With restaurant industry sales projected to be $899 billion in 2020, it’s not surprising that potential business owners are searching for ways to get a loan to buy existing restaurant establishments. By purchasing an established restaurant, business owners can avoid the high failure rate in the first few years common among all start-ups. A going concern restaurant has an established customer, employee, supplier, and operational base that reduces risk over start-up restaurants.
In this article, we discuss some myths about the restaurant industry, how to prepare for business loan inquiries, and some commercial financing options to consider.
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Myth of Restaurant Failure Rates
There’s a common myth that 90% of restaurant start-ups fail withing the first year, but there are no studies to support that assertion. In fact, a 90% failure rate would cause a year-to-year reduction in the number of restaurants, but this isn’t happening. According to a Cornell and Michigan State University study over a 10-year span stated that:
- 27% of restaurant start-ups fail within the first year
- 50% of restaurant start-ups fail within three years
- 60% of restaurant start-ups fail within five years
- 70% of restaurant start-ups fail within 10 years
The percentages above are in the range of total small business failure rates. According to the Bureau of Labor Statistics, small businesses launched in March 2009 faced similar success and failure rates:
- 23.3% of small businesses failed within the first year
- 40.1% of small businesses failed within three years
- 49.9% of small businesses failed within five years
- 65% of small businesses failed within 10 years
Many traditional commercial lenders cite the high risk of failure within the restaurant industry as justification for denying business loans. The first hurdle for those looking for a loan to buy existing restaurant operations is overcoming the mythology behind failure rates in the food service industry.
How to Prepare for a Restaurant Business Loan Application
It’s important for potential restauranteurs to do their homework before applying for a commercial loan to buy an existing restaurant. It can be difficult to obtain a business loan for those who don’t prepare. The following are some tips that may help streamline the loan application process.
- Obtain the Restaurant’s Financial Statements
Try to obtain three to five years of the restaurant’s financial statements or tax returns preferably audited. The first step is to make sure the restaurant is currently generating profit. The second is to look at revenue and profitability trends. Are sales increasing or decreasing over the five-year span? Are profits rising or falling? Are costs increasing faster than sales and profit?
You’ll need this information to not only negotiate the purchase price, but to build a comprehensive business plan.
- Ask for Detailed Cash Flow Statements
You may or may not receive cash flow statements as part of the financial statement package. Cash flow is the lifeblood of successful businesses. It’s important to demonstrate to commercial lenders that there’s enough cash flow to pay the bills as well as the business loan.
- Location, Location, Location
We’ve all heard that location is an important component of a successful business. If sales of the targeted restaurant are declining there may be obvious reasons. For example, a highway bypass may result in lower traffic. Or a major business in the area has closed. Make sure the lease is transferable. Investigate thoroughly.
- Why is the Restaurant Owner Selling?
Restaurant ownership is hard work with long hours. It may be that the owner wants to retire, lost interest, or it’s not economically viable. Study the financial statements and compare to the owner’s reason for selling. Perform a thorough due diligence. It’s important to understand the big picture when applying for a loan to buy existing restaurant ventures.
- What is the Condition of Appliances and Equipment?
It’s important to understand the value of appliances and equipment. There’s a greater chance of older equipment breaking down and needing replacement. Having to replace revenue-generating equipment can severely impact future cash flow. It’s wise to get an independent appraisal from an expert.
- Does the Restaurant Have a Good Reputation?
It can be difficult to overcome a bad reputation even with new ownership. Perform an online search for restaurant reviews. Check the Better Business Bureau for red flags. Ask family, friends, and co-workers if they’ve eaten there and what their experience was like in terms of food and service. This is also a good time to consider whether it’s more beneficial to keep the restaurant’s name or rebrand under a new one.
- Is the Liquor License Transferable?
Alcoholic beverages can be very profitable. Make sure the liquor licence is transferrable and ask about applicable fees.
- Check for Liens, Claims, Health Code Violations, and Lawsuits
A thorough company background check will turn up any red flags on the restaurant. It’s possible to perform a background check yourself, you may want to engage with a commercial lawyer for a thorough analysis.
- Create a Staffing Plan
Compare current staffing to similar restaurants. Research optimal restaurant staffing within your niche.
Will you be keeping current staff? Will you be employing family members? What role will you play? Are you going to be taking a salary? Are current owners receiving a salary? How much?
