Which financing method is right for your restaurant business?
Financing is your first and biggest challenge to launching your new restaurant. You can fund your restaurant using traditional business loans, alternative loans, personal savings, private investors, strategic partnerships and crowdfunding. After that, you need to arrange for ongoing working capital.
Alternatively, if you want to avoid debt or do not have a lot of capital available to you, you can start your business using creative and nontraditional methods.
In order to qualify for funding, you'll need a solid business plan and an accurate budget, plus you'll need to demonstrate that you wisely manage your personal and business credit.
What Are Restaurant Startup Costs?
It varies. Many industry experts recommend budgeting a minimum of $100,000 for a modest restaurant. Experienced restaurant entrepreneurs suggest doubling your budget to cover unexpected costs and ongoing expenses after opening. Some individuals will need as much as $500,000.
As you consider how much money you will need for your restaurant, here are some of the most common costs (your list may vary):
- Business and license fees
- Deposits and lease payments
- Staff wages and benefits
- Employee and sales tax
- Building renovations
- Kitchen equipment
- Front-of-house furniture
- POS system
- Inventory stock
- Kitchen and serving tools
- Working capital
- Marketing budget
- Loan fees
- Debt payments
- Accounting and legal fees
- Opening event costs
Traditional Restaurant Loans
When seeking a loan, banks and investors will ask for your business plan and a detailed budget. In addition, your personal and business credit history will be scrutinized. These lending sources may also consider how much you're willing to invest and the collateral you're willing to put up. Before applying for any type of restaurant business loan or approaching investors, have a solid business plan in place. It is best to have a three-to-five-year financial plan mapped out as well.
SBA 7(a) Loans
These are government-backed business loans and a good place to start when seeking a traditional small business loan. Terms and rates are often competitive, and larger loans are available. The application paperwork is extensive but worth your time, as these loans offer good terms.
Your local bank may be interested in funding a local project that benefits the community. Some individuals find success with local banks rather than national banks, which do not have regional interests. Start with the bank you have your business account with, but you might need to apply at a few banks before you are approved.
An equity partner can be a professional investor, associate or other business. If you've seen a few episodes of "Kitchen Nightmares," you know that partner relationships can be stressful. Carefully pick your equity partners, whether they contribute to daily operations or not. Even if you partner with a family member, get all agreements (including a buy-sell agreement) in writing, and specify payout details as well.
Private investors often don't own part of your company but will likely have a payback agreement instead. You may find one or two large investors, or numerous small investors. If you have several investors, keep in mind that some restaurateurs provide hosted VIP parties and other special events for investors.
Alternative Restaurant Lending & Fundraising Sources
With many new restaurants failing within the first year, obtaining traditional small business funding is challenging. Alternative lending sources include crowdfunding, in which you repay donors or offer them discounted services (or perhaps there's no repayment obligation at all). Some entrepreneurs have found success by first collecting funds through these alternative resources, which they then deposit in their bank accounts to help them secure traditional loans.
This involves accepting investments from several investors or donors. Some are all-or-nothing efforts, so if you do not reach that goal, you have to return the money. Other types give you the funds you raise even if you don't reach your goal. Platforms include Kickstarter, Indiegogo and Fundable.
You will need to self-promote this effort to make it successful. Some people have found that even if their original funding campaign was unsuccessful, they were able to garner attention and capital from other investors.
Alternative lenders, such as Kabbage, OnDeck and StreetShares, offer nontraditional bank loans. However, often they have minimal consideration requirements. Some require, for example, that your restaurant be in business for a specific amount of time (one or two years) and that your annual revenue meets a certain threshold ($100,000 annually). Some alternative financiers are funded by investors who allow the company to make loan choices; others allow investors to choose what projects they put their money into. Interest rates may be higher with these lenders than with traditional loans.
Some websites, such as EquityEats, allow you to offer gift card opportunities to patrons interested in supporting your business. For example, often restaurants will offer a $125 gift card for a $100 investment. EquityEats has reportedly helped restaurants raise $5 million in funding in 2015. Of course, this requires work on your part. However, you could manage a fundraising project like this on your own.
Funding for Working Capital & Expansion
Once you launch your restaurant, you still might struggle to cover ongoing costs and costs for expansion and improvements. For these types of loans, you'll need to show a recent revenue history of your business, and you may be required to have fair credit.
Both installment loans and lines of credit may be available to you. Installment loans require a regular monthly payment to pay back a large payout with interest. Lines of credit are more like credit cards that you use as needed rather than all at once.
