Restaurant and Bar Financing For Dummies

Thinking about getting financing for your restaurant? Look no further! We cover all the major financing options for your restaurant or bar in this post.

This results in a small window for success, and an even small window for the return of investment money or funding capital. On the bright side is, if you do have the right financing option, it can provide you with the battle ammunition you need to win the war against restaurant failure rates. That being said, the first step to the right financing option is to be educated about the funding options that exist.

This post will help you with learning about the options for financing your restaurant or bar purchase. 

In this read we cover a few main financing points:

1. We cover why you should raise funds.
2. When you should raise funds.
3. Restaurant fundraising options.
4. And most importantly, how to evaluate your options.

Now that you have our roadmap, let’s get started.

Read Also: Active Restaurant Private Equity Firms

When Should I Think About Outside Capital?

Restaurant owners think about external funding in various situations. Here is a list of some obvious and not so obvious reasons.

This is not an exhaustive list, but rather just some common reasons restaurateurs have sought out capital for their business. It helps you understand the different scenarios so you can relate to your own restaurant. 

1.  First and most obvious, when you wish to start a new restaurant business or open another location. 

2. You believe your restaurant needs renovation work and some updating. 

3. You are now ready to expand your existing business into new categories like packages goods, home delivery, catering, and so on.

4. Your restaurant needs new equipment, such as a new double oven, dishwasher, walk-in, etc.

5. The restaurant is doing really well and you are thinking about expanding. This could include items like taking over your neighbor’s lease, expanding your patio, or changing the existing floor plan to accommodate seating.

6. You want to revamp your restaurant operations and need an influx of money for things like software, computer equipment, new POS systems, bringing on a management team and other similar items.

7. Also, a smart strategy by some business owners is to create a reserve for unforeseen circumstances 

8. Time for rebranding. You want to say change your restaurant from a “small cute family-owned shop” to “high-end cocktail bar”, that definitely requires some good number of notes stacks 

The nature of these capital funding is innately complex, one lender is quite different than another, and one restaurant business funding is very different from another, likely for varying reasons. Before reading further, I recommend you have a plan of action.

For example, if you wish to invest in renovating your restaurant, have in mind the approximate amount, the time it would take for you to reopen, other resources you would need, additional costs associated with it (for instance, management salaries you will pay through the renovation). When you have thought out a plan along with a logical reason to raise restaurant financing, it quickly becomes clear which path you should follow to raise your desired restaurant capital. 

The next section will cover what possible paths can you venture into. 

What Are My Options?

With a plan visualized, you go on to see your options. There are many ways to realize your plans, from traditional loans to crowdfunding or even getting professional investors on board. All these options come at different costs, with different terms and different complexities.

Therefore, understanding them from a macro point of view and then deep-diving into your ideal choices is a great plan when reviewing your reasons to seek capital. 

This section will introduce you to the most common routes restaurant business owners take to seek external funding. It could seem intimidating at first, but don’t worry, once you are educated, we provide a framework at the end of this post to help you with your decision.

Traditional ‘Brick and Mortar’ Bank Loans

The traditional option for restaurant financing is one that you are likely already familiar with. It is often talked about or mentioned when launching a business, the concept of going to the bank to get a loan to start your new business venture, or leverage up an existing business.

If you have a solid restaurant plan, strong historical financial performance, decent net worth, and a local bank, it may be worth sitting with this local lender to get an idea of your options. 

Some of the benefits for this option include:

• Flexibility to tailor your payback period: Interest-only options, sometimes small minimum payments, different loan options, and the choice to choose a loan you are comfortable with.
• It is a less risky method than selling part of your business to an outside investor and has been a normal approach for years (since the origination of moneylenders).
• Most often, you pay a monthly fixed amount inclusive of principal and interest. This means it is easy to plan out of your monthly expenses and keep a track of it. 

As always there are some drawback to this approach:

• The application process can be very time-consuming.
• With a notoriously high rejection rate, you may have to apply to multiple banks before you can get approval.
• You always need collateral to back your loan. You might have to use your personal assets (such as home, cars, or other valuable assets) or some of the business assets, this tends to increase your personal risk profile, as all your eggs are now in one basket.
• Personal guarantee, after the great recession, banks require a personal guarantee on almost all loans. Meaning that if you default, you still have to pay the money back in the future.
• Failure to pay has real consequences, unlike raising outside capital where investors understand they may lose their principal investment if the business fails.

I often advise this traditional route for businesses already in operation that have a strong financial track record. Banks are notoriously conservative lenders but love a stable business. Opening up a line of credit through a financial institution should be a great rainy day option for your restaurant or bar business.

Alternative Loans (Hard Money Loans)

Usually seen as the last resort when you cannot obtain a bank loan and all other capital options are exhausted, this is another approach to get some financing. Alternative loans or hard money loans are basically taken from lenders such as individuals or non-bank entities.

