IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities. Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Oliver Kotelnikov. Mr. Kotelnikov is the Director of the Hospitality Transaction Division at IBA (www.ibainc.com):
Maximizing the Value of a Hospitality Business at the Time of Sale
Have you thought about selling your business and wondered how much it is worth? What are the key parameters impacting value? Accurately pricing the enterprise prior to listing it for sale is the single most important factor in maximizing your exit dollars. Valuing a business is a complex and nuanced process, but it starts with profitability. Profitability obscured by discretionary spending, accounting write-offs, non-recurring expenses, and general reductionist reporting courtesy of well-meaning accountants diligently whittling down the bottom line to minimize your tax burden. For purposes of sale, the goal of a knowledgeable representing broker is the exact opposite: presenting a convincing financial narrative to show the full earning power of the business. Generating an accurate opinion of value involves a detailed review of 48-60 months of historical and running financials. Considering an EBITDA multiple of 2-6X will be applied to every dollar of profit at valuation for a hospitality business, a dollar of profit documented equals multiple additional dollars of sale value. Outlined below are some of the more common categories often containing extra retirement dollars for ownership.
Compensation of Ownership
Ownership’s W-2 wages, medical benefits, and retirement plan contributions are all forms of compensation of principals. These are profits of the business categorized as expenses for tax reporting purposes requiring an adjustment at valuation. In the event of a group plan or company insurance policy, it is important to itemize and track ownership’s medical premiums and/or retirement plan contributions separately from the employees. Employee benefits are legitimate business expenses. The justification is that employee perks and benefits are part and parcel of retaining quality staff in a tight labor market.
Significant additional dollars can be reclaimed from this category to the benefit of the bottom line. To maximize write-offs, businesses will frequently report employee meal costs at full retail value. The actual cost to the business is equal to the cost of goods. A restaurant with a team of 50 allowing one shift meal per person can easily accrue $75,000-$100,000 a year in annual employee meal expenses at full retail cost. Estimating an average COGS of 35%, the expense may be inflated by as much as $65,000 reducing the reported bottom line by the same amount. An adjustment for valuation purposes should be made.
Pandemic Related Expenses
COVID was a unique event bringing with it many expenses considered to be non-recurring. Extra dollars spent in 2020 and 2021 on modifying facilities to comply with mandates and stocking up on personal protective equipment are justifiably not a part the ordinary course of business. Carefully auditing the Repairs & Maintenance category and the Supplies expense column will pay off at valuation. Remember how much gloves and masks cost? How much was spent building the makeshift outdoor patio with plastic roofing and running electricity to power the space heaters? What about the barriers separating the tables and ensuring a six-foot radius? On the administrative side, compliance with pandemic related aid programs is another source of non-recurring expenses. Many business owners enlisted the help of professional advisors to determine eligibility criteria and sort through forgiveness guidelines of programs like PPP, Restaurant Revitalization Fund, Employee Retention Credits, EIDL, and various state and municipal level assistance packages. These one-time expenditures should be removed from the Professional Services expense category.
With pent up demand unleashed and eager foodies returning to the dining rooms, restaurants are generating record amounts of tip revenue. Operationally, tip income is a pillar of the hospitality industry benefitting owners and employees alike. From the accounting, and hence valuation standpoint, accurately categorizing this large transient stream of dollars flowing through business is critical. Tips are reportable compensation to the employees, but not wages or productive labor expenses to the business. This revenue is sourced from the customers and must be separated from the aggregated payroll figures to accurately represent the labor expenses sustained by the business. Three restaurants I evaluated recently reported an average annual labor expense of $500K-$750K representing 25%-30% cost of labor as a function of gross sales. Each of these three very busy restaurants known for great service generated an additional $300K-400K in tip revenue. Including the gratuity revenue in the payroll expense doubled the apparent cost of labor. A negative optic for a perspective buyer to say the least. The smart alternative is to proactively segregate the tip revenue from the payroll and present it as an asset rather than a deterrent. Strong tips signal a reputation for good service and the increased ability of the business to retain and compete for quality employees in a tight labor market. On the back end, running the tips through payroll triggers an employer contribution to FICA equal to approximately 7.65% of total reported tips received and paid out. The business is not obligated to match payroll taxes on the tip revenue portion of employee compensation and is due a refund for this amount at year-end reconciliation. I frequently see this discount omitted on the business returns and applied to ownership’s K-1 and/or personal returns. Originating from business activities, this refund should justifiably reduce the Taxes & Licenses expense category on the corporate returns. In recent projects, the employee tip credit boosted the annual profitability by $25-$30K.
These are expenses that the business is not writing a check for but still reaping the tax benefits. Two of the most common such items are depreciation and amortization. Depreciation represents equipment and leasehold expenditures capitalized over time. Amortization is similar to depreciation but applies to intangible assets such as goodwill or intellectual property acquired at the time of purchasing the business. These expenses are tracked in a straight-line manner in accordance with the appropriate schedule and can be a source of significant add backs for businesses.
Discretionary spending and indirect expenses can have a sizable impact on the bottom line and are subject to review. Business related travel, meals & entertainment, networking, and expenditures associated with research and development are frequently partially adjustable expenses. A trip to a trade show is discretionary. An annual company party or monthly employee recognition practices can be considered part of company culture and a legitimate business expense. Ownership’s automobile and cell phone write-offs can be reconciled for strictly business-related use of these assets with additional dollars coming back to the bottom line.
If you have questions relating to the content of this article, the process associated with preparing a business for sale, or establishing the market value for a privately held company or family business, Oliver Kotelnikov would welcome the opportunity to talk with you. Mr. Kotelnikov can be reached at (425) 454-3052 or firstname.lastname@example.org.
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