Restaurant valuations remain depressed and deal flows have slowed substantially. In the overall M&A market, the second quarter of 2009 represented the lowest buyout volume since late 2004, according to mergers tracking firm Dealogic. Restaurants remain among the slowest sectors, with just 49 global transactions announced in the period, compared to 77 during the same period last year.

Even so, merger experts say there is still cautious money hunting for deals, underscored by the June sale of Atlanta-based Church’s Chicken to private equity firm Friedman Fleischer & Lowe for an undisclosed amount. There seems no better time than now, in this highly selective market, for chains considering putting themselves on the auction block to get the house in order.

Regardless of size or corporate structure, the biggest consideration for quick-serves prepping for a sale is the ability to produce clean and accurate financial statements, says attorney Steven E. Siesser, a partner with Lowenstein Sandler and chairman of the firm’s specialty finance group. Before hiring an investment banker or broker to shop the business, would-be sellers should bring together a team of attorneys and accountants with experience in merger transactions to get the books in order.

“Financials are the first thing; get those in shape,” says Siesser, noting that today’s buyers prefer to see audited financial statements whenever possible. Red flags include expenses unrelated to running the operation, like country club dues, or payments to family members not directly involved in the business.

“The common pitfall is that they’ve been running their own private company like a personal candy store,” Siesser says. “They never really ran it with a view toward selling it.”

The checklist of preparations is extensive. It includes a thorough review of all legal documents, Siesser says. Sellers must provide up-to-date leasing agreements and ensure that landlords are apprised of a possible change in ownership. Trademarks and intellectual property must be current; pensions, if applicable, should be fully funded.

Franchisors must provide proper notice to their franchisees; meanwhile, large multiunit franchisee systems require consent from the parent company. The implications of applicable union contracts must also be clearly spelled out.

“Those agreements are going to need to be organized and accessible because buyers are going to want to read them,” says David Lobel, founder and managing partner of Sentinel Capital Partners, a lower middle–market private equity firm with a $1.25 billion portfolio that includes restaurant holdings.

“They’ve got to work with their accountants and financial experts to make sure that the library of financial history is easily accessible, organized, and accurate,” he says.

“Give me forecasts for the future. Show me your crystal ball. What assumptions would you make and why are those reasonable assumptions? It takes a lot of work.”

Lobel also wants to see a clear snapshot of what the company’s management structure will look like after the sale. Most private equity firms require management to remain intact following a buyout; strategic buyers, by comparison, usually call for a clearly stipulated period of transition.

Besides the necessary scrubbing of financials, Dennis L. Monroe, senior partner with Krass Monroe, a law firm specializing in restaurant transactions, recommends a thorough review of a company’s operations. He sometimes advocates that quick-serves create a separate entity for underperforming stores or other properties seen as a drag on the balance sheet.

“If you’ve got bad assets or personal assets and can spin them off and get them out of the company … we put them into a different entity so the entity we’re selling is clean,” Monroe says.

He also works to unravel obstacles such as so-called cross-collateralization of assets, which occurs when one loan is used as backing for another. This is sometimes the case when a large franchisee has holdings under multiple concept banners and the lender lumps them together into one financial agreement.

Another trouble spot, Monroe says, is personal guarantees against real estate. “There are all these things that in the past we could work through, but now you’ve really got to get those things taken care of before the sales process,” he says.

Once a firm is dressed for sale—a process that, depending on circumstances, can take anywhere from 30 days to a year or longer—an investment banker is contracted to handle interaction with potential buyers. Communication with prospects varies, depending on whether a strategic or financial buyer is sought. In either case, bankers work with management to create an offering memorandum or book.

That requires meeting with sellers to ensure that expectations are in line with the business’ current and projected financial performance, says Carty Davis, a principal with the Cypress Group, an investment banking firm specializing in the fast-food industry. In addition, bankers will make site visits to one or all stores, review contracts, and reformat financial statements into a user-friendly format.

“What you want when the buyer reads the offering memorandum is that they understand the facts, understand the concept, and get a very good feel for all of the information,” Davis says. Investment bankers typically require a lump sum or monthly retainer; after the deal closes, they take a percentage of about 3 percent of the total sale price, he says.

Right now the market for independent concepts is much more difficult than for large, multiunit franchisees, he says. Those businesses are fetching valuations of four to six times cash earnings after factoring out the costs of running the operation.

Bankers and attorneys say buyers are using larger portions of equity to finance deals than in years before, reflecting the constrained and costly debt markets and the ability to generate better returns due to lower valuations. Private-equity firms are seeking compounded returns of about 30 percent over a holding period of five to seven years.

Amy V. Forrestal, managing director with Brookwood Associates, a middle-market investment-banking firm, says sellers are also agreeing to take on more risk to get deals done. One way is through earn-out agreements, where a buyer pays a percentage of the asking pricing up front; if the business meets certain performance goals, the seller gets an additional amount at a later date.

“There’s a big value gap between buyers and sellers,” Forrestal says. “In this environment you have be really creative.”