Funding a New Restaurant – Mission Impossible?

Owning a restaurant can be a dream, a goal, an ambition, an opportunity, a way of life, an addiction and for some a nightmare. It can be one of the most exciting times in a person’s life and has been likened by some as akin to a romance.  Excitement and high emotions often engage as the possibilities unfold in front of your eyes. You have fallen in love with this spot and now you need to pay for the wedding, as this spouse will require a substantial dowry.

With more than 30 years as a restaurant owner, business broker, consultant and then small business finance executive, I have seen all manner of entrepreneur considering the prime question – “How do I finance this opportunity?” People in the restaurant business can be incredibly adept at calculating food cost in their head, or managing their hourly payroll so that they keep their business in the black, but can be fairly naive and under informed when it comes to financing their business. This is especially true for funding a new restaurant. 

Once you can identify sources of capital, how you structure your financing is as important as how much financing you obtain.  I could go on for hours about where to look for capital, but in this article I am going to talk more about structure and strategy.

Lesson #1 – Debt is much cheaper than equity in more ways than just cost.

Typically when I see young entrepreneurs looking to fund a new venture they are looking for “backers” or “investors” to buy a chunk of the business.  They want to tie their wagon to a financially sound individual (or group) that can invest the funds to get their vision launched, but often not much more.  They think about the wedding itself and not the fact that actually they have to live together for life.  The fairytale is awesome, but sometimes the reality is a bitch. 

For whatever reason, these investors share in your excitement and the thrill of being in the restaurant business. The fact is these people are now your partners and will share in the profits, decisions and have influence in how you run your business – even if they are “non-operating partners”.  If you think they will be quiet and let you do what you want – think again. The Golden Rule applies – he who has the gold, rules!

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The attraction of taking equity is the misguided belief that you don’t have to pay that money back.  Once a loan is paid, it is done, but partners are forever.  You will be paying them back for as long as they have shares or until you pay them to go away.  In tough times you don’t know how they will react until things really go south.

Sophisticated partners can take over control of “your business” looking to recover their investment.  I have seen 5 restaurants this year alone where the visionary “owner” was locked out of his restaurant and hip deep in litigation.  Like I said, equity is FAR MORE EXPENSIVE than debt, even high interest money.

Lesson #2 – It is much easier to negotiate from a position of strength. 

If you have money – you are much stronger, it is a simple fact of life. I am still baffled by restaurant people that expect to be able to open a restaurant without putting up a meaningful amount of their own cash.  You can’t buy a collateralized asset like a house without a down payment, so why would you think your bank would give you money to open one of the riskiest businesses on the planet? 

Unless you have strong assets to pledge as collateral, you are NOT getting a bank loan or an SBA guaranteed loan.  You can’t negotiate when you have no skin in the game so if you plan on opening a business – start saving now.

It doesn’t end there!  Even with you plunking down a pile of cash, to get a commercial loan, you will need to sign a Personal Guarantee.  I find it very funny that many starry eyed newbies with no real assets can dig in their heels and refuse a “PG” as a condition of getting a loan. Really?  You have no bargaining chips here. Sorry dude, but if you don’t believe in your venture enough to back it with everything you’ve got, why would a lender? 

Lesson #3 – Friends and family are the most likely supporters of your effort – BEWARE! 

Anyone who has opened a restaurant has gone down this path.  Grandma, Uncle Bob and the rest of the clan believe in you and want to see your dream come true.  OK, it all sounds nice and human nature tends to accept those short-term solutions, which relieve immediate problems.  This one can and often does destroy friendships, family bonds and marriages.  If you succeed and pay everyone back you will be a hero.  If not it will be a really rough time at your family’s Thanksgiving dinner!  If you take this direction, make it a formal business arrangement.  The old saying, “friends are friends but business is business” is a good rule to follow.  Double that for family. Write up a clear understanding of what the investment and performance expectations are and have everyone sign it.  Detail the risk factors and that everyone in the deal can possibly lose their investment. If they can’t accept that – DO NOT take their money. Nothing is worse than a “he said / she said” argument with each side having their own separate understanding of the facts.

Lesson #4 – Leverage assets you may already have – it’s easier. 

If you already have an existing business, you may be able to borrow against its assets to get the new venture rolling.  Strategic Funding regularly works with restaurant owners seeking to expand, by leveraging the assets of the operating store.  It may appear to be more expensive than traditional financing, but if you can’t get it – that simply doesn’t matter.  If you are burning with a passion to do your deal and need liquidity you might consider selling things to get it.  Your house, cars, motorcycles, jewelry you name it.  If you succeed, you can buy things back.

Lesson #5 – Be realistic.  Critical thinking today can save you and others grief later.

Shut off the dream machine and look at your deal with a critical eye.  Can you REALLY produce the income you think you can? Why would someone want to invest in you or lend you money instead of placing it in something safe or with a high yield?  There better be a realistic ROI (Return on Investment) that you can show and support. No pie in the sky salesmanship. If you want to have investors and lenders take you seriously, you need to be fully invested as well. 

Create a well crafted capital plan that combines debt and equity in sync with your realistic projections and cash flow. This can keep your dilution low and debt service manageable.  I always built a “worst case” scenario just incase my place became a total flop.  In the case of massive success, you should also build in mechanisms that allow you to buy out equity investors at pre-determined multiples if you ever want to reduce the number of your partners.  This will prevent them from asking exorbitant multiples to buy their shares.  Success could be your downfall.

Each situation is unique and you might need some experienced help in formulating a strategy. As a veteran of many years, I regularly work with small business owners trying to live the dream and would be happy to talk to you about yours. 

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David Sederholt
David Sederholt is a multi-discipline entrepreneur who has launched and built numerous companies in specialty finance, foodservice and commercial real estate over 40 years. After owning, financing and operating over a dozen restaurants in his career he found a niche in serving small businesses seeking financing and strategic advice. For 10 years he served as Chief Operating Office of Strategic Funding Source, Inc., (now called Kapitus). David has also been a Managing Partner at a boutique investment bank and a specialty commercial real estate firm. He is a regular guest lecturer and contributor to business and industry publications as well as serving as a Board member and advisor to numerous companies and non-profit organizations. He is currently owner of Ragnar Partners, LLC, a private investment and advisory firm.