Here are few types of loans available to restaurants:
Working Capital Loans
These loans help you cover operational costs such as rent, payroll, inventory purchases, utilities and debt payments. They are intended to cover short-term needs rather than the purchase of assets or extensive expansion. Some businesses have used credit cards, such as American Express Business cards, to help them with ongoing costs, which they repay each month. Carefully review the terms of your loan and keep in mind that many "working capital" loans are often actually merchant cash advances.
These loans help you cover food and beverage costs. You will need to demonstrate a business history to acquire this type of loan, especially considering the fact that food is not long-term collateral. An inventory loan is usually a short-term loan of six to 12 months. Another option is to ask vendors to extend your payments due to net 30, or even net 60, to give you time to build up capital so you can purchase inventory more easily.
Merchant Cash Advances
This type of loan is usually negotiated with your current credit card processor, or you may have to contract with one that will offer you the advance. This type of financial arrangement is based on future sales. Usually the terms involve the processor taking a portion of daily credit card sales until the original advance amount is repaid plus the agreed-upon increase. For example, the company may loan you $20,000, but you agree to pay $25,000 back. The company that provides the advance will want to see that you have sufficient business to cover the loan amount. These loans can often be processed quickly and do not require pristine credit.
This is basically selling your account receivables at a discount in exchange for funding. However, most restaurants are not in the business of selling services without collecting immediate payment. It may be possible if you have catering accounts. However, in most cases, restaurant factoring is actually a merchant cash advance.
Creative Ways to Start With Minimal Capital
Not everyone has access to hundreds of thousands of dollars to start a new restaurant. Luckily, there are other ways to launch your business without a lot of upfront capital. It may not be your dream restaurant, but alternatives can help you save up more startup capital and test your menu items and market. You will also benefit from starting small and honing your restaurant management skills before scaling up.
By keeping your eyes open and being creative, you may find interesting opportunities in your community, such as these:
- Subleasing a restaurant. Not all restaurants provide three-meals-a-day service. You may find an existing restaurant that is willing to lease you the restaurant for services they do not cover, such as breakfast, Sunday brunch, or late-night after-bar (or post-event) service.
- Find an unused kitchen to lease and cater or deliver. Most food safety laws require you to use a professional kitchen to prepare your food, which can be costly. However, you may be able to find a low-cost kitchen you can lease. Some organizations that may lend you their kitchens include churches, private schools and private clubs.
- Start with a food cart or truck. This option is significantly cheaper than starting with a brick-and-mortar restaurant. Food carts are low-cost, but they must be mobile. Food trucks are costly, but you may find an agreeable lease option. Be aware that there are specific local laws you'll need to comply with, and you may also need to rent a commissary or professional kitchen to prepare food items.
- Offer to manage food services within an existing business. Sometimes hotels or event spaces don't fully use their kitchens, or barely use them at all. You can consult with them about managing their kitchens. Be creative: You could manage breakfast and room service for a hotel or grill items for bowling alley patrons. An event space may need help managing caterers, and you could use its kitchen during non-event days for your own food prep.
- Join an incubator or shared-use facility. These services can provide you with commercial kitchen access for a low rate. Many rent by the hour with rates ranging from $20 to $30. Some even come with dry and refrigerated storage space. This arrangement is ideal for food trucks or for preparing items for sale, such as baked goods for a coffee shop.
- Rent kitchen space to create items for direct sales. Some get their start in the food business by selling items such as canned goods, infused oils or fermented foods. You could peddle these items at local food fairs and farmers markets, through local retailers, or online.
- Buy a franchise. This is often costly and requires good credit, but it may give you a solid start in the food business. These arrangements usually come with training, marketing and menus already created. Some offer turnkey options; others require more effort.
- Purchase an existing restaurant. Sadly, many restaurants fail, but you can take advantage of that by purchasing an existing restaurant. You'll benefit from discounted equipment and perhaps even a prorated lease.
- Start a pickup and delivery business. You can start this kind of restaurant with a small space, since you do not need a large dining area. You'll still need to make sure you have use of an approved professional kitchen, though.
- Partner with an existing restaurant. You may find a restaurant that could benefit from your expertise and capital. If you can find a good relationship, it can benefit you and your new partner. This will require some capital investment, but it may cost you less than starting a new restaurant on your own.
Starting a new restaurant is challenging, but it certainly can be less stressful if your venture is fully funded. Many budding restaurateurs use a combination of the above funding options to meet their needs, so don't give up if one financing option doesn't work out. Creativity and good community relations go a long way. Finally, excellent food and service can help you successfully launch your business and attract investors and patrons for years to come.
Image from patpitchaya/Shutterstock. This article was written by Pamela Stevens.