though, Richard, if what you've described is indeed the case (10K net before owner's comp; bearish outlook on "potential"), then the cafe is generally worth its liquidation value, no more (as Taxonomy has suggested). Working full time + ownership headaches, in exchange for 10K, = loss, economically. 40K into high-grade corporate bonds, + a full time job would give you a superior return, in terms of both magnitude and risk.

One notable exception would be the situation wherein you're aware of some larger outfit (a chain, maybe) for which the cafe might be a valuable asset in its portfolio of operations. It happens; the combination of location and the chain's marketing and management resources might have potential.

Somewhere in my dusty archives I have a study that was undertaken some years ago by a couple of economists, concerning the paradox of small restaurants. They have a failure rate that's high vis-a-vis other types of businesses, and yet the successful ones on average only return an average rate of return. The study tackled the puzzler of why small restaurant ownership continues to be a popular objective of many, given the unattractive economics. They concluded that with restaurants, there's more of a psychological element going on, more so than with other types of businesses. People just love the idea of owning their own restaurant.

All that rambling was just to address the question you raised about what you're seeing out there: lots of cafes and small restaurants just breaking even, yet selling owners hanging 30-40K price tags on 'em. While the pure numbers don't support those valuations, I guess when you bring that psychological angle into the scene, it starts making a little more sense. Regardless of the hard numbers, there'll always be somebody along soon, hooked on the notion of running his own cafe, willing to plop down the 40K to buy the dream.

But again, it really comes down to what you could do with the biz, rather than what the current proprietor is doing.

 

[RichardinDorset]

Yes you are all confirming what I have found to be the case.

I agree that a business making 50k profit is going to cost 200k or more.

What I am looking at is a business that returns 10k, essentially runs itself with my input at a top level (not slaving over a hot stove) for a cost of approx 50k.

I also know about the 'cash from the till' benefits that most cafe owners enjoy and of course any valuation can only be based on the figures in the accounts and those need independent vetting too.

Sellers going on about 'potential' and 'well we always help ourselves when we cash up' are wasting their breath when it comes to getting money for their business.

I have other investments and I am looking at this as another string to my bow, but as mentioned above, it has a strong psychological attraction over other investment vehicles. I don't quite understand why this is, but it is very common to 'dream' of owning a cafe rather that a company operating out of an industrial unit making widgets. There is a lot of irrational romance associated with cafe businesses which is usually ground out of the new owner after the first six months when they realise how many bacon butties they need to sell to cover the rent, let alone pay themselves more than £6 an hour!

I have found it very interesting just visiting some of these businesses and looking at how they run are run, especially in a very competitive area.

I am not looking to gamble my entire life savings, more to find something I can get involved in, hopefully without it becoming a massive chore or money pit, that will return better than 5% PA and I'm willing to take some risk.

By the way, I have done the industrial unit making widgets and it was very profitable eventually!

 

[ArcSine]

Yeah, a market (such as the one for swapping ownership of cafes and restaurants) in which the buyers tend to be smitten with that "irrational romance" is a market characterized by overpricing, on average. Nice market if you're on the supply side, not so great on the demand side.

I kinda think there's also a bit of "familiarity breeds overconfidence" at play, as well. Nobody walks into a law firm, looks around, and says, "I could run one of these." Primarily because your Average Joe (a) isn't inside a law firm very often (hence a certain 'mysterious' factor); and (b) understands that there's a certain demanding expertise required. For the same reasons, nobody strolls into a plant that manufactures electronic components and says, "I could do this."

But restaurants are a different story. Most people have been in restaurants and cafes hundreds of times, nearly daily for some. They interact with the personnel and chat with the owners across the counter like old friends. Out of that familiarity arises a confident sense of "I've always wanted to be self-employed, and THIS biz is one I could run, starting this afternoon."

So I think that in at least some cases the dream originally isn't necessarily for a restaurant per se, but more broadly for that of owning one's own business. But then when one starts trimming the list down to realistic possibilities, "restaurant" always survives the cut and makes it onto the short list.

Interestingly, though, the high failure rate suggests that maybe the level of required expertise is much higher than most people think .

By the way, I have done the industrial unit making widgets and it was very profitable eventually!

I'll take low-glamour and high-ROI every day of the week.

 

[RichardinDorset]

Yes you're right there ArcSine, one does find one's self thinking 'I could do this better' and 'all they need to do here is...' when sitting in a cafe...

Maybe it is down to familiarity and a perception that the business process is simply serving punters with tea and coffee and not being aware of what's going on behind the scenes: staff issues, delivery issues, health and safety, hygiene, customer issues etc etc. Things that usually accompany most businesses...

Anyway I'll keep on looking at what pops up on Daltons just in case the perfect business comes along!

 

[David Griffiths]

Perhaps cash transactions are not reported fully to evade tax??? For example income tax on self assessment if sole trader and corporation tax if limited company.

I would be least suprised if their actual turnover turns out to be a lot higher than what they have reported on the SA or CT600. Lots of take aways, corner shops, car washes are the same..

And if they claim this, what reliance are you going to place on the word of somebody who is admitting that they have lied to the taxman? My experience suggests that they'll be quite as happy to lie to potential buyers as well.

 

[internetspaceships]

It's worth nothing.

Move along and find something else. The owner is working long hours for less than minimum wage. If, buts, and maybes, count for nothing in business.

 

[Tom McClelland]

At £10k profit/year for the owner you're not buying a business; you're buying a job, and a job with long hours, no holidays, and minimum wage at that. You'll never find a manager who can bring in that £10kpa for the owner without the owner being constantly hands-on.

Unreported income is worthless, and on the contrary, be careful that the figures aren't being bumped up to make the prospect more attractive.

 

[RichardinDorset]

It's worth nothing.

Move along and find something else. The owner is working long hours for less than minimum wage. If, buts, and maybes, count for nothing in business.

Indeed my thoughts exactly, but I was curious about the valuations of break even businesses that the owners put on them.


In rare cases, it might be possible to find a business that obviously isn't reaching it's full potential, but most of the businesses I've looked at are struggling to keep going and are, therefore, liabilities and worth, at best, the value of the fixed assets.

 

[Philip Hoyle]

Unreported income is worthless, and on the contrary, be careful that the figures aren't being bumped up to make the prospect more attractive.

I'd second this.

I've dealt with more clients who've found out that the prior owner's turnover was falsely over-inflated than clients who've found out the turnover was under-stated.

In fact, it's quite common for the seller to "nudge and wink" that the turnover per the accounts is lower than reality with vague references to cash sales, back pocket money, etc - almost always never the case - just trying to make things look better than they are.

In one particular case, of a shop owner who was well over state pension age, actually put his state pension through the till to inflate the takings, even though he ended up paying VAT and income tax on it - he was so desperate to make the figures look better so that someone would buy his shop.

I've also found it common with small guest houses - time and time again, there's the suggestion that turnover is really above the VAT threshold but that some cash takings are pocket-ed to stay under the limit - again, time and time again, when the new owners move in, it's absolutely clear that the real turnover is no-where near the VAT threshold, let alone above it!

 

[RichardinDorset]

Agreed, for valuation purposes, if it ain't in the books, it don't exist...