Is more really better? I have been seeing an increasing number of restaurant owners taking the big jump and expanding their businesses. Some are adding space by taking the store next to their restaurant and putting in a bar and more dining tables. Others are opening their second, third or fourth location because they think they have found a great deal. Is it really the best decision and could you make more money investing in other ways?
When I was a young restaurateur (geez, don’t you just cringe, when you hear some old guy say that?!) – I wanted more. I started out with one restaurant on Madison Avenue in New York City and was successful for over 10 years. I packed it in because my 65 seat restaurant had size limits and the rent was more than doubling, so it made no sense to work for the landlord. I left the big city and headed out to the suburbs with plans to expand into a multi-unit restaurant company cheered on by a dear friend who taught me my first lesson in scalability and growth. He said, as a single unit operator, I was nothing more than a shoemaker working 12–16 hours a day, 6 days a week. I had plenty of work but I wasn’t building wealth. I needed to replicate to get real value out of my business. He was right… but it is a big stretch to go from hard working restaurateur to head or a group of restaurants!
In the following 10 years, I went from 1 successful restaurant and catering operation to more than a dozen. Some were great. Some mediocre performers and others were just stupid decisions. The great part about the graduate education I received was that I learned a lot about what to do or not to do when deciding on expansion.
I have seen a number of friends and acquaintances in the business start to buy or build new restaurants because they feel the economy is strong and that they can ride that wave. Assumptions are made on perceived wisdom and what people experience at the moment – not on what they need to survive in a downturn. It may look good today but leases are typically for 10 years, which is long enough for an economic cycle to evolve. There are absolute certainties in this world, beyond death and taxes and one of them is that the economy will go up and down.
In my many years of opening and closing restaurants, I have always found the greatest opportunities in a down economy. If you were lucky enough to buy or build a new restaurant in the last recession and took advantage of downward market pressures to negotiate a cheap price or under market rent – you won in a big way.
What I am seeing today is quite the opposite. Encouraged by reports of strong economic growth, prices of existing restaurants are going up. Rents in good areas are rising for restaurants, not just because people believe the current economic hype, but because restaurant owners are plentiful and eager to do a deal even if the lease is bad. Landlords are also filling the void from retail tenants who have been beaten into submission by internet marketing machines like Amazon. Landlords know that restaurants still need brick and mortar locations and someone has to feed the real estate beast. This is particularly true in places like NYC and other hot spots in Brooklyn, Long Island City and Jersey City.
These conditions also spawn other strategies. I know of a few savvy restaurant owners who bought for a low price in a down market, negotiated extremely favorable long term lease and waited to build up their business. Their strategy is to “flip it” and sell high, and make a substantial gain from their arbitrage. They get out while pocketing the next 3 to 5 years profits (guaranteed) with little or no risk from starry-eyed newcomers eager to have their own place. Even experienced operators are falling for this as they believe the current sales levels in these places will continue, or they believe their own BS that they are the best restaurateur on the planet. Both are very expensive bets.
Great deals can be had however, even in an up economy if you are lucky. You should evaluate each deal by preparing a formal pro forma operating projection. Do a three-tiered analysis – Best Case – Most Likely Case – Worst Case scenarios. Be realistic and use the numbers of your predecessor if there was one and they are available. You really need to be strict with yourself and determine what the catastrophic numbers are and pay particular attention to fixed costs (rent, insurance etc.) and hard variables like utilities. What is the absolute floor / break-even mark for you to survive without going into deeper debt? If you can live with the “Worst Case” and feel you can get out without bankrupting yourself – go for it.
The other mistake that I have seen and I have made, is that I believed that if I had a successful restaurant / concept in one location that I could replicate the same format to the next town or state and be equally successful. Wrong. Each town, state or even neighborhood are very distinct with varying tastes and preferences. You can be a massively popular restaurant in say New Haven and a huge bust in Norwalk. Lower Eastside loves it Upper Eastside hates it. I have suffered this a couple of times and can tell you it is pretty painful to unwind.
Subtraction by addition happens when the successful owner is a “hands-on”, very involved operator. He is doing well and accumulating cash and decides to do a second location. Patrons very often frequent his place because they get to know and like the owner. Customers realize that things just run better when he / she is there and they drive the business. Once they open a second location, they realize they can’t split themselves in half and one or both of the locations often suffer.
Many of my friends have said, “but yeah, I have a great manager on staff and no one will miss me.” This is hopeful, but not absolute and let’s face it – no one pays attention more than an owner.
The last pearl of wisdom I will share is that it takes two good restaurants to pay for one bad one. If one of your places goes into a death spiral, it will probably suck all the profits out of two of your good ones until you can resolve the situation. This is very costly and can set you back for years. Not great mathematics. If you are not absolutely sure that the new venture you are contemplating is a winner that can return at least 15% to 20% net income after all expenses (including owner’s salary) you should probably consider putting your money in a managed portfolio of mutual funds. It will be less risky and give you more predictable performance. Good luck!
If you have any questions or just want to discuss the expansion of your business please contact me at dsederholt@ragnarpartners.com
