If you are purchasing a restaurant, bar or club business you need to have adequate money on hand as indicated below before you move forward with the acquisition. Let’s assume for illustrative purposes you will be purchasing a business for $150,000 which includes an alcohol license.
Purchase Price. In addition to $150,000 cash you will need to purchase the business you will need additional cash per the items indicated below.
Salable Inventory. This includes the food, beverage, papers supplies and cleaning supplies inventory the Buyer purchases from the Seller at the Seller’s cost based on a physical inventory to be taken between Buyer and Seller immediately before the close of escrow. There is usually a not to exceed amount for this inventory which is written in the Asset Purchase Agreement and it is stated that the Buyer will not be obligated to buy any additional inventory above this not to exceed amount. For purposes of this exercise lets assume the salable inventory will be $5,000.
Escrow Fees and Closing Costs. To purchase a business in California you need to use an escrow to assure you get title free and clear of all liens and encumbrances. If the Buyer does not use an escrow he is liable for the Sellers past tax liabilities including State Franchise Taxes (FTB), State Board of Equalization Taxes (SBE), Employment Development Department Taxes (EDD) and County Taxes as well as any Seller vendor debt owed. Escrow fees and closing costs are split 50/50 between Buyer and Seller and they normally run approximately $1,500 per party.
Deposits. You will need the deposits indicated below.
- Premises Lease Deposit. Usually 1 to 2 times the monthly rent is required as a security deposit to make sure the Buyer returns the premises at the end of their lease in the same condition they received it in with normal wear and tear. If the rent is $5,000 month the Buyer will need to put up a security deposit of somewhere between $5,000 to $10,000.
- Utility Deposit. Usually the gas and electric vendors require one to two months the businesses monthly utility bill as a security deposit. Assuming you’re monthly utility bill will be $2,500 you’ll have to come up with a utility deposit of somewhere between $2,500 to $5,000.
- State Board of Equalization Deposit. In California the State Board of Equalization (SBE) may require a security deposit ranging between $2,000 to $50,0000 to act as collateral against any potential future State sales tax liabilities. The State will release the security deposit after the business has had a history of three years of perfect tax payments. For illustrative purposes the State Board of Equalization security deposit will be $10,000.
Fees and Permits. These will vary in different cities, counties and states.
- Department of Alcoholic Beverage Fee. In California if you are transferring a beer and wine license the transfer cost is approximately $600 and if you are transferring a hard liquor license the transfer fee is approximately $2,000. In addition to these up front fees there are yearly renewal fees.
- Health Department Fee. In California in order to get a change of ownership health department clearance the Buyer is responsible for paying for the inspection report which is approximately $300 and the seller is responsible (unless it is an “AS IS” sale which means the Buyer is buying the business AS IS and is responsible for all governmental clearances including the change of ownership health department clearance) to correct all the items on the report and get signed off by the health department.
- Business License Fee. In California this will vary from several hundred dollars to a couple of thousand of dollars depending on the county.
Remodeling Costs. If you plan to do major remodeling you could spend money on an architect, food facility engineer (who design kitchens and the other mechanical systems in the business), general contractor and various sub-contractors. There will be all kind of fees associated with the use of these individuals in addition to building permit fees and other miscellaneous construction fees you may incur.
Training Costs. You may hire some of the employees from the prior operation but undoubtedly you will be hiring new employees who will need to be trained prior to opening the business. There will be advertising costs for finding these employees and training costs for training employees prior to the opening.
Pre Opening Marketing Costs. Typically not much is spent here as most marketing for independent non franchised businesses come primarily from the word to mouth experiences of its customers. However it is common for a business to have a couple of preview openings, before the restaurant is open to the public, whereby selected guests are invited to have a meal for free. These guests usually include vendors, management of the business and their spouses, selected customers and friends. Sometimes these preview openings are tied in to a sponsorship by a non-profit organization whereby the invited guests pay to come to the preview opening and the proceeds go to the non-profit organization. These preview openings are good practice for the employees to get some of the kinks out of the operation and help assure a smoother opening when the business opens to the public. Frequently adjustments are made to the menu and service procedures as a result of these preview openings which help assure a smoother transition.
Rent and Other Costs During Remodel. Unless you can negotiate free rent from the landlord before you open for business which is unlikely in the San Francisco Bay area you will have to start paying rent and other operating expenses from the time you take possession of the premises. These expenses include utilities, insurance and of course payroll and some food costs for training purposes and possible preview opening events.
Working Capital Reserve. The thumb rule here is that you should have art least six months of projected payroll set aside for unanticipated expenses. Unanticipated expenses include the items indicated below. 1) Your operating results to be far less than expected and you need this reserve to pay the negative cash flow you will generating from an underperforming business. The restaurant business is a cash business to the extent that you need to pay you employees and vendors regularly if you want to stay in business. If you don’t pay your bills (food, beverage, insurance, utilities, etc.) you won’t receive products or services. If you don’t pay your employees you won’t have employees to serve your customers and if you don’t pay your rent you will be evicted. 2) Unusual unforeseen events – these may include acts of god such as extremely poor weather conditions such as excessive rain, earthquakes as well as major downward turns in the economy. Assuming your monthly payroll is averaging $15,000 month you should have $90,000 ($15,000 monthly payroll times 6 months = $90,000) set aside as a working capital reserve.
Summary of Cash Needed to Open and Operate a Restaurant, Bar or Club
If you are buying an existing business and keeping the same name, menu and concept and not making any major changes to the business. (Using the assumptions indicated above.)
| Purchase Price | $150,000 |
| Saleable Inventory | 5,000 |
| Escrow Fees and Closing Costs | 1,500 |
| Premises Security Deposit | 10,000 |
| Utility Deposit | 5,000 |
| State Board of Equalization Deposit | 10,000 |
| Department of Alcoholic Beverage Control Fees | 2,000 |
| Health Department Fees | 300 |
| Business License | 500 |
| Working Capital Reserves | 90,000 |
| Total Cash Needed | $274,300 |
Summary of Cash Needed to Open & Operate a Restaurant, Bar or Club If You’re Changing the Name & Doing Remodeling, etc.
(Using the assumptions indicated above and assuming you’ll spend $100,000 for remodeling, spend $10,000 in training costs, $10,000 in pre opening marketing costs and you’ll have to be closed for three months for remodeling before you open for business the summary of this scenario is indicated below. For this scenario we will remove salable inventory as it is assumed if a Buyer is changing the menu he does not want the Seller’s salable inventory.
| The costs indicated above | $274,300 |
| Remodeling costs | 100,000 |
| Training Costs | 10,000 |
| Rent Costs During Remodeling | 15,000 |
| Salable Inventory | (5,000) |
| Total Cash Needed | $394,300 |
As you can see per the information above you need additional cash raised in addition to the initial money needed to purchase the business. Unfortunately a lot of businesses go out of business because they didn’t anticipate all the start up expenses indicated above. In many transactions I have sold in the past where owners were forced to sell because they were undercapitalized many of these businesses would still be around today as successful businesses if they had raised the proper money initially.. Unless you have raised the appropriate money to start a business I would strongly recommend that you do not proceed to purchase a business. In my next article I will be discussing the sources for raising money for purchasing a restaurant, bar or club.