Going Into the Restaurant Business With Eyes Wide Open

Marty Bombenger….KEY WEST & FLORIDA KEYS RESTAURANT BROKER  (305) 310-1982

Even for businesspeople who have been successful in other industries,  opening a restaurant can be one of the most challenging yet fulfilling  entrepreneurial ventures one can encounter. Each year tens of thousands  of people begin the process of creating a new restaurant. Their chances  of success often hinge on how well prepared they are to face the  challenges. Those who approach this business with “eyes wide open” are  often in the best position to ensure the process doesn’t turn into one  of the worst experiences they’ve encountered. Starting and failing at a  business can leave in its wake financial setbacks and personal crises. The purpose of this article is to provide some basic knowledge on why  people succeed or fail when they open a new restaurant and to provide  some realistic benchmarks that you can use to enter or expand into this  multifaceted business. The authors know what they’re talking about. Both are experienced and  successful entrepreneurs/independent restaurateurs, who know the  challenges and rewards of this business. In this article, they share  their advice, informational resources, and words of wisdom of  successful independent restaurateurs.

It’s often said that there’s a thin line between success and failure in  any venture. The difference is not just having the desire or enough  capital or being persistent, all certainly important, but success is  also the ability to understand what you’re getting into at the time  you’re getting into it.

A big advantage current restaurant owners have when they open a new  location is that they’ve done it before. While experienced independent  restaurateurs have a slightly different decisions matrix versus  first-time restaurateurs, there are reference points that are common to  all successful restaurant operations. The major chains have been able  to take these basic techniques and refine them to a level of  sophistication that borders scientific.

It’s important to remember, however, particularly for the first-timer,  that the restaurant business is not all about chains. There is plenty  of room in this dynamic industry for smart independents who can give  the customer a unique experience that will be remembered and talked  about again and again. In fact, according to National Restaurant  Association statistics, 7 out of 10 restaurant operations are still  independently owned and operated. Industry sources also point out that  last year local governments issued 52,000 new restaurant business  licenses. The statistics indicate there are a lot of entrepreneurs  still out there opening their own places. The big question: Should you  be one of them?

It All Starts With a Good Business Plan

You’ve heard it before: The place to start looking for the answer is in  a well-thought-out business plan. This plan is not necessarily for  potential investors (although much of the thought and research that  goes into it can be used later for that purpose), it is to help you  decide if opening a restaurant is something you really want to do and  are prepared to do.

It’s true that with enough capital anyone can open a restaurant, but  that’s not really the point. Anyone can throw money down the drain. We  assume you want the word “profitable” in the list of adjectives that  describe your business. There’s an old saw that says the restaurant  business is about making the customer happy while the business of a  restaurant is about making the owner happy. A business plan helps sort  out how to do both.

This article is not about how to create a business plan. For a good  overview of that process, we recommend that you read “Mapping Your  Restaurant’s Journey: The Fundamentals of Creating a Sound Business  Plan,” RS&G, May 2005. The following will help you form ideas on the  opportunities you might want to grasp and the threats you will want to  avoid when creating your blueprint for success.

Why restaurants fail. Over the last few years several industry-specific  research projects have quantified and helped identify some of the key  attributes of successful restaurant operators. These research studies  can be a great help in not only putting together a business plan but  also help to formulate some of the questions you need to ask yourself  as you compile and consider your restaurant startup options.

The most extensive of these published research articles appeared  in  the August 2005 Cornell Hotel and Restaurant Administration Quarterly.  Titled “Why Restaurants Fail,” it is a must-read for anyone considering  investing and owning a restaurant operation. You can find this report  at http://www.hotelschool.cornell.edu/research/chr/pubs/quarterly/featured/execsummary.html?name=restaurantsfail.pdf. It may seem pessimistic to read about failures while seeking success in  your new restaurant but according to media mogul Sumner Redstone (CBS  and Viacom), “Success is not built on success. It’s built on failure.  It’s built on frustration. Sometimes it’s built on catastrophe.” It’s  better to read about somebody else’s failure and learn about it rather  than experience it firsthand.

The research by professors H.G. Parsa, John Self, David Njite and  Tiffany King provides key insights into what it takes to open and  operate a successful restaurant. The study can offer a reality check on  the clarity of your vision as you plan your new business or expansion  efforts.

In their commentary, several very specific elements of both successful  and failed restaurants are mentioned. While you’ll have to consult the  entire study for the list of the 12 “Elements of Success” and the 21  “Elements of Failure” (the difference in number of items alone can be a  tip-off that it’s easier to fail than succeed), here are some  highlights:

√ A successful restaurant requires a clear concept that drives all  activities.

√ A restaurant’s inability to differentiate itself from its competition  can be fatal.

√ Undercapitalization or poor financial skills are a critical factor in  restaurants but the authors note that in the personal interviews they  conducted that many successful operations have been started for no more  than $100,000.

