Preparing a hospitality business for sale in the rapidly changing marketplace

By Oliver Kotelnikov

Embracing the new normal

If change is a constant, then the hospitality industry has enjoyed unprecedented levels of blissful consistency lately. Those who survived the pandemic are assessing the damage and facing more questions than answers about the future. Business is booming, but how long will rising costs and crippling labor shortages persist? Is the current partnership model with third-party delivery platforms sustainable or even beneficial for independent restaurants? Are technology and advancing automation an ally or a threat? When will things finally go back to “normal?”

Opinions vary on whether the pandemic created or merely highlighted some of the systemic issues facing the industry today, but most will agree that change is not only imminent, but a matter of survival. Paradoxically, having made it through the global health crisis is not enough. The scope of the task at hand for industry leaders and the business community is much larger: design and build the new hospitality business model and position the industry to thrive for decades to come. Successful business owners contemplating retirement are at a crossroads and may justifiably feel disinclined to reinvent the playbook for the next generation.

But everyone is inherently a partner in the project. The general state and health of the industry impacts every single business in it and the prospects of a successful sale for those evaluating exit strategy options. Whether you’re selling or staying at the helm, focusing on the following areas will help lay the foundation for the new chapter while building value towards a future sale.

Quality of earnings

At its core, the buyer’s decision to purchase a business is financially motivated. The business opportunity must be priced fairly and yield a competitive return on investment to generate demand in the marketplace. Documented profitability will be a key factor in determining the fair market value of the business. Monitoring operating expenses and keeping up with rising costs of doing business will ensure a healthy profit margin and premium market value at the time of sale.

Net profit margin

The expected profit margin for a retail hospitality business is 10%20%. This means that a business producing $3 million in topline revenue should generate $300,000-$600,000 in cash flow to ownership annually. A higher percentage of every dollar produced falling to the bottom line indicates a more efficient business model. Improving the profitability ratio may include reducing the menu offerings, optimizing hours of operation, and taking a critical look at staple operating costs.

Cost of goods

Rising costs are part and parcel of doing business in an inflationary economy. Protecting the bottom line will require a pragmatic and disciplined approach to raising prices and eliminating lower margin items from the menu. In the example of the $3 million gross revenue threshold, a traditional 30% cost of goods margin represents an annual expense of $900,000. With the consumer price index up over 8% in the last 12 months, the business will sustain an increased operating cost of $72,000. This can mean an increase or a reduction of $200,000-$250,000 to an owner at the time of a sale. Meanwhile, the same 8% represents a very manageable $4 to the customer on a $50 ticket.

Convenience fees

Reassessing credit card fees and third-party delivery platform expenses can substantially improve profitability. Many operators have successfully adopted the policy of shifting the burden of credit card processing fees back to the customer without much pushback. The justification is that the party benefiting from the convenience should pay the associated costs.

On $3million of revenue, adding the standard 2-3% transactional fee to the bill of customers paying with a credit card can produce an annual savings of $60,000-$90,000 to the operator with significant impact on profitability and by extension, the value of the business. Third-party delivery fees have come down recently because of industry regulations but continue to take a large chunk of the operators’ profits. These low-margin sales tax the bandwidth of the business at standard rates while yielding inferior returns.

Company culture & leadership

The retail and hospitality employee shortage did not begin with the pandemic and will not end now that it’s over. The shallow labor pool cycle is expected to persist for the next five years, or indefinitely if root causes of the problem are not addressed.

Recruitment

The systemic labor shortage must be addressed at the source with robust education and workforce development efforts. The Hospitality Business Management program at Washington State University is one of the best in the nation. IBA recently held a seminar on the topic of business ownership for the students at the Wine Country Culinary Institute at the Walla Walla Community College. Connecting with vocational schools and establishing a collaborative relationship with hospitality-oriented college and university programs can be a great sustainable resource for quality talent for the business community.

The employee experience

A happy team is the key to a quality customer experience. When choosing a company to work for, employees are increasingly looking beyond the paycheck and focusing on company values and workplace culture. Successfully retaining employees in a competitive marketplace is further enhanced by offering flexible scheduling to allow for outside activities and time with friends and family.

Identity shift

The industry’s image as the “first job” or the playground for late night shenanigans has produced many entertaining acceptance speeches and best-selling novels but done little to create a sustainable quality labor pool for the employers. While a portion of retail and hospitality jobs will always be seasonal and temporary, attracting top talent for leadership and management positions requires raising the bar and becoming the industry that can consistently deliver on the promise of a rewarding career path and a competitive standard of living for dedicated professionals.

Oliver Kotelnikov is the director of the hospitality transaction division at IBA, Pacific Northwest’s premier full-service business brokerage serving the hospitality industry since 1975 with over 4200 businesses sold. Please email your questions to oliver@ibainc.com.■