How to overcome common restaurant finance hurdles

Tim O'Connor

Nowadays, a great idea and a lot of enthusiasm aren't enough to get a new restaurant up and running. You'll probably need to borrow enough to get you started and in a financially sustainable position.

That's where banks come in. It pays to know what makes them tick—particularly in a tighter economy—and how you can avoid some of the biggest pitfalls to getting funded.

Here's what various bankers have told me over the years when they look at restaurant loans:

1. Poor credit. One banker said that if a business owner has poor credit (which generally means a credit score below 650), he or she they should not even apply for the loan. Instead, work to improve your credit score and open a dialog with your local banker about your project. This will help you understand what the bank will need to approve your loan, a much better approach than applying for a loan, having the loan denied and then re-applying for the loan down the road.

2. Guarantor not strong enough for the loan. A bank loan officer sometimes will suggest that the loan applicant apply for the loan by using the Small Business Association. This brings a level of comfort to the bank because a significant portion of the loan is guaranteed by the federal government, which means that the bank has less risk of loss in the event of a default.

Nevertheless, most bankers do not like this option because the SBA rules are complicated and the agency can be cumbersome to work with. Some of the bankers also say that the SBA rules can change with little or no notice. Finally, the cost associated with this type of loan may not be worth it for a relatively small amount, meaning $350,000 or less.

3. Not enough collateral in the deal. The bank must have collateral to approve the loan. Your loan officer will almost always ask for collateral in the form of real estate. Under most circumstances, this usually means you must be willing to put up your personal home as collateral. In some circumstances, the bank will use a liquor license as additional collateral, provided the license can be readily sold in the marketplace.

You will not be able to use any of the restaurant supplies as collateral as the bank considers them worthless. However, some of the larger banks will put liens on the fixtures in the event these items need to be sold to pay back the loan should the restaurant end up going out of business before the loan is paid in full.

4. Inexperienced operator. Banks will look at your involvement in the restaurant business, including past track record. They don't want absentee owners.

Bankers’ experience has shown them that owners and operators must be engaged in the operation of the business for things to work. If your plan says that you're planning to run the restaurant on a “part-time” basis while you work at another job, then the bank will almost certainly reject your loan application.

5. Owners not willing to personally guarantee the loan. Your bank will want you to have “skin in the game." In general, this means that the bank will want you to be able to prove that you have the ability to put a cash down payment of 20 percent or more into the deal.

Also, as the borrower, you will need to clearly and accurately demonstrate to the bank what you are going to do with the bank’s money. You must show:

• A thorough understanding of the local demographics and spending habits of the residents in the community you wish to operate.
• A detailed analysis of the competition and little to no risk of market saturation. If there is market saturation, you need to prove what is different about your concept that will separate you from the competition.
• Sufficient cash flow to operate well and enough financial strength to endure a slow period in the business cycle.
• How your lease, if any, fits into your business plan and the loan context.

Banks will also pay attention to the professionals you choose to work with when you prepare your business plan. You want to work with the very best people you can afford when it comes to financing a restaurant. This is a horrible place to cut corners. Solid professional advice can be invaluable to you as an owner and it can save you thousands of dollars.

Tim O'Connor is a Boston-based CPA and a member of the firm of Edelstein & Company, LLP. Contact him at [email protected] or 617-478-3426.