These loans have notoriously high-interest rates, to quantify the risk associated with your business defaulting on them. Again, these are often negotiable interest rates and if your business is less risky, the interest rate should quantify this. 

They are an alternative to traditional bank loans for multiple reasons. First off, they are traditionally easier to get, assuming you have access to these types of lenders in your network. The requirements from these lenders are less rigid as they are not monitored by the Federal Government as banks are. For example, banks need to see a historically profitable business, owners with strong credit scores and significant collateral before offering you an even small loan. Alternative lenders, these barriers are more relaxed or sometimes completely non-existent. They are also ready to lend based on your business performance potential, plans, and projections.

Additionally, alternative lenders usually charge a higher rate of interest, and this is why they are often not the first lending choice of most businesses. Considering the higher risk they have to take to make their loans, they justify this with the higher interest rates they charge.

Another often overlooked benefit that alternative lenders provide is flexible pay-back options. With the traditional bank loans, you are required to pay a monthly fixed installment, unless it is for a line of credit, which often has different caveats. Failure to pay the monthly expected amount comes with a penalty and/or increased interest rates.

Alternative lenders allow for ebb and flow options. For instance, the payback can often be a fixed percentage of your sales till you repay your loan, or flexibility to pay weekly, quarterly, etc. This allows these lenders to be more flexible in your operational process. 

Some additional benefits include: 

• Usually, an easier and quicker overall loan application process when compared to traditional bank loans.
• Flexibility when it comes to the use of funds. You can use the loans in whatever manner you see fit without much monitoring.
• Many alternative lenders do not require collateral.

On the other side of the coin, some drawbacks: 

• Some lenders could have short track records 
• With the luxury of the flexibility of repayments, a default can lead to really high penalties and compounded interests.
• These agreements tend to be encroaching and may have specific caveats allowing the lender to take ownership of the business if you miss or are late on payments (get a good lawyer to review before signing any agreement).

I consider this a last-resort option and recommend restaurant owners research deeply before they make one of these commitments. Additionally, they should model out if they are able to repay these types of loans. These alternative loans can result in the first step of the death spiral for a business if not managed correctly. Ensure that you can service the interest or the regular repayments.

If you have the options, I always recommend going the more traditional route, even if it means putting business growth off another quarter or two. As the key to long term business success is simply staying in business.

Small Business Administration (SBA) Loans

The US Small Business Administration loans out funds often called an SBA loan. The administration has a vast network of partners and lenders that give out the actual funds (think your local bank), and the SBA provides the guarantee to these lenders that in case the business defaults the payment, the SBA will take over some of the repayment. 

You need to fulfill certain criteria to be eligible for these loans (similar to the bank loans mentioned above). Some of the main points require that you need to be US-based, you have to be for-profit, you need to have substantial equity in the business.

Additionally, they like to see that you have exhausted all other traditional routes with other lenders, before offering you a loan option.

The benefits of the SBA loans include: 

• Overall one of the cheaper options to obtain capital (though not compared the traditional bank loans as the interest rate can be a few points higher)
• Usually, the period of this loan is relatively longer compared to some options (in some cases, even up to 25 years).
• The Small Business Administration forgoes many loan application fees, which is usually a high upfront expense with other types of bank loans and lenders.

Drawbacks to the SBA are highlighted here: 

• The applicants are usually expected to personally provide collateral.
• The application is notoriously long and lengthy, some of them taking weeks to months. 
• Applications are lengthy and complicated. You are required to submit a large stack of forms, financial statements, business plans, and so on. 
• SBA loans cannot exceed $5 million, so little to no flexibility there for larger restaurateurs.

The SBA loan options are a solid choice for a business that does not have the track record to get funding through a normal institution. Your local, regional, or national bank can even help facilitate this loan. Additionally, these banks often recommend them if you are not a fit for their normal loan profile.

This is one of my top funding recommendations.

Crowdfunding

This is an interesting one, as it not only helps you raise funds but also validates the idea with potential future customers. Under this option, you pitch your future or current business plans on an open platform, where individuals, lenders, investors, and anyone can have access. Certain platforms are restricted to accredited investors (high net worth, high earning investors), but most are open to the regular average individual.

If they believe in your plan, they lend you their money in exchange for a return of capital or some type of ownership. As you can see these are very broad criteria as crowdfunding is inherently flexible.

The benefits of Crowdfunding include: 

• The structure is defined by you and the crowdfunding marketplace, making it inherently designed for your best interest (versus other lenders we will discuss later).
• Get market validation from current or future customers.
• These can often be a percentage of revenue or a 2x return of capital, allowing them to be flexible repayment options.

