Wednesday, September 21, 2011

Top-Ten Reasons Why Restaurants Fail

#1 Undercapitalization - The Startup Restaurateur's Biggest Issue

This one is Numero Uno and is such a serious problem that it earns the top spot on my list. People often argue about what the most daunting task of opening a new restaurant is. Some say it's finding the right location, developing the right menu, and hiring the best servers. And while all of these are very important to any restaurant's success, they still play second fiddle to being fully funded. Here's why –

Because everything else in your restaurant hinges on you having enough money on hand to cover your operating expenses until you can start turning a profit. 

And most likely, that won't be until after your first year of operation. May sound cruel, but that's the reality of it. Without the dough, you can't pay your distributors on time. This means you've already got hassles when you need to order food. Something you don't want or need as a new business owner. A bad relationship with a supplier can be a huge distraction and cause an undue amount of stress at a time when you really need to concentrate on building your customer base.  In addition to your food costs, you'll also need to be able to cover your lease, insurance, payroll, kitchen equipment, dining room furniture, decorating, municipal licensing, gas and electric, grease and waste disposal, and employee training. Oh yeah, and don't forget about marketing. The Butcher Block Rule says you should allocate the same number of dollars for advertising that you have in your kitchen equipment. Sounds like a lot, but that's a topic for a whole other discussion.

As you can see, all of the things I have mentioned cannot be accomplished without adequate capital. Unfortunately, the startup costs for a new independent restaurant are typically pretty high, and can often run into several hundred thousand dollars when all is said and done. I've seen it done for as little as $80K, but that was in a college town a long time ago. For a franchise, it can easily be a half -million dollar investment depending on what type of foodservice operation it is. Yet, there are still many well-intentioned startups that go into the venture woefully underfunded. Thus, the high failure rate.

Now for the good news: If you really want to own a profitable restaurant, it is still doable even in this economy.  But be sure to have at least six-months of operating expenses in reserve, preferably a year.  Depending on whether you are building from the ground up, doing a makeover on an existing business, or leasing, your monthly costs may vary considerably. 

Monthly Cost
Gas & Electric
$   800
Waste Disposal
$   600
Take a quick look at the chart to the left to see what I mean. For example, if your anticipated monthly costs are $9,800, you should have at least roughly $60,000 of operating cash on hand before you open your doors. This may sound like an awful lot of padding but trust me, your chances without it will be less than the traditional one-in-three estimate of restaurants that make it past the first year.  So, you're probably going to have to borrow enough to make the whole thing fly. But where do you get the money? And exactly how much are you going to need? Banks have not typically been a reliable  source for seed money when it comes to backing a restaurant, so you might have to get creative in your search for financing.  A recent online Business Week article citing H.G. Parsa, an associate professor in Ohio State University’s Hospitality Management Program notes – " Because of the belief that restaurants are high-risk investments, he says, many banks won’t lend to restaurants at all. Typically, the ones that do require would-be restaurateurs to pay sky-high interest rates or put up significant collateral (say, a house) to mitigate the perceived risk (see, Winter, 2007,“Tapped Out”). Ironically, Parsa’s research identified lack of sufficient startup capital as one of the major elements that contribute to a restaurant’s failure—making the myth a self-fulfilling prophecy of sorts. "

One alternative to a bank is to find a small group of venture capitalists who have backed other restaurants before. If you have a strong concept and at least some track record in the business, you might just get lucky. Or, you can use keywords like "restaurant financing" to find many lenders who specialize in only restaurant financing. Some won't work with start ups, but others will. You'll have to do some digging, but before you approach any potential lender about your restaurant, make sure you know exactly what you are trying to accomplish, how much it will cost, and that you have a realistic timetable for how long you can take to pay it all back. Many start-up restaurateurs put their house up for collateral to secure a loan, but this is generally not a good idea. Why? Because if the business fails, you're left holding the bag and maybe without a roof over your head. It also causes a lot of worry at a time when you need to be completely focused on making your business a success. If at all possible, keep your personal finances and your business dealings separate.

You will need  a legal and/or financial consultant anyway, so you might as well start searching for someone you can trust as soon as you begin putting your business plan together. There are many good CPA's and attorneys that can help structure your business to reduce your personal liability in the unfortunate event of a failure. Many restaurant owners pay themselves a fixed salary and are on the regular employee payroll. This is one way to protect yourself, there are many others. Again, find one that specializes in the restaurant business and has a solid understanding of the industry before you enter into any contract with a lender. 

Don't have a business plan? Don't worry. Even if you've never written one before, there are many online resources to help you create one of your own or find a professional business plan writer to help you. Just key in the words "business plan writers" and your browser will yield thousands of hits. The fees range from a few hundred dollars to a few thousand depending upon the length and complexity of the plan, so shop around like you would for any other professional service. 

A well researched and properly prepared business plan will significantly increase your chances of getting the money you need.

Try to find someone who specializes in writing restaurant business plans, as the restaurant biz is in many ways unlike any other animal.

By now you might be thinking of chucking the whole idea of owning a restaurant. For some, that may ultimately be the best decision they can make. But for those who are willing to take on the challenge of owning and running a restaurant, great success and personal fulfillment can still be achieved with  creative financing and a viable business plan. Remember, your restaurant is first and foremost a business and an eatery second, and it should be treated as such. Get the money first, and the rest will follow. 

Next week, we'll tackle the 2nd biggest culprit in restaurant failure, the menu. I can't wait.