Are you following the 12 dos and don'ts of restaurant financing?

Opening a restaurant may be a dream of many, but it’s often lost when a would-be business owner realizes it takes hundreds of thousands of dollars to pursue. While raising funds isn’t easy, it is possible, especially when it comes to opening a fast casual concept, said Sherri Seiber, COO of FranFund, a funding solutions provider for the franchise and small business communities.

"As recently as two years ago, borrowers for the fast casual restaurant segment could expect to be required to make a 50 percent equity injection to obtain a loan for a start-up if they could find an interested lender," Seiber said. "Since the fast casual segment made it through the financial crisis and performed well, now borrowers seeking funding via the regular Small Business Administration-backed channels are seeing affordable interest rates, and 20 to 30 percent required equity injections."

What’s a SBA loan?

A SBA-backed loan is the most standard avenue for financing a start-up because the guarantee provided by the government often comforts lenders and mitigates risk, Seiber said. The borrower should expect to pledge collateral to cover the entire loan amount, however.

"For a $250,000 total project cost, the borrower should expect to make a personal cash contribution of approximately $75,000 (30 percent) and to pledge collateral for the loan amount of $175,000," Seiber said.

That means borrowers for any type of restaurant start up should expect to have nine to 12 month's cash reserves available to cover loan payments and living expenses, Seiber added.

Other funding avenues

While common funding avenues include bank debt, private equity funds, landlord financing (particularly tenant improvement dollars included in a building lease), leasing assets (commonly used for equipment purchases), and crowd funding, there are newer and often more feasible ways to raise funds, said Alexis Becker, co-leader of the National Restaurant practice at BDO USA.

"Pursuing an IPO and going public has become more common in recent years, particularly among emerging growth companies eligible under the Jumpstart Our Business Startups Act of 2012 (JOBS Act) and specifically, within the fast casual segment," she said.

The JOBS act allows companies with less than $1 billion in revenue that qualify as an emerging growth concept to delay the internal control requirements of the Sarbanes-Oxley Act.

Another new way to raise dollars is crowdfunding, which is used both as a tool for start-ups as well as for growth or improvement for existing businesses.

"(It) has exploded in recent years," Becker said.

Private equity vs IPO

Becker said those considering private equity, should consider the following:

• Cash flow and reporting requirements.
• Impacts of management fees on business performance.
• Restrictions on future equity transactions if more capital is needed. Will the private equity firm be willing to put in more cash in the future?
• The private equity firm’s investment horizon and exit strategy. Ensure all parties are on the same page.
• Attributes and resources of the private equity fund that could help fuel growth, including its familiarity with restaurant operations. What can you learn from them to strengthen your growth plan?

Going public is gaining popularity in the fast casual sector as a variety of chains, including Noodles & Company, Zoe's Kitchen, Shake Shake and Pot Belly, have recently made the decision. One advantage is that it provides a strong financial base for an organization, which can ease the process of obtaining debt financing, Becker explained. She noted that public companies often attract better talent, as stock options in a liquid market are more appealing to executives than options in a private market. It’s imperative, however, to also consider the disadvantages, which include:

• Increased pressure to maintain earnings growth. Restaurants should consider whether they will have the freedom to make decisions for long-term growth or be pressured to meet needs in the short term.
• Significant administrative costs in the form of legal and accounting fees, independent directors fees, periodic filings fees and directors and officers liability insurance.
• Required disclosure of company and personal information.
• Potential loss of operational control, as the organization is accountable to shareholders and boards of directors.

"Be thorough, taking into account and thinking through how your organization could be impacted," Becker said.

Dos and don’ts of restaurant funding

Although there is no one-size-fits-all recipe for opening a buisness, Becker and Alex Zukovski, CEO of Merchant Cash U, said there are some practices that should always be followed and even more to avoid:

Do:

• Consider not only short-term financing needs but where the next round of funding might come from. Businesses will always need funding, so be sure to think through how decisions today could impact future financing needs, Becker said.
• Have solid cash flow projections ready to share with potential lenders and investors.
• Invest in a strong system of corporate governance.
• Always keep proper accounting records, and make sure your corporate/government documents are up to date, Zukovski said. "The restaurant industry can sometimes be cash heavy, but this can't mean you fall short on accounting. If you do, your possible loan or advance may not be what you need."
• Ask questions so there's a complete understanding of how a loan vs. a cash advance works. You must understand important information such as how repayments work and how interest accrues over time. The more you know, the less stressful the financing process will be.
• Hire the proper people and keep hiring costs low. "I have seen many restaurant owners hire friends or family, but this is business, so don't make it personal. Hire good management and servers who have experience. Most restaurants fail because of bad management and more times than not, this can be avoided," Zukovski said.

Don’t:

• Blindly pick a funding avenue simply because it provides the highest valuation. Rather, spend time considering all relevant factors in potential deals, Becker said.
• Sign a long-term expensive lease, Zukovski said. "I have seen restaurants fail from this because they just can't pay high rent for three or more years. This goes for bank loans as well. That's the beauty of a cash advance as companies make daily repayments based on sale fluctuation. It's very ideal for those in the restaurant industry because they never know what the day may bring. If your sales are low one day, your repayment is lower since it's based on a percentage."
• Sign anything without fully understanding the transaction’s impact. "This is especially relevant to bank debt covenants. If a restaurant signs a document to secure bank debt knowing it will not meet covenants, it could, at a minimum, face significant waiver fees," Becker said.
• Market yourself improperly and spend money you don't have on bad or expensive marketing. "Keep costs minimal through social media, word of mouth, and only spend marketing dollars on the type of clientele you want," Zukovski said.
• Lie on a loan or advance application. The more honest you are, the more confidence the financing organization will have in your abilities.
• Jump from bank to bank. Develop a relationship with one lender and keep them informed and avoid surprises.
• Overlook smaller regional banks when considering bank debt. Remember that there are options outside of the "big players," Becker said.