Drawbacks to Crowdfunding are highlighted here: 

• Not a long term capital solution, as it is not a revolving line of credit or a consolidation of debt.
• You have to craft a very strong pitch that relates to the crowdfunding user base.
• The use case is small, as it is great for launching a new venture or an offshoot of a brand, but not for renovating your current kitchen.

Some of the downsides of this approach are it is not suited for long term needs. It could be useful in raising the initial capital for a new idea or to expand to multiple locations, but when you wish to raise money to bring on a management team, or to buy new equipment – these are not convincing crowdfunding ideas.

Additionally, it is a non-private process. Meaning, you might have to divulge detailed information about your restaurant, everything from your plans, strategy, future financials, historical financials, margins and so on.

Family or Friends

Probably the easiest and most popular method out there for raising capital. Little to no paperwork, no red tape, no lengthy approval procedure, no fees, little or no collateral, and of course, none of the hassle. Sounds almost utopian. In reality, it comes with restrictions and you need to iron out the details. Most importantly, you bridge the gap of your personal and professional life, making it hard to unravel the two.

You must establish if these are equity investments, loans, or gifts. Additionally, you must develop term sheets, legal agreements, and repayment plans.

Finding the right friend or family member can also be very challenging, as having the capital is not the only requirement, they must like the terms of the deal and trust you with their capital. It doesn’t stop there, you must keep them abreast of your activity going forward, particularly depending on the structure of the money.

The benefits of the family and friends financing include:

• Quick and simple process.
• Fewer stipulations related to the business.
• You and the family or friends decide on the structure and payback period.

Drawbacks to the family and friends financing are highlighted here:

• Mixing personal and professional can be challenging.
• Finding the right friend or family member that has the ability and desire to lend or invest can be challenging.
• Reporting to a third party at every family gathering or Friendsgiving can be challenging.

The friends and family option is usually a strong choice as it has little barriers to entry. I always caution individuals or partners to be leary of this and ensure their friends and family understand that their money is at risk. These investments or lendings may result in complete loss of capital, no liquidity, and so on and so forth.

Assuming all partners understand and agree upon the risks, can set aside their personal relationship, it is a solid option for a restaurant business at the early stages.

Professional Investors

Professional investors come in many different forms. They could be an equity partner (where they invest some money in your restaurant and get a share of your business based on the valuation of your company and the amount invested). They may or may not contribute to daily operations, in other words, they can be an active or silent partner, depending on your arrangement.

They could also just be private investors, wherein they do not own equity in your business but have a revenue-based payback agreement with you or a loan agreement. 

Side note: You could watch some episodes of “Kitchen Nightmares” and get some idea of how partnership deals could unfold 🙂  

Some benefits of this kind of partnership go beyond money. If you can onboard a reputed, or experienced partner – your business could get an influx of brand name, insights, fresh ideas, guidance, and so on. The downside of this is there are chances of you losing autonomy over your business. For instance, when the partner owns a good portion of the equity in the business, you may need their written approval for certain hires, distributions, or large purchases.

So, partnerships come with their own risks and challenges, but also many opportunities, such as much needed cash to grow the operation.

The benefits of professional investors financing include:

• Can add operational or financial leadership to your team.
• The flexibility of structure, either debt or equity, flexible and negotiable terms.
• A partnership can take the business to the next level if done correctly.

Drawbacks to professional investors financing are highlighted here:

• Must be compensated for the risk, so interest rates or equity may be higher than other options.
• Savvy investors can structure agreements to benefit them solely, leaving the restaurant owner high and dry.
• For equity financing, you need to ensure that you align with the professional investor for the long term (think marriage).

In order to avoid the downside, I recommend that you be in sync with your partner about your primary ownership in the business and have written terms on what you both expect the partnership to look like. Educate yourself on these agreements and also ensure there are mediation options in writing (can avoid a costly legal dispute).

Another key takeaway is that, like a marriage, partners should align personalities and leadership styles to reduce the chance of conflicts. Additionally, set key expectations from both sides. These simple steps will ensure success from the get-go.

Professional investors can be a great resource and really drive the business forward.

Now That You Understand the Options

This list is a good starting point to narrow down your choices. For example, if you think you want a more secured loan, have good credit scores, payback plan and have collateral to offer, and do not really seek insights and experiences – then based on your business size, you can start investigating options for SBA or bank loans.

If you are venturing into unknown territory, say you have a successful Italian restaurant in Nashville but want to now open in New York, the two regions are very different and come with their own unique challenges. Having a successful NYC restaurant owner invest in your plan, guide you, and be partnered in your success for a portion of the equity seems like a great option for you and you should research professional investors in your space. Let this list be a good checkpoint to your plans and then pivot into researching your educated options.

Still not sure what option is