√ External forces, other than too many restaurants in one area  (restaurant density), are seldom reasons for failure.

√ The ability to balance family and restaurant business time is a key  component of success … and “failure stems in large part from an  inability or willingness to give the business sufficient attention.”

√ Food quality does not guarantee success.

√ Good relationship marketing is common to successful restaurants.

√ Solid record keeping including keeping track of food costs and customers is essential.

These common-sense pointers need to be specifically applied to the  restaurant environment that you are creating, as well as the  fundamental financial numbers that go into making a restaurant a good  investment. That’s what we’ll talk briefly about now.

Keep your eyes on the numbers. There are two basic financial terms  anyone starting an independent restaurant must understand: Return on  Sales (ROS) and Return on Investment (ROI). These often-confused terms  are particularly important and vary greatly depending on what type of  operation you’re going to start.

These and other important financial formulas were discussed in the  article “Rules of Thumb” and they’ll play an  important role in many of your basic financial decisions.

“Return on investment” is, as the name says, the amount of money you  can expect to be returned to you for each dollar you put into your new  restaurant. Most experts agree that a successful restaurant should  return its original investment in three to four years. That would  equate to a 33 percent to 25 percent ROI.

“Return on sales” is simply the percentage of return you receive on  your sales volume. Restaurant ROS normally ranges from 2 percent to 12  percent or more. An excellent source for these types of numbers can be  found at the National Restaurant Association with its “2006/2007  Restaurant Industry Operations Report.” You can order the NRA survey by  calling the association at (202) 331-5900 or going to its Web site at  www.restaurant.org and clicking on the “Industry Research” button.

The difference between these two numbers is substantial and  understanding it can make a big difference in attracting potential  investors to participate. ROI is very attractive while ROS percentages  can be captured in much safer government bonds.

There are other critical numbers featured in the January 2007 “Rules of  Thumb” article that offer important insight into the financials you’ll  need to calculate as you look at the business side of your startup.  Here’s a brief review:

Sales-to-Investment + Annual Sales/Startup Costs

Leasehold: Sales-to-Investment should be at least 1.5 to 1 ($1.50 sales  for each $1 invested or, if you’re investing $500,000, you need sales  of $750,000).

Own Land & Building: Sales-to-Investment can be $1 to $1

Sales per Square Foot

At sales levels of $150 to $250 psf (per square foot) for full-service  and $200 to $300 psf for limited-service, restaurants with effective  cost controls may begin to approach break-even. At sales levels of $250  to $325 psf for full-service and $300 to $400 psf for limited-service,  restaurants may see moderate profits defined at 5 percent to 10 percent  of total sales. High profits can be defined as sales levels of more  than $350 psf for full-service or $400 psf for limited-service.

Food Cost

Should range from 28 percent to 32 percent but there are exceptions on  both the high side for steaks or seafood at 38 percent-plus or pizza at  20 percent or less.

Other Costs & Expenses

· Liquor Cost – 18 percent to 20 percent.

· Bottled Beer – 24 percent to 28 percent.

· Draft Beer – 15 percent to 18 percent.

· Wine Cost – 35 percent to 45 percent.

· Soft Drinks – 10 percent to 15 percent.

· Regular Coffee – 15 percent to 20 percent.

· Specialty Coffee – 12 percent to 18 percent.

· Iced Tea – 5 percent to 10 percent.

· Paper Costs – About 4 percent (as a percentage of total food sales.  This figure applies to quick-service restaurants only).

· Total Payroll Costs – 30 percent to 35 percent full-service; 25  percent to 30 percent limited-service.

· Hourly Employee Gross Payroll – 18 percent to 20 percent  full-service; 15 percent to 18 percent limited-service.

· Employee Benefits: 5 percent to 6 percent of total sales.

· Prime Cost (payroll + cost of sales) – 65 percent or less for  full-service; 60 percent or less for limited-service.

· Rent Cost – 6 percent or less.

· Occupancy Cost – 10 percent or less.

Business Value Calculations

· Gross Sales Method – 38 percent to 42 percent of gross sales. · Cash Flow Method – Three to four times net income before  depreciation, debt service, owner compensation.

Know Your Entry Points

As a prospective owner/operator, there are several ways to get into the  restaurant business. Here are brief descriptions of the primary options  available.

You can develop a new concept from scratch. Entrepreneurs with  restaurant experience, especially those with a creative flair, often  want the challenge and freedom to create their own restaurant from the  ground up.

Typically, this path entails the most startup cost and risk. Often new  concepts are developed from the perspective of what the owner likes,  with little regard to analyzing the demand for a particular type of  concept within a particular geographic area. Building a concept around  the preferences of an owner alone has proven to be the kiss of death to  many an upstart restaurant venture.

