Article written by:
Michael Schultz, CPA
Manager, Transaction Advisory Services

When looking to acquire one or a group of restaurants, consideration of an advisor performing a Quality of Earnings (QofE) analysis can be helpful to ensure a fair purchase price and provide a complete understanding of what you are purchasing from a financial standpoint. A QofE analysis normalizes EBITDA (earnings before interest, taxes, depreciation and amortization) for one-time, non-recurring, non-cash and non-operational income and expense items, and is typically performed during the exclusivity window of an executed letter of intent, which is usually between 90 – 120 days. The analysis is derived from at least three years of historical financial information of the restaurants to be acquired with most emphasis placed on the trailing 12-month period. Below are common areas we come across within the restaurant industry in analyzing potential EBITDA adjustments:

  • Common Adjustments: Some examples of common one-time, non-recurring, non-cash and non-operational income/expense items that most restaurants incur include gains/losses on sale of assets, interest income, insurance proceeds, impairment losses, gift card liability breakage, closed store reserves and the non-cash portion of straight-line rent expense among others. It is important to analyze these items individually and adjust EBITDA appropriately to understand the true cash flow impact of each.
  • Owner Expenses and Wages: At times, restaurant owners may incur personal expenses recorded within operating costs and/or pay themselves over/under fair market. EBITDA should be adjusted and normalized for such personal costs and the difference between an owner’s historical salary versus the fair market salary or expected replacement salary to be incurred post-transaction.
  • Run Rate Adjustments: Occasionally, there could be pro-forma adjustments to reflect newly opened, reimaged or closed restaurants on a 12-month basis. Normalizing these periods under each circumstance to best reflect a fully-operational restaurant can be critical in analyzing a restaurant’s financial stability.
  • Repair Costs: It is important to ensure all costs incurred to repair a restaurant’s building and/or equipment are not capitalized and appropriately expensed within EBITDA. Conversely, sometimes for tax purposes, items that should be capitalized are expensed as repair costs, which could understate operational EBITDA.
  • Corporate Office Activity: At times, a corporate or home office that oversees a group of restaurants may, or may not, allocate certain operating expenses down to each operational restaurant. It is important to understand the process, as well as the kinds of operational costs that are included within the home office’s allocation methodology to ensure all costs that should, or should not, be incurred at the restaurant level are reflected in EBITDA historically and going forward after a transaction.

Acquisitions take a lot of time and effort, so ensuring you have an experienced advisor on your team can provide you time to focus on your daily tasks and ensure your current operations are functioning efficiently. A QofE analysis will help ensure that you are prepared to meet your current and future goals post-transaction.

Are you in the process of acquiring a restaurant, or set of restaurant units, and have questions related to the process? Please contact Transaction Advisory Services Manager Mike Schultz, CPA, or Tom Powers, CPA, Director of Assurance Services.

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Tags: M&A, Valuation