Who do you call?
Professional business valuators and lawyers. You need to know how to properly assess the value of the company and handle any related legal issues.
What they say
When you’re valuing a company, you’re either basing it on the net asset value of the company (assets less liabilities) or cash flows. In the case of a restaurant, one of the biggest assets is typically lease-hold improvements, including flooring, décor, fixtures and chairs.
Generally, restaurants are valued around three times normalized cash flow, and then you take into consideration any outstanding debt. If the restaurant is part of a franchise, the franchisor will dictate the trading value of that particular restaurant based on its agreement with the franchisee. For cash flow, look at the income of the restaurant and adjust some of those non-cash expenses, like depreciation and amortization.
managing director, national industry programs, BMO, Toronto
Then, subtract any interest that might be paid and normalize the income statement for any excess remuneration that could be going to the owners. A typical multiple for a mom-and-pop restaurant is three to four times the initial investment, or three to four times cash flow, but franchises trade more like five times. If a buyer purchased it for $500,000, he or she is assuming it would generate at least an operating pre-tax cash flow of 15% to 20% annually.
The Canadian Institute of Chartered Business Valuators recommends using a five-year average cash flow. (If it’s a newer restaurant, a five-year average is not a good measure because you’re taking into account leaner start-up years.) You want to make sure you’re measuring different years and different economic cycles.
While some lawyers may tell you to get two valuations to compare, you don’t need more than one valuation—and they can cost between $5,000 and $15,000. If you’re in a situation where things are contentious, the party that’s keeping the asset would want a low value, and the party that’s departing would want a high value. If that’s the case, each party could pay for a valuation separately. You may also want a third party to mediate. But restaurants tend not to be that expensive, so you have to manage fees.
If you can’t agree on a value, you can agree to sell the asset and share in the proceeds. All liabilities will have to be paid off before any funds are disbursed from the corporation and the only thing that will be disbursed to the owners is the net proceeds. If it’s a losing business, then it might not have any value and, chances are, both parties would be happy to leave the business. But if they can’t sell, it’s no longer valued on its cash flow; the only value would be the net asset value, which in a restaurant business consists of lease-hold improvements.
You want to see food making up no more than one-third of your operating cost. Also, take into account other things, such as location. Are you in a good area? Is the economy around you growing? Can you benefit from the businesses around you? What’s the remaining life on the lease and what are your options on that lease? The lease may come up for renewal and the owner can be hit with a 40% to 50% increase that could shut down the business. If the rents are below market, that’s not a bad thing if you still have a lot of life left on the lease.
If the restaurant is a franchise, you need to know the network’s reputation. Is it ascending or descending? How are the other franchises in the network, and what’s the relationship between the franchise and franchisee?
What’s excluded From Family Property In B.C.?
- Property acquired by a spouse before the relationship began
- Inheritances to a spouse
- A settlement or an award of damages to a spouse as compensation for injury or loss, unless the settlement or award represents compensation for loss to both spouses, or lost income of a spouse
- Money paid or payable under an insurance policy, other than a policy respecting property, except any portion that represents compensation for loss to both spouses, or lost income of a spouse
- Property held in trust for the benefit of a spouse
- A spouse’s interest in property held in a discretionary trust
- Property derived from property or the disposition of property
Source: B.C. Family Law Act
It’s not only financial equity that’s important, but also sweat equity—the effort each owner has put in to the business and goodwill. Sweat equity can be difficult to measure, and people who put in financial equity tend to feel they deserve more. Ideally, outline from the start how you plan to document your contributions.
Some people track their hours and calculate it based on an average salary amount, but this would be difficult to do after 12 years. Plus, most small business owners work almost 24/7 on their businesses.
When determining the split, Dave and Sandra should consider, on average, how much time they put into the restaurant in a typical month or year, factoring in both operational and back-end work. For instance, Dave may have been at the restaurant each day, but Sandra might have done all the accounting and marketing.
First, see if the business falls within what’s defined as family asset, pursuant to the rules in B.C.’s Family Law Act.
If it’s a business that started during the marriage, and is the source of one or both spouse’s income in the marriage, it’s considered a family asset. If one spouse is the sole proprietor and the other helped in bookkeeping, for instance, the income derived from the company is a family asset. So, the property owned at the date of separation is a family asset unless it’s excluded property (see “What’s excluded?,” above). Since the business is family property, the increase of the value of the business is shareable. The presumption is 50/50, but the other party can plead unequal division. If the process involves a buyout, the person looking to be bought out could be compensated by other family assets. He or she could be paid by transferring a house, which would require its own valuation, or through partial rollover of an RRSP. Once a valuation is performed, the lawyers will sit down with the clients and discuss any disputes arising from the valuation. Retain joint experts who will work with each party toward a resolution. Parties in a family law matter can resolve … matters using processes such as mediation, mediation-arbitration, arbitration, the collaborative law process and litigation.
Originally published in Advisor's Edge