Let’s face it, obtaining financing for a restaurant isn’t easy. Restaurant loans historically have high default rates regardless of the age of the establishment, something lenders don’t easily forget.
Here’s some insight into how a bank evaluates loan applications irrespective of a restaurant’s point in its life cycle.
StartupsSo how did they find financing? Surveys continually show the majority of startup restaurants – or most businesses for that matter – are funded by a combination of the founder’s savings, loans or gifts from family and friends, credit cards, equity in a personal residence or a business partner with financial means.
Those who are able to obtain bank financing generally have previous restaurant management experience, a well thought-out business plan and some level of cash equity to inject into the business.
Generally, a lender will require a minimum equity contribution of 20 percent of total project costs; however, every lender and every project are different and this amount may be increased depending on myriad factors. Banks want the borrower to have some skin in the game, so the applicant should not ask the lender to finance 100 percent of the costs except in very rare cases.
ExpansionsExisting restaurants looking to expand or add a second location generally will find easier access to bank financing than startups, assuming their current location is operating profitably. Because the business has an established track record, the loan officer is better able to estimate future cash flow and repayment ability.
In addition to historical financial statements, the bank will ask the borrower to prepare cash flow projections for the expanded operation. While the figures in the projections are important, the logic and assumptions behind the projections are likely more important to the bank.
For example, if the projections show increased revenue per seat or lower food costs, additional commentary is needed to explain why the borrower feels these improvements are attainable. Ultimately, the loan officer has to decide how likely it is the borrower will be able to achieve the figures in the budget.
AcquisitionsAn individual may choose to purchase an existing restaurant, which creates a few advantages: an established customer base, existing brand awareness, immediate cash flow and generally less risk.
The buyer must do significant due diligence to ensure all equipment is in good condition, there are no problems with management and the reputation remains solid among customers and the public.
If leasing the property, the buyer should ensure the remaining lease term is adequate or the landlord is willing to renegotiate the lease.
The primary disadvantage to the acquisition strategy is the buyer will pay for the cash-flow stream, which will generally create intangible assets on the buyer’s balance sheet if the business is performing well and is deserving of a purchase price in excess of the tangible assets. This generally increases leverage, and thus risk, and may make the business more vulnerable in the event of a decline in sales or profitability.
In addition to ensuring the historical cash flow of the business can corner the proposed debt, banks will want to ensure the buyer has the managerial experience or skills necessary. Prior operational success is the best indicator of how the individual will fare with the new venture.
Micah Scott is vice president of small-business banking for Guaranty Bank. He can be reached at mscott@gbankmo.com.
