A plain-language guide to restaurant financing on the smaller scale.

Restaurants and Institutions

Allison Perlik
Senior Editor

Collection analyst Diane Henriquez and legal secretary Diana Rivera believe they have what it takes to kick off a new career as restaurant operators. They've signed a franchise agreement with The Buttercup Bake Shop in New York City, scheduled a five-week training period and are prepared to leave their current jobs. Now all they need is $400,000.

"We're going to talk to several banks and see what our options are," says Henriquez, who will work with Jennifer Appel, Buttercup's founder turned franchisor, to seek a minority business loan to open the store.

Without any foodservice experience or funds of their own to contribute, first-time entrepreneurs Henriquez and Rivera likely will face some hurdles in their search for financing. Working in their favor, though, are a number of options meant to help open doors for operators of all kinds, from small-scale franchisees and independents to startups and growing chains.

Some investors are more amenable than others when it comes to new or early stage foodservice operations. Limited partners, "angel investors" and the U.S. Small Business Administration (SBA) are among the most receptive resources, while traditional banks, private equity firms and venture capital sources can be less within reach. In between are credit cards, home-equity loans or lines of credit, and loans or investments from friends and family. For many, a patchwork of funding sources is the most realistic approach.

Regardless of the type of financing sought by would-be restaurateurs, those who pledge their own assets are the most attractive prospects. And whether it comes from time spent managing, serving or cooking, foodservice know-how counts as a big plus.

"Without a doubt, industry experience is the biggest selling point," says Dennis Max, a veteran of chain and independent restaurants who is expanding his Boca Raton, Fla.-based Max's Grille concept in that state. "The advice I give is to keep it as simple as possible, do something within your budget and don't tackle a huge enterprise [if you're just starting out]."

Take It to the Bank
Banks, often the first stop for prospective business owners, are a good starting point for potential restaurateurs as well. Although they rarely grant direct loans to high-risk ventures such as restaurants, banks can direct clients to a number of resources.

For candidates who don't meet a bank's credit criteria for personal or commercial loans, the institution often recommends the SBA. Not only does the government agency provide lenders safeguards by offering a partial guarantee on loans, it also can help establish longer loan terms with smaller payments. To be eligible, restaurant companies must have average three-year annual sales at or below $6 million.

Available amounts range from $25,000 to $2 million, says Director of Loan Programs Jim Hammersley, with interest rates that typically run two points over prime but may be higher or lower depending on individual circumstances. Personal guarantees are required.

"More than 50% of [our franchisees] go to the SBA—at least for their first loan. They are open to helping people out, especially minorities and women, and their rates and terms are very good," says Joe Arancio, vice president of business development for Ronkonkoma, N.Y.-based CoolBrands International, franchisor of such brands as Bresler's Ice Cream & Yogurt and Tropicana Smoothies, Juices and More!

In restaurant business plans, the agency looks for information about the potential market, menu prices and food costs as well as all the details in between, from utilities and rent to permits and manager certifications, Hammersley says. Experience carries a lot of points, he adds, but "everyone has a chance."

Aside from SBA-backed loans, entrepreneurs often tap banks for home-equity loans or lines of credit, which can be simple to obtain and faster than the typical SBA waiting period of two to three months. It's often the method of choice for those just getting started in foodservice, such as new franchisees of two-unit-and-growing chain 2 Scoops Cafe in Orlando. Founder and President MaryAnn Kilgallon, who expects to add at least eight more stores this year through single-unit operators, says lower interest rates and quick returns make home equity appealing to franchisees seeking financing. Interest payments on such loans typically are tax-deductible as well. On the negative side, however, is a significant risk: If the venture is a bust, the borrower could lose not only her business, but her home as well.

Two Heads Better Than One
When independent restaurateur Frank Taylor opened his first two concepts, he relied on a commercial loan for one and an SBA loan for the other to fill the gap not covered by investors. Now owner of a third restaurant, the fine-dining jazz supper club Seldom Blues in Detroit, Taylor believes partners attracted by a well-executed business plan are the best way to go. "Partnerships are better than having a note to the bank," he says.