Notwithstanding the inherent risks above, developing a restaurant from  scratch and making it a success is possible. The owners who do it right  find a way to converge on an appealing concept in the right market at a  good location with the right ambience and environment. Sure, there are  many other factors that influence success but in most  start-from-scratch restaurants these are the essential elements that a  startup operator can’t afford to miscalculate without putting the  venture in a precarious position right out of the blocks.

Franchising a restaurant concept has been a common way for thousands of  people, especially those with limited restaurant experience, to get  into the restaurant business. When you license a franchise, you’re  essentially purchasing a proven business system, managerial know-how as  well as ongoing guidance and support from the franchisor.

Starting out with a turnkey business system from Day One can greatly  reduce the risks of developing a new concept from scratch. For one  thing, with a franchise you can at least find out how successful the  concept has performed in their previously developed restaurants. When  developing a concept from scratch there is no such operating history or  track record to evaluate.

Having already constructed and opened similar restaurants, franchise   owners have a generally easier time estimating startup costs upfront.  In addition, there is usually a shorter development period, which means  a new restaurant can get open and, hopefully, begin operating  profitably quickly. Instant name recognition can also be a big plus. On the downside, franchisees pay for these advantages with an upfront  franchise fee that can cost tens of thousands of dollars plus ongoing  royalties and advertising fees that typically run 6 percent to 8  percent of gross sales.

Purchase an existing restaurant. With hundreds of thousands of  independently owned restaurants in the United States, there are always  plenty of restaurants available for sale. Some of the potential  advantages to purchasing an existing restaurant include access to past  operating history, a shorter opening time with less red tape for  licenses, permits, etc., less startup cost than new development, an  already established customer base and the chance of obtaining owner  financing.

Some of the potential disadvantages include higher repair and  maintenance costs than a new facility, having to overcome a poor  reputation of past management and a lack of documented systems and  procedures to maintain consistency and quality after the previous owner  leaves.

As in buying any business, a thorough examination of the existing  restaurant prior to the sale is essential. At minimum, a prospective  buyer will want an experienced attorney and CPA on their due diligence  team. (See “How to Buy an Existing Restaurant: The Twelve Points of Due Diligence”.)

How Independents Finance Their First Restaurant

In our online surveys, hundreds of operators provided feedback on how  they were able to capitalize their first restaurant. The top three  sources of financing, regardless of the amount of startup costs was,  first, personal savings, then relatives and, third, funds from a home  equity loan. Other popular sources were SBA (Small Business  Administration) loans, one or more investors, conventional bank loans,  seller financing, and a surprising number said they used credit card  financing to fund some part of their startup costs.

Nearly all respondents indicated at least two of the above sources and  many indicated three. In startups of $100,000 or less, the prevailing  sources of funding were from savings, relatives and credit cards. As  the cost of the startup increased to $250,000 or more, bank financing  and investors/partners become more common and in restaurants requiring  $500,000 of startup capital or more, close to half indicated they had  received startup funding from one or more investors/partners.

When asked about the most important lessons they learned in opening  their restaurant, the most common response by far involved the amount  of startup capital needed. Here are just a few of the hundreds of  comments that echoed the same theme:

√ “You cannot have too much money to start.” √ “I would have been in a better position had I borrowed more of the  initial startup cost, and kept my savings account intact for operating capital.” √ “A lot of money does not go a long way.” √ “You need capital. Start with a business plan and borrow more than  you think you will need.” √ “Always find more funds than you think you might need. You will find  yourself using these extra funds.” √ “You never have enough money. Something always gets forgotten. Nothing is easy. Plans go wrong. But it is rewarding when your  restaurant becomes a success!!”

Prospective restaurant owners should take heed that the importance of  accurately projecting startup costs and the importance of securing an  adequate amount of capital cannot be understated.

Survey responses also repeatedly echoed the importance of thorough  planning, the crucial role of having a professional business plan to  secure loan and investor financing and having the right contractor to  handle the construction and buildout process.

We recommend that you read “How to Create Realistic Financial Projections for Your New Restaurant,” a  primer on creating a restaurant financial plan.

A Rewarding Business, but Don’t Just Take Our Word

Particularly to an outsider, starting a restaurant can appear to be, in  ways, an almost insurmountable challenge because of the immense body of  knowledge required and the significant financial exposure that comes  with nearly all restaurant ventures.

However, there are many  enterprising and determined folks who found a way to overcome the maze  of difficulties and create a successful restaurant business. Most of  them wouldn’t think of doing anything else. Here are some comments by  seasoned restaurant owners on what they find to be most rewarding about  owning and operating their own restaurant:

“I really enjoy the creating-community aspect of running a restaurant –  hearing that people enjoy coming to our cafe is very fulfilling. We  donate to a lot of charitable organizations, host benefit events here  and really work at being a community gathering place. That is very  rewarding. “I also enjoy the creative side — designing the restaurant itself,  working with graphic designers on the menu look, managing the  aesthetics of the cafe, working with the merchandise, etc.”

