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For accountants, restaurants are a dynamic sector with brand recognition that adds context to journal entries, trial balances, and spreadsheets. Despite seeming simple, the industry has unique challenges and risks requiring careful navigation to avoid financial problems. This article follows our March 2024 article, Read the Reviews Before Purchasing the Meal, which covered the Quality of Earnings process. In this article, we will focus on issues in financial due diligence in the restaurant sector.
10 Buy- & Sell-Side Considerations
The following considerations apply to buy-side and sell-side transactions. In buy-side due diligence, it’s important to analyze these aspects to manage risk and avoid surprises. While focused on the buy-side, these points can be adapted for the sell-side by addressing potential buy-side questions promptly and providing necessary documentation for review.
1. Treatment Of Gift Card Sales & Corresponding Deferred Revenue Obligations
Franchisees may use different methods to account for revenue from gift card sales. Accurately determining the amount of deferred revenue outstanding during a change in control is essential for setting a precise net working capital target and assessing any impact on the profit and loss statement due to accounting practices.
2. Revenue Recognition For Food Delivery Services
With the rise of food delivery services like Uber Eats and Grubhub, new processes may introduce errors in transaction recording. The potential for risk and error correlates with the volume of food delivery sales. Understanding how these transactions are processed is essential to evaluating the impact of any error on a target’s P&L.
3. Benefits Of Benchmarking
The restaurant industry provides extensive benchmarking information to compare a target against its peers. Important metrics include store-level unit economics, prime costs, direct labor costs, general and administrative spending, and growth metrics. Additionally, understanding macro trends affecting labor and food costs is crucial for contextual analysis of units in different geographic locations.
4. Store Level Analysis
Analyzing the performance of individual units is essential. While overall trends can be reviewed at a consolidated level, identifying risks from underperforming units requires detailed unit-level ledger analysis. Using analytical tools like Alteryx, PowerBI, and Power Query simplifies this process.
5. Lease Accounting
The implementation of Accounting Standards Codification 842 – Leases has greatly affected the restaurant industry. This standard mandates recording a right-of-use lease asset and a corresponding lease liability for operating leases. It’s important to understand rent on a cash basis and its impact on earnings quality, as well as any short-term lease asset and liability balances, which are typically removed to view net working capital accurately.
6. Lease Agreements
Lease agreements require careful review during due diligence. Understanding future rental escalations and sublease agreements is vital for a smooth transition. Relocating units can complicate historical rent reconciliation. AI tools such as Microsoft Copilot can help quickly identify key lease terms in lengthy agreements. Always verify the accuracy of AI-generated information.
7. Intercompany Transactions
Analyzing unit-level financials requires scrutiny of intercompany transactions. Significant cash transfers between related entities can obscure financial statements, necessitating a detailed review to reconcile payables and receivables. The risk is that an expense might be incorrectly recorded on the balance sheet instead of impacting the earnings.
8. Capital Expenditures & Deferred Maintenance
Assessing historical capital expenditures at the unit level is key to identifying immediate or future needs. Financial analysis and site visits are necessary to understand each location’s condition and avoid unexpected expenses post-acquisition. If units need significant CapEx, it can often be negotiated via a purchase price reduction. Additionally, review capitalized amounts on the balance sheet for potential repairs and maintenance expenses to accurately reflect their impact on earnings.
9. Shared Services & General & Administrative Expenses
Acquisitions of parts of a business require careful review of general and administrative expenses to ensure all overhead costs are accounted for. It’s important to consider the future G&A structure under new ownership to avoid surprises after control changes. Comparing unit economics to similar brands helps understand relative G&A structures and prevents post-transaction issues.
10. Related Party Transactions
Related party transactions can influence operations, particularly in multi-unit, multi-brand settings. Understanding the nature and purpose of any transactions with related parties ensures the P&L includes all necessary expenses, such as rent expense when the property is owned by a related party, Propco. Unit-level ledger analysis can help identify any potential related party transactions beyond inquiry alone.
Seek Additional Assistance
Addressing these considerations can reduce acquisition risks and streamline the transaction process. For questions about acquiring a restaurant or group, reach out to a member of the GBQ Restaurant Services team for assistance and additional insight.
By Kyle McKee, Director of Transaction and Business Advisory Services
Seeking additional transaction advisory insight? Check out these resources:
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