Managing the Sale Process:
Proforma Cash Flow Adjustments: What Works and What Doesn’t

The Price of a Restaurant

The price restaurants change hands at is typically based on a multiple of cash flow. It is a Buyer’s expectation that the cash flow he is buying is:

1. Verifiable
2. Sustainable
3. Financeable

To determine if those three tests are met the Seller starts with the actual historical cash flow then makes adjustments to reflect circumstances that actually have or are virtually certain to impact those cash flows, either positively or negatively. Conflict between Buyer and Seller can arise if there is disagreement as to whether any of the proposed adjustments fail to meet the three tests. The onus is usually on the Seller to substantiate any cash flow adjustments. To maximize the likelihood the Buyer will accept the Seller’s adjustments, the Seller needs to spend the time and effort required to build a well-reasoned and well documented argument in support of the
adjustments. Because these adjustments are then multiplied by anywhere from five and eight times, the stakes can be enormous.

Proforma Adjustments

What Works:

• Partial year stores, both for new stores and remodel closures
• Bona fide one-time expenses
• Unusual weather-related closures. (Not snow in Minneapolis)
• Bump from remodels especially if you have multiple prior examples or system averages that can substantiate
• Renegotiated leases or other contracts
• New store pre-opening and ramp-up costs
• Sales transfer from closure of a nearby store
• Sales increases and operating cost efficiencies from a scrape and rebuild or offset
• Closure of a nearby competitor especially if you can extrapolate a clear trend line
• Excessive R&M which can be shown to be substantially above brand norms or expensed as a result of the tax code that favors expensing rather than capitalizing
• Store closure if lease and franchise agreement liabilities can be extinguished
• All non-cash charges
• Work Opportunity Tax Credits, if they have been ongoing for several years
• Reduced insurance costs as a result of better claims management
• Reduction in property taxes as a result of negotiations with local county tax assessor

What Doesn’t Work:

• Cuts in advertising
• Cuts in bonuses
• Labor and benefits cost reductions
• Lower overhead other than reduction in owner’s  compensation and benefits
• Extrapolating lower commodity costs
• New product launch
• Generally improving economy
• Opening of a new traffic generator
• Temporary franchisor incentives
• Cash shortages
• Miscellaneous income unrelated to restaurant operations

Final Thoughts:

The key to winning the negotiation with the Buyer on a proforma adjustment is to make sure that the adjustment is defendable, quantifiable and sustainable. A Seller should also focus on just the largest adjustments. Trying to push through a large number of small adjustments will burn out most buyers leading to quality of earnings concerns and deal fatigue.