Finance
by Paul Fields

An Introduction to Restaurant Financing

[editor’s note: Paul Fields comes back to FSM to start up his much requested series on restaurant financing – a step-by-step process of realizing the funds for your restaurant dream and/or expansion – step 1]

The financing of restaurants is as varied and broad a topic as any in the food industry. There are many aspects of finding and placing financing. Is this a start-up or an expansion? Is the need short-term or long-term? Is there existing debt or equity? What is the ownership structure? These are just a few of the questions that a restaurateur must ask before proceeding with financing of a restaurant.

Over the coming months, this column will explore many aspects of restaurant financing. The information provided is designed to give restaurateurs the basic information necessary to obtain and secure financing. Topics to be covered are deal structure, valuation, the business plan, financial structure, investor financing, bank financing, SBA & SBIC & Certified Development Company financing, venture capital, private placement of equity and public equity market financing. Should a finance professional be used to procure the financing? Each column will cover one of the above topics. A summary of each is shown below.

The first step in restaurant financing is to determine the ownership structure. Will the restaurant be owned as a sole proprietorship, limited partnership, corporation or limited liability corporation? This is very important in the development process and can have legal and accounting repercussions over the life of the venture. A legally acceptable structure could have hidden or adverse tax consequences. Therefore, it is important to work with experienced attorneys and accountants to determine the best structure for your organization.

In order to obtain financing, the restaurant venture must first be valued. The value is important for an investor to determination how much money to invest/lend. The basic approaches to value are 1) direct sales comparison 2) income/present value 3) replacement cost 4) liquidation value and 5) component value. More about valuation in an upcoming article.

Almost every investor or lender will request a business plan. While there are many variations, the standard format should include an in-depth analysis of the following items: executive summary, the concept, description of the business organization, development team, market analysis and marketing plan, the menu, sources and uses of funds, income and expense pro forma (for 3 years), break even analysis, balance sheet and development schedule. Supporting documentation should include: operating history for 3 years (if applicable), supporting data for income and expenses, floor plans and renderings, property information (including a lease and/or purchase contract) and reviews and/or promotional information. The business plan can be prepared by the restaurateur or a consultant.

The next step is to determine the financial structure. Will the financing be debt, equity or a combination. Debt is borrowed money and must be repaid. Equity is funds contributed in return for ownership (either stock or limited partnership shares depending on the ownership structure). The return on equity investments is generally a function of profits of the business and paid in the form of dividends or distributions. The general rule for either type is "the higher the risk, the higher the return". Therefore, the riskier an investment, the more a restaurateur must give up in return for the financing.

With the above factors in place, one will be ready to seek out the financing sources. The following types of financing are most often found in local, regional and national chain restaurants.

Investor financing, involved in many restaurant transactions, are funds contributed by investors who, in most cases, are not active in the operation or management of the restaurant. Generally the contribution is in the form of equity (but sometimes debt). The amount of investor financing depends on the deal. In some transactions, the investors contribute the cost of development less what can be borrowed as debt. In others, it is all investor financing. Sources of investor dollars come from friends or relatives, business partners, or small groups of professionals who band together for specific investments. One good source of investor financing comes from restaurant patrons who are willing to fund new ventures or expansion.

Debt, or borrowed money, is involved in most financing transactions. Loans can come from many sources: private, commercial, government and quasi-government organizations. Short-term loans are paid back within one year. Intermediate-term loans (sometimes called "term loans") usually have a maturity of less than seven years. Long-term loans are for a tem of 15 to 30 years and generally are secured by real estate. Generally, these loans are repaid monthly with a portion of each payment credited to interest and a portion to the reduction of the principal.

Some examples of private debt sources are friends or relatives, personal savings, second mortgages, credit cards and personal savings. Commercial loan sources include savings and loan associations, commercial banks, savings banks, credit unions and venture capital companies.

The primary government source is the Small Business Administration (SBA) which guarantees a portion of a loan made by another lending source (usually a commercial bank). Many conditions apply, so watch for the article on government financing. Quasi-government sources include SBA Certified Development Companies, Small Business Investment Companies (SBIC's), Specialized Small Business Investment Corporations (SSBIC's) and, if you choose to do business overseas, the Overseas Private Investment Corporation (OPIC). Finally, there are many community, county and state loan programs that provide loans to businesses and restaurants.

Venture capital companies are professionally run investment companies that take positions in start-up and expanding business that have potential for future growth. Generally, these are businesses that have a risk level not attractive to traditional lending sources such as commercial banks. Venture capital companies most often invest in the form of equity and one must expect to give up a significant portion of the business.

An often-used source of financing is the private stock offering, generally referred to as a "private placement". This mechanism is designed for small groups of investors to participate in a venture of limited size. The private placement is generally quicker, less cumbersome and less expensive than a public offering, but has many pitfalls so contact your attorney and accountant.

Finally, a restaurant company can participate in the public equity markets or "going public". A restaurant company can raise money by selling stock to the public in the form of an initial public offering (I.P.O.). While it is possible to raise large amounts of money this way, the state and federal regulations can be very complicated and the process can be quite expensive. Again, consult your attorney and accountant.

What is the best way to obtain the financing? Should the services of a broker or investment banker be used? What are the advantages and disadvantage of going it alone?

Just when you were beginning to think that financing a restaurant is just too complicated, it is time to step back and review your situation. Where are you in the process? Is this a start-up, expansion of existing space, a single-unit operation ready to open additional stores or a chain seeking expansion in new geographical markets? Whichever case applies, the steps remain the same. First, determine the ownership structure, value the business and write a business plan. At that point, one can determine the financial structure and the source from which to raise money. Remember, financing a restaurant can be complicated and have many adverse repercussions so confer with your restaurant consultant, attorney and accountant.

Paul Fields is a principal of Restaurant Development Services, Inc., a financial services firm providing contract CFO assistance, business plan preparation and placement of financing to the restaurant community. Fields has more than 18 years of financing and consulting experience. He can be contacted at paul@restaurantdevelopment.com or 301-263-0400.

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