Though many operators turn first to friends and family as investors, industry experience paired with a first-rate idea can create a deeper pool of potential partners. Such was the case for John Parlet, president and CEO of John's Incredible Pizza Co., a six-unit chain based in Lake Forest, Calif. After opening his first three stores on a combination of SBA loans, help from friends and his own contributions, Parlet met the owner of an independent grocery store chain when looking at a piece of property. Based on the restaurant's existing units and Parlet's formal presentation of his business plan, the grocer came on board as a silent partner, providing full financing in exchange for an equity position and substantial performance-based returns.

Connecting with willing investors need not be left to chance. More restaurateurs are capitalizing their dreams of first-time ventures and multi-unit growth with help from "angel investors." Working in networks or on their own, these high-net-worth individuals fill the gap between self-funding and higher levels of venture capital by providing their own funds to new or growing enterprises.

"Appealing to the big boys [such as venture capital and private equity firms] is really difficult for an early stage brand," says Dan Rowe, president and CEO of Alexandria, Va.-based Fransmart, which advises emerging chains on growth issues, including financing. "There are a ton of angels out there who write checks between $50,000 and $250,000 apiece. It doesn't take long to find 10 of those people [to fund franchisors and franchisees]."

Part of a 100-member angel investor network himself, Rowe says such partners are getting easier to find. An Internet search for the term returns a surplus of sources and information. Business contacts such as lawyers, accountants, venture capitalists and even customers can offer leads as well.

Whether angels, colleagues or friends, partners can lend some level of complication to a business's operation. Veteran venture capitalist Mark Saltzgaber, now an independent advisor to restaurant companies looking to finance development and private equity firms seeking restaurant-industry investments, says that while the partnership route brings fewer risks than taking on debt, the method works best when total ownership is not vital to the founder.

"If you have a concept that you are going to expand and ultimately raise equity in, then ownership dilution is a big issue," he explains.

Industry financial consultant Jim Parish, president of Parish Partners Inc. in Portland, Ore., says the advantages of bringing on partners—capital access, risk transference and industry know-how tops among them—outweigh negatives such as possible control issues and the potential for costly buyouts down the road. To protect themselves from drawn-out negotiations later, he says, entrepreneurs should be sure to structure exit strategies into their original partnership agreements that clearly delineate terms for buying out limited partners in the event of the sale of the business or its repurchase by the original owner.

Nontraditional Options
Partnerships and loans make up the bulk of new and early stage restaurant financing, but paths less traveled can work just as well.

Shocked to be turned down for bank loans despite her sparkling credit, 2 Scoops owner Kilgallon used money from family and her own resources before turning to an increased credit line from her longtime local credit union for the rest of the capital she needed for her first two stores.

First-time restaurateur Rika Horie found her own unusual solution when funds ran out on her already-under-construction space in West Hollywood, Calif. Bargaining with her landlords at the newly built retail complex, Horie agreed to pay higher rent to help increase the area's value in exchange for a substantial loan that allowed her to open upscale French-Japanese concept Rika Restaurant & Diamond Lounge in September 2004.

For their part, franchisees can benefit from signing on with companies willing to play active roles in helping them find capital. Martin Sprock, founder of seven-concept, fast-casual company Raving Brands in Atlanta, travels around the country to familiarize potential franchisee-funding sources and landlords with his emerging brands and sell them on their chances for success. The Scottsdale, Ariz.-based Kahala Corp., franchisor of seven quick-service brands, is exploring the logistics of creating an internal fund financed by share-holders to provide capital to its veteran franchisees.

"We have a much better idea of their ability to pay back any loan than a traditional banker would, and we can match them with money much faster than the bureaucracy of traditional lenders," says Chairman and CEO Kevin Blackwell. "We see it as a way to offer one more service to the franchisee."

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Loan Apps: Getting It Right

• A personal introduction goes a long way at any financial institution.
• Get multiple copies of forms so first-timers can practice with mock applications.
• Anticipate more time than you think to get capitalization together.
• When in doubt, provide extra information versus the minimum required; don't hesitate to call and ask questions; and provide as much detail as available.
• Make sure any supporting documents are complete (tax returns, appraisals, etc.).
• Provide good contact information so any questions a lender may have can be addressed quickly.
• Identify and make copies of key items (tax returns, financials) early so you are not looking for them later.