4 things to consider when financing your restaurant

Feb. 10, 2014
4 things to consider when financing your restaurant

By David Sederholt,
COO of Strategic Funding Source

When I opened my first restaurant, I was young, enthusiastic and starry-eyed. I didn't know anything about financing the first of what would ultimately become many restaurants over 25-plus years.

I know a great deal more now.

Most new restaurant owners embark on their journey using savings and tapping the goodwill of their family and friends. This seems to be a sensible idea in the early stages where we all dream the dream and those closest to us want us to succeed. They buy into our vision and plunk down hard dollars to show us how much they love and support us. If everything turns out great, we pay them back with a nice return. If you believe in fairytales, this story comes true every time.

Realists know better. Restaurants are a crap shoot. I guarantee that 50 to 70 percent of the time something will go wrong or fall short of expectations.

Lesson 1: Taking money from friends and family is not always the best option.

Family Financing can make for some miserable Thanksgiving dinners, the loss of friendships or even major family breakdowns. It becomes worse when the novice restaurant owner, driven by dreams and emotion, thinks that the answer to subpar performance is to pour more into a sinking ship, asking loved ones for more money. Be objective and use your head. If you love your friends and family, look elsewhere for funds.

As restaurateurs, we all know that this is one of the most difficult businesses that anyone could enter. One of the reasons I loved it was because it was never boring. It required me to become an expert in every area from food quality to systems and controls, human resources, plumbing and electrical to marketing and public relations. The one major mystery was finding the best way to finance new and existing restaurants. I was a restaurant guy, not a finance expert and what I learned rarely made sense and I was often misled.

My bankers were lovely people who greeted me cheerfully when I came with my daily deposits and to pick up change. They made me feel as though they would be there for me as my "banking partner" and I felt all warm and fuzzy — until I needed a loan.

I had been with my bank for years and needed some extra working capital to renovate the kitchen and spruce up the front of the house. The wear and tear of years of being busy, generating the dollars that I deposited in their bank, now needed attention. Their words and body language told me that they would provide me with the loan I needed, but the reality was far different. I went through the motions and provided financials, tax returns, a business plan and an affidavit attesting to my personal net worth. My "banking partner" danced, stalled and requested documents from me to the point of exhaustion. After a couple of months of the money mambo, they informed me that the only way they could give me a loan was through the SBA guarantee process which also involved a full personal guarantee on my part as well as my restaurant partners.

Lesson 2: No matter how friendly your bank is, they have very tight limits on what they can or cannot do. Expect nothing and you won't be disappointed.

Super Prime and Prime business owners (700+ FICO and above with no issues) can and do get loans, but not without tying up their business and personal assets and providing a personal guarantee. SBA loan programs can be very helpful, but their "guarantee" is limited and you are still on the hook for 100 percent of the loan. They are there to protect the bank — not you. You should be prepared for heavy documentation requirements and long waits for an answer. There are a couple of exceptions, but the amounts are limited and the standards are high.

As more equipment started to break in my kitchen and the dining room looked even more beaten up, I needed to get my hands on some working capital and fast. In 1993, I became one of the early customers of a company called TransMedia, which later became Rewards Network. This was a group of highly seasoned marketing professionals that provided restaurants with cash in return for future dining credits and discounts. In return, the company marketed to "member" customers who would dine at a discount to repay the obligation. The downside was that it was very expensive and hard to control.

The next generation of creative finance came from a company that provided a less expensive way for restaurants and other retailers to leverage their credit card revenues to get cash immediately and pay back over the next few months. This was far easier to manage with automatic payments tied to my sales volume. Today, more than $3 billion in working capital is provided to small businesses from numerous companies that use this model and a fixed payment approach.

As with any good idea, the small business and restaurant lending industry has exploded and there are now numerous players in the space and hundreds of brokers selling these products. Some are very professional and have your best interest in mind, but that is not always the case.

Lesson 3: Know who you are dealing with in business. It is a relatively new industry and not everyone you speak to is reputable.

Here's a list of things to discuss with your financing expert:

  • Are they are a broker or do they actually fund your restaurant?
  • Do they charge additional fees above the actual cost of the financing? This is a clear sign of a broker. Good brokers will tell you how much they think they can finance and approximately how much it will cost.
  • If a broker, ask what funding companies they expect to submit your application to. If it is more than two, you should be concerned as this means they are taking a shotgun approach. More importantly, your credit will likely be pulled multiple times, lowering your credit score.
  • Lastly, check their websites. Reputable companies list their address, not just phone numbers – questionable operations do not. The top companies actually disclose the names of their management team because they take pride in the integrity of their firm. If they aren't willing to disclose who they are, consider doing business elsewhere.

After 30 years owning multiple restaurants and even taking one of my chains public, I can say there are many ways to find the capital you need, but it takes time and tenacity.

Final lesson: Do your research and find the right financing option for you.

Read more about operations management.

Topics: Financing and capital improvements, Franchising & Growth, Operations Management

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