Laile Fairbairn Snow City Café, Anchorage, Alaska

“The most rewarding aspect of my business is watching my employees work  so hard for me to make our places such a success. Without them I would  not have been able to accomplish my goals. I have several employees who  have been with me for all 14 years growing from one location and 11  employees to three locations having 80 employees.”

Darwin Hassen DJ’s Dugout, Bellevue, Nebraska

“I am a high school graduate who works hard and [I’ve] kept my nose to  the grindstone and reasonably clean. My rewards have been recognition  by my family, friends and customers both emotional and financial. I  love the business and hope to continue for another 10 years at least.  This has been my most financially rewarding year. Business is up and I  have a great team in place to continue on.”

Raymond Hottenstein The Olde Greenfield Inn Lancaster, Pennsylvania

“I am very proud of being a producer. I love knowing that our little  restaurant has a big impact on the local community. Being a cog in the  wheel of the community is important to me. But when it gets down to  brass tacks, the most rewarding aspect is knowing that what we do makes  people happy. A good meal, in a good restaurant with good friends or  family or even alone, is sort of an escape from reality and having the  guests leave with a little of that euphoria makes it all worthwhile.”

Michael Passalacqua Angelo’s Restaurant Washington, Pennsylvania

Ultimately, You Have to Decide if It is Worth the Effort

The body of knowledge required of any restaurateur is significant.  That’s one of the attractions of the business. Pulling together all the  elements, from financing to location to menu to service staff is  certainly a challenge but also a reward in itself. These are tasks that  when completed successfully lead to a lot of self-satisfaction and  independence that most other careers simply can’t offer. It’s not hard  work; it’s damn hard work. But joining this fraternity of restaurant  owners with your eyes wide open can change your life in very positive  ways and serves not only your lifestyle needs but adds to the community  you live in. For us, it is worth doing.

Restaurant Startup & Growth

Startup Stats:

How Independent Restaurateurs Capitalize Their Startups

Within the last 18 months, Restaurant Startup & Growth’s official Web  site www.RestaurantOwner.com has had more than 1,000 independent  restaurant owners respond to online surveys regarding the startup  costs* and financing of their restaurants. The responses confirmed what  we had already suspected from our own experiences in the business –  that most independent restaurant ventures require a substantial amount  of upfront capital. However, we were surprised to find that in one of  our surveys, of the 400-plus respondents, one in eight reported they  opened their restaurants for less than $125,000 (see below).

Of all respondents: Total startup costs* for restaurants in leased space: Median (50 percent of respondents above and 50 percent below)            $212,000 Average                                                                                        $460,000


Total startup costs for restaurant owning land & building: Median (50 percent of respondents above and 50 percent below)            $400,000 Average                                                                                        $700,000

Of the lower quartile (25 percent) of respondents who had the lowest startup costs: Total startup costs* for restaurants in leased space: Median (50 percent of respondents above and 50 percent below)            $125,000


Total startup costs for restaurants owning land & building: Median (50 percent of respondents above and 50 percent below)            $175,000

Of the upper quartile (25 percent) of respondents who had the highest startup costs: Total startup costs for restaurants in leased space: Median (50 percent of respondents above and 50 percent below)             $500,000

Total startup costs for restaurants owning land & building: Median (50  percent of respondents above and 50 percent below)             $850,000

Another important consideration that is either overlooked or underappreciated  by first-time restaurant owners is the amount of time it takes independent  restaurants to become profitable. It is common for even experienced chain  operators to budget three to four months of operating deficits after opening.  Even with strong sales, when restaurants are new labor costs as well as food and  beverage costs can be particularly high for several weeks and even a few months  after opening. When sales start out weak, operating deficits can be significant  and can quickly put the restaurant at risk without additional capital. While  difficult to project, it is critical for independent restaurants to consider the  effect of initial operating deficits and have some amount of capital reserved  for this contingency.

Our surveys showed that few new independent restaurants become  profitable immediately after opening:

Number of months after opening to become profitable: Median (50 percent of respondents above and 50 percent below)          12 Months Average                                                                                     18 Months

*Startup costs include but are not limited to the follow expenditures:  land (not included in leasehold case); construction costs (referred to  as buildout or leasehold improvements); Kitchen and bar equipment;  dining room and bar furniture; exterior finishes (landscaping, parking  lot, signs, decorations); interior finishes and equipment (POS, office  equipment, security system, sound system); professional services  (architect, engineering, legal, accounting, graphics); organizational  and development (insurance binders, permits, deposits, menus);  preopening expenses (employee training, menu development, opening  inventory); working capital for operating deficits.