Who among us hasn’t at least flirted with the dream of owning a restaurant at some point? If you’re beyond daydreaming and you’ve decided to enter the highly competitive restaurant industry, one of your most important tasks will be securing adequate financing.
Opening a restaurant is challenging, especially for people who are new to the business. About 60% of new restaurants fail within a year of opening, according to CNBC, and almost 80% go out of business by their fifth year.
You’ll stand a better chance of succeeding if you understand what your financial needs are, says David Gilbert, the founder and CEO of lender National Funding.
“A lot of people get loans that aren’t large enough,” he says. “Most businesses fail because they are undercapitalized.”
Adding Up Your Costs
There are numerous things to spend money on when you own a restaurant. You’ll need enough capital to pay your lease, buy equipment, pay a staff, and buy supplies. You’ll also need to factor in the cost of signage and promotion to make sure customers know where to find you.
“A new business owner has to understand the fixed and variable costs of running their business, estimate how many customers they will get and the capacity they have,” says Chris Moloney, the chief marketing officer and head of products at CAN Capital, an online lender. “It takes a fair amount of financial understanding.”
There are a variety of ways to raise the money you need. One of the easiest ways is to tap into your own resources. You’ll save money by avoiding commercial loan interest rates. Your resources may include personal savings, borrowing from a 401(k) retirement plan, borrowing against a life insurance policy, seeking loans from friends and family members, or tapping into home equity.
“Home equity is the primary form people use to finance a small business, especially restaurants,” says Gilbert.
Finding Restaurant Loans
Restaurateurs often seek small business loans from banks and other commercial lenders. To qualify, you’ll need to show that you’re a good risk. This means having adequate experience in the industry and a good credit score.
Be prepared to explain what collateral you’re willing to put up to get the loan. This may include a home, a car, or restaurant equipment.
You’ll have to convince your lender that you’re prepared to make a success of your business, says
Meredith Wood, vice president of content for Fundera, an online lending marketplace. Lenders want to know exactly how you plan to spend the money they loan to you.
Developing a Business Plan
Before you go in search of a loan, you’ll need to develop a business plan that demonstrates that you know how to make your business successful. The plan should explain how you’ll earn enough to repay the loan.
“If you are a start-up, the business plan and personal financial history are very important,” says Wood.
In addition to having a good business plan, banks and other lenders typically will require you to put some of your own money into your business. If you have a financial stake in the enterprise, you’ll be less likely to walk away from your debt.
“You are going to think more strategically about how you spend,” explains Wood. “Putting your own money in is a good way to force yourself to think that way.”
Weighing Your Choices
Finding a restaurant loan may be easier if you visit a lending institution that participates in U.S. Small Business Administration (SBA) programs. The SBA guarantees small business loans against default. This makes lenders more willing to take on risk and frees up money for borrowers. SBA loans are made through banks, credit unions, and other participating lenders.
In some cases, entrepreneurs seek high-worth investors or venture capitalists to provide start-up funding for restaurants. However, this can mean surrendering some degree of control over your business, depending on the terms of your investment agreement. You may need to hand over a share of your business in return for the cash.
Venture capital firms typically expect a high return on investments. Wood advises borrowers not to turn to investors unless it’s absolutely necessary.
“For the average small business, investors don’t make sense because they don’t want to give up ownership,” says Wood. “They just want to open a restaurant. That is what they aspire to.”
Making a Wise Decision
Whatever method of financing you choose, be certain that it’s one you can live with over the long term. Make sure you end up with a loan you can actually afford to repay, or investment partners you truly want to work with.