- Check Your Credit Score
It’s wise to get your credit report before applying for a loan to buy existing restaurant facilities. U.S. Federal law authorizes consumers free access to their credit reports every 12 months. Study the report for errors and any outstanding debts that you’ve previously paid. Pay valid unpaid debts. Keep a record of all payments to present to commercial lenders. The credit report may or may not provide FICO scares. Credit Bureau Equifax provides instructions for accessing your FICO score and dispute options.
- Check the Restaurant’s Credit History
Make sure the targeted restaurant is paying its bills. Business credit report services include Equifax, Lexis Nexis, Experian, and Dun & Bradstreet. There’s likely a small fee for access. If the credit report is positive, then all is good. If it’s negative, it’s important to find out why the business is not meeting its obligations. You’ll be inheriting the restaurant’s credit history upon purchase and a negative report can have an adverse effect on future cash flow.
- Will the Owner Sign a Non-Compete Clause?
You don’t want to purchase the restaurant and have the current owner open a new one next door. A non-compete clause will prevent this from occurring in a specific geographical area.
- What is Your Personal Investment?
The value of the purchased restaurant will likely be used as collateral for a business loan. But most commercial lenders insist on a substantial investment from the buyer before approving a loan. Investment funds can be from savings, home equity, investor partner, or even retirement funds.
- Consider Getting an Independent Restaurant Appraisal
There’s a cost to hiring an independent restaurant appraiser. But the exercise can help you negotiate the sell price and get an idea on the value of the assets being purchased.
- Create Proforma Financial Statements
If the steps above are acceptable, then it’s number crunching time. You can do this using a financial projection template like the free one from the Corporate Finance Institute (CFI). Or you can engage a financial accountant that specializes in commercial finance.
- Prepare a Detailed Business Plan
At this stage, it’s time to put your research, financial forecasts, and vision into a business plan. Again, there are several free templates online that will guide you through the process. The Small Business Administration (SBA) provides business plan guides. There are also free business plan templates designed specifically for the restaurant industry as well as supporting documentation. You can find restaurant statistics to back up your proposal at Market Realist as well as other online sources. It’s beneficial to consult with a commercial financial expert to create or approve a business plan for restaurants.
The steps above are not a comprehensive list for buying a restaurant. They are preliminary steps to decide if the purchase is worth pursuing as well as provide a well-researched proposal for commercial lenders in order to apply for a loan to buy existing restaurant operations.
Loan to Buy Existing Restaurant Options
There are several ways to access financing to buy an existing restaurant. Putting together a business plan as shown above will increase your chances for success. Commercial lenders like business loan applicants who have thoroughly researched and created a workable business plan. Small business loan options include:
- Medium- to Long-Term Small Business Loans
Armed with a detailed business plan, the first inquiry should be your bank. Traditional commercial lenders like banks tend to lend to those with good to excellent credit scores and a significant down payment. The profitability of the restaurant and your personal work history in the industry can contribute to a positive outcome.
Alternative commercial lenders generally have fewer conditions for approving a loan to buy existing restaurant operations. Interest rates are typically higher than bank rates so be sure that borrowing costs can be covered in your financial plan.
- Small Business Administration (SBA)
If your bank denies a small business loan, then a guarantee from the SBA may allay lender risk. The SBA doesn’t actually lend money, but guarantees loan repayment up to 85% for participating commercial lenders in your area. Requirements include a minimum credit score of 680 and a 10% personal investment. Veterans can qualify for the Veterans Advantage program. There are also specific SBA loan programs for women- and minority-owned businesses.
- Seller Financing
There’s a possibility that the seller will finance part of the sell price or lease the restaurant to you with an option to buy.
- Merchant Cash Advances (MCA)
Merchant Cash Advances for restaurants are primarily used for short-term operating expenses. The loan term is typically less than 18 months. Once you secure business financing to buy an existing restaurant, a Merchant Cash Advance can provide operational funding.
With projected sales of $1.2 Trillion by 2030, purchasing an existing restaurant can be profitable. But obtaining a loan to buy an existing restaurant requires a comprehensive analysis of the business opportunity. There’s still a lot of misinformation about restaurant failure rates so be prepared to present contrary information. Research the opportunity fully and prepare a business plan that shows commercial lenders you’ve thoroughly analyzed the viability of the targeted restaurant. Be sure to consult with financial and legal professionals before finalizing all business acquisitions.