Opening your First Restaurant? Here’s How to Raise Capital
October 10, 2018
Opening up a business for the first time in any industry is difficult. Opening up your first restaurant is even harder. Restaurants are capital-intensive and expensive to build out, and the stabilization period is long and uncertain.
Compared to experienced business owners with a financial history, first-time restaurant owners will have limited access to sources of capital. Therefore, it is very critical that we identify the best resources and restaurant investment structure to help establish and sustain the business.
Despite the challenges, if you have the passion, drive, and talent to make it work, you can create a successful restaurant business.
Building Up a History
The biggest hurdle for first-time business owners is their lack of a track record. Even if you’ve had experience running someone else’s business day-to-day, on paper, you have never been an owner. For institutional capital sources (i.e., banks or private investors), there is nothing to underwrite what you have done in the past.
Because of this lack of a track record, many first-time restaurant owners find that small business loans and traditional debt or equity options are not available to them.
U.S. Strategic Capital (USSC) in Atlanta has worked with a wide variety of businesses seeking capital, including hospitality groups and restaurants. Jan Zalud, managing director and Chartered Alternative Investment Analyst at USSC, has led transactions and capital raises across numerous industries and has seen his share of decks from restaurant owners.
Zalud admits there is a certain “catch-22” for first-time business owners. “They need a proven record of success before they can access the more attractive non-equity capital and loans,” he says. “But it can be hard to find capital outside of those non-institutional sources.”
Most first-time restaurant owners rely on two main sources of capital for their first business: personal resources and capital from friends and family.
“Skin in the Game”
If you believe in your dream, you may need to back it up with some personal assets.
“People want to see that you have everything on the line,” says Zalud. “Someone who has risked their livelihood, who has skin in the game, is showing that they are really committed to making the business work.”
Most restaurateurs start their business with at least some of their own capital. Business owners should first consider their liquid assets, such as cash or marketable securities (bonds, certificates of deposit). After that, they can think about their debt-serviceable assets, such as a car or home refinancing.
Some restaurant owners eye their 401(k) as a possible personal resource. ROBS (Rollover for Business Startups) transactions are marketed by some companies as a way to structure an investment within your 401(k) without the fees and taxes. However, if you or your accountant make one misstep or “disqualifying transaction,” your entire 401(k) can become taxable — even if you only invested part of it.
Most finance professionals would advise caution, but if you really believe in what you’re doing and are determined to use some of your funds from your 401(k), it is better to take out the money you want, pay the penalty fees and taxes, and use it. ROBS transactions are a risky and complicated approach to using 401(k) funds.
First-time owners may need to put their money where their business is, so it is best to carefully research your options and talk to your tax advisor to decide what is feasible for you.
Families, Friends, and Introductions to Friendly Investors
If you need more than just your personal resources for your first restaurant, you can consider non-institutional sources of debt and capital. The most accessible sources of private investment will come from your “family and friends” network.
“At this level, people are investing more in you as a person than your business idea,” says Zalud. Without a business track record, you are banking on your credibility, integrity and reputation within your network. Your first private investors will be people who know you personally.
This can be “a very friendly source of capital,” according to Zalud, with negotiable repayment timelines or creative dividends that are more flexible than traditional capital sources.
Zalud offers some advice about transparency when it comes to personal relationships and investment. Institutional investors may understand there is a risk of loss, he says, but family and friends may not. From the beginning, the agreement terms and possibility of loss should be clearly understood and laid out by both parties.
Friends and family can also provide another valuable resource: introductions to investors a degree or two outside of your network. First-time business owners may be able to find substantial private investment, but these sources will most likely come from a personal connection. Family and friends can help provide that personal introduction that will give you the opportunity to make your business pitch to an investor.
Many first-time restaurateurs also choose to form business partnerships with people in their network, which can take many forms.
Frequently, a chef or restaurant manager teams up with a partner who has capital but may or may not be in the restaurant industry. Each individual partnership differs; some partners split responsibilities, and others negotiate employee roles.
Good partnership agreements can make or break restaurants, so be sure to find an attorney who specializes in partnership taxation and structure. Partners should address operational questions, profit and loss allocations, and investor repayments from the beginning.
Common Capital Pitfalls
Finding capital for your first restaurant can be an exhausting, difficult, and drawn-out process. But this shouldn’t stop business owners from trying to avoid some of the biggest mistakes in capital-raising.
Mistake #1: “Giving away gold”
The most common mistake first-time restaurant owners make? Giving away too much equity, or “too much of the ranch.” Although it is tempting to give away equity to get the capital necessary to open up the doors of your restaurant, ownership is gold if it is successful.
Having many partners at the table can also make it difficult to adapt and grow in the long term. Maintaining complete or nearly-complete ownership of the company leaves restaurateurs with more flexible options, as long as they fulfill debt and profit sharing agreements.
Instead of giving away equity, restaurant owners may structure “friends and family capital” more like debt. Individuals who know you personally probably aren’t investing strictly for equity; rather, they are giving you money because they like you and your idea.
This flexibility can be used to enable more debt financing, similar to what restaurateurs could get through a small business loan (if they had a track record). For example, rather than offering a stake in the company, you could offer to pay back friends or family on a quick timeline with a good interest rate.
Some businesses also add an “equity kicker” of a profit share, referred to as “carried interest” in the industry. Investors rewarded with the profit share don’t actually own equity; rather, they share a slice of the profits on top of the equity in your company.
For major investors interested in your business, equity can still be on the negotiating table. But most business owners find it best to keep outside equity in the single digits.
Mistake #2: Underestimating working capital
First-time restaurant owners may focus on the capital needed to open their doors, but they should also be planning for working capital once the restaurant is operating. Zalud recommends that first-time restaurants include working capital in their initial capital projections, “enough to cover them for quite some time.”
A fund of working capital is “essential” for fledgling restaurants, says Zalud. “In the beginning stabilization period of a restaurant, they will probably have a spotty cash flow and few assets besides kitchen equipment, which depreciates pretty quickly.”
Without working capital, you can run into unexpected issues that can halt operations, or you may not be able to quickly adapt to a changing marketplace. It is harder to get capital when you’re in a financially weak position, and restaurants with a short business history will need to be even more proactive.
Go for It!
While finding capital for your first restaurant may seem like a big task, it is possible. Many experienced business owners describe their first-time foray into business as a “pulling yourself up by the bootstraps” process. However, with the right resources and approach, you can open the doors to your first restaurant. Get the expertise and advice to set up a restaurant investment structure that’s right for you.