One of the great things about having over 30 years experience in the restaurant business followed by 15 more as a finance executive and small business advisor is that I have seen a lot. One fascinating phenomena is the “blind spot”. This is when restaurant owners fail to honestly see or recognize problems that jeopardize their business. They don’t really research, plan or seek an outside opinion and fail to see that even a good restaurant can be a bad business.
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The first time I heard the term “blind spot” I was learning how to drive and my Dad was telling me about that car sitting right next to me that I couldn’t see in the mirrors. He told me I needed to turn around and really look before making my move. If I didn’t, it could be… a disaster.
People in this business are smart, tenacious and for the most part survivors driven by instinct more than strategic planning. They are more reactive than proactive when running their businesses and deal in short term solutions as opposed to long term planning. Often they make very serious decisions based on gut feelings not facts.
In response to my April article in TFS questioning why restaurant owners closed up and walked away from viable businesses, the partners of an upscale white tablecloth steakhouse in NYC contacted me. Concerned about the lack of profitability of their 3-year-old business, they were trying to decide if they should fight on, restructure or fold up the tent and leave before everything collapsed on them. Serious stuff. I was intrigued by their sincerity and candor and decided to go and see for myself.
On my visit to the restaurant I found a handsome, well-appointed, clean, attractive restaurant worthy of being a high-ticket prime steak and seafood house in a very strong location. These hands on guys work hard and deliver great food and service consistently. They take pride in their establishment and it shows. Reviews on Yelp, Open Table etc., are overwhelmingly positive. After having lunch and doing a quick evaluation, their issues quickly came to light. These guys have a great restaurant – but a bad business model. With this location and their lack of capital – this restaurant was a very bad risk from the start.
Unlike many other distressed restaurants, the issue wasn’t food quality, service or lack of systems and controls – it boiled down to limited capital to promote and build a brand in a high cost, low frequency diner, with a highly competitive crowded market and expensive NYC rents. There are 12 other top steakhouses within walking distance, each with big marketing budgets. These guys don’t have sufficient capital or sales to compete and survive. There are about 5 blind spots that they didn’t see when building their dream.
Over three years they had their heads down and were working hard to build the business. They managed to grow from $1.8MM in 2014 to $2.8MM in 2016. This is a very respectable number with one huge and glaring problem. The BUSINESS MODEL doesn’t work.
Prime steakhouses have high food costs and even though theirs is under control (40%), the total occupancy costs (rent, CAM, taxes, insurance) demanded that they do at least $4.1MM to comfortably achieve profitability. Holy crap! At $2.8MM in sales, you can’t sustain an occupancy cost exceeding 20%. There is nothing left for marketing, PR, Direct Operating Expenses or G&A. You simply can’t compete if you are losing between $4,000 to $7,000 per week – Game over.
Even established iconic steakhouses like Ben Benson’s have closed their doors due to occupancy costs and now legendary Spark’s may do the same and they are doing over $18MM per year!
They approached their sales projections with rose-colored glasses for sure. I’m certain they didn’t run “Best Case – Worst Case and Most Likely” projections and determine if they could survive the “Worst Case” scenario. Most starry-eyed owners don’t do this. Every new owner should do this before they consider putting the key in the door. I’m sure these guys projected some big numbers while they were falling in love with their new restaurant. In reality they were nowhere near the $4.1MM needed to be viable.
Unable to see this, they invested everything they had, tapped friends and family, brought in some outside money and continued falling behind in rent and taxes. The downward spiral escalated. Despite the brutal truth, they decided to stay the course. They believe in their restaurant, their abilities and that everything will work out. Every time they book a big party they try to convince themselves that they are coming out of the woods. HUGE BLIND SPOT!!
Reality Check: Early in the first year they needed to pick their heads up from the daily tasks and objectively SEE the deficiencies in their business. Instead they continued to drive the same flawed business model while it was driving them over a cliff. They have lost hundreds of thousands of dollars are in debt and now may lose their beloved restaurant.
Ignore the signs at your own peril: Many restaurant owners are great at making excuses for low sales or constant losses. “Naw, my kid’s not on drugs – he’s just tired all the time and going through a phase…” Yea, right. “Nope, that stabbing pain in my chest is just heartburn.” Wake up and smell the coffee!! Face the brutal truth – negative cash flow, insufficient sales and growing debt topped with tax delinquencies, pissed off landlords and vendors are all reason for a 911 call.
The next blind spot appears when owners try putting a band-aid on a sucking chest wound! A little bit of cash may stop bill collectors from calling for a while but the real problem is not fixed. Many distressed owners seek loans from family and friends (really stupid) or financing like merchant cash advances, which get misused and abused. This accessible yet costly financing is good for growth – not for covering a black hole of debt. Don’t use this money to put your bad business on life support while you deny there is a problem. This debt, like any formal debt comes with the responsibility to repay and most of the alternative lenders will come after you personally if you don’t.
I gave it straight to my friends at the steakhouse. For now they are sticking it out and seeking a new equity investor, as they can’t obtain loans with their current financial statements. If they can attract a real equity partner it will cost them dearly as equity is always more costly than debt and they are not negotiating from a position of strength. I will report back and let you know how they made out.
My advice – look for the restaurant business blind spots and watch your numbers obsessively and listen objectively to what they are telling you. You will sleep better at night.
If you’d like to discuss strategies or other financial issues facing your business please contact me at dsederholt@sfscapital.com.
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