In my last few articles, we have discussed challenges that restaurants have when seeking loans from banks, the SBA, credit unions and other traditional financing sources. After banging their heads against that wall for a while, business owners often say – “Well, I could just take on a partner”. Which sounds fairly simple in concept, but may be just as frustrating as dealing with a bank. Or it could be worse.
In lucky cases, a partnership can be a match made in heaven. You find someone with aligned interests and understanding of the deal. Everyone is happy. But, in other cases, you end up with the partner from hell. What might have looked easy and started out on a positive note has devolved into a monster over time. You never know for sure how it will turn out.
In the past year I have seen two cases where financial partners physically locked out and removed operating partners from the business and changed the locks. I have even been told of one hostile take over where the financial partner from hell sent armed goons into a restaurant at closing time to make the operating partner a deal he couldn’t refuse… “it’s going to be either your brains or your signature on this transfer of your stock”.
I hear about similar situations quite a bit – especially after loan applications get shot down in rapid succession. Gee, why wouldn’t some cashed-up person want to invest in my dream of culinary grandeur? They assume that anyone could see why investing with them is a great idea; but they don’t actually think it through. In a majority of cases people with money can get far better returns with traditional investments. So why do so many restaurants attract investors eager to own a piece of paradise?
Let’s start from the beginning. There are a number of investor types that gravitate to restaurant opportunities and each has their own characteristics. The most typical for start-ups and newer businesses are Friends and Family. These are the people who know and love you. Some want to support you, just because you are you. Others get guilted into helping you because Grandma actually believes your BS and dumps her retirement account into your dream. Most of the time no one has any real business sense, restaurant experience or even common sense. WARNING: There is nothing worse than crushing a family member or old friend when your restaurant blows up and you can’t pay them back. Thanksgiving dinner at your house will never be the same
Next up are the Ego Investors. These are the folks whose prime motivation is to tell all their friends that they “own a restaurant”. They are very eager and happy to be the big man at the restaurant with waiters and bartenders fawning all over them. They throw their weight around and bump paying customers for seats at peak times, drink too much and give too much away to their friends. They don’t fully understand the underlying business and don’t want to – until you tell them that the place isn’t profitable and you need all the “partners” to kick in some money to cover the taxes. This is when the proverbial sh#t hits the fan. At this, they can just melt away quietly into the sunset if you are lucky, or they get hyper aggressive and confrontational as they try to “recover their investment”. Their sudden interest in the business often drives it right into the ground. It may seem easy when you are accepting their money in the beginning, but it can get really ugly later and have long term effects on you and your finances.
In my August 2017 article on “When a great restaurant is a bad business” I wrote about a terrific steakhouse in NYC with a number of issues that made it a bad business. One of the big issues was that there were 5 partners – all of whom had different ideas about the business, how it should be run, its marketing position and risk tolerance. They were all great guys and good friends. The “Band of Brothers” investor group were shoulder to shoulder walking in the door. But despite the efforts of the very competent operating partners, once they were through the door, it was easy to see that things were falling apart as debts grew. The liability from taxes, the landlord and vendors shook them up pretty badly. Some wanted to sell. Some wanted to close up and walk. Others wanted to stay and fight it out. Lawyers were brought in, negotiations had… and on my latest visit this month, one partner remains and he has taken on all the liabilities. The others are gone and no one got their money back. The best they hoped for was to be relieved of their liability, which is still questionable. If they had done their homework before opening instead of buying into the collective dream machine, it might have turned out differently.
True Financial Investors are rare in the restaurant business unless they have had some previous experience in the industry or some level of connection to the geography / real estate. For this group there must be some demonstrable financial benefit and protections or they aren’t writing a check. For these professionals, the numbers tell the story and management can make decisions based upon real data not emotions and excuses. This group often includes landlords and real estate developers looking to place quality foodservice operations into their properties. Typically they pay for build out and furnishings commonly referred to as “T/I allowances” for tenant improvements. Very often these investors make attractive deals in the early portion of the relationship in order to give operators time to establish themselves. As the lease matures the costs escalate. Sometimes beyond what a restaurant can afford to pay. This strategy has crushed a number of multi-unit operators who could not grow the revenues fast enough to out run the rising occupancy costs.
The one common thread that runs through this strategy is that taking on a partner is often very expensive – financially, emotionally and/or personally. Eager entrepreneurs do what they need to do to get their enterprise off the ground only to find out that they traded off ease in getting an investor for more onerous terms as they move along.
An instrument I have used and favor is called a convertible debt obligation. In this structure you obtain financing from an investor in the form of debt, with built in performance metrics. If for some reason, you fail to perform the debt can convert into equity and a very favorable valuation for the investor. This incentivizes the business owner to perform to avoid a new partner or losing control of the business. A partner from hell doesn’t go away unless they are bought out. They will very often have a say in the business and will feed from the profits for as long as they remain owners. Debt, even expensive debt, is far more forgiving. Once it is paid – it is done and gone. Structured properly, convertible debt obligations can work out very well, but I suggest you speak to someone who has done them before so you get can get a realistic deal done. Once you come to terms, tear it apart and look for the downside before you sign. If you can live with the worst possible outcome – then it’s good.
Good luck in your hunt for capital. If you have questions or would like to discuss your business you can email me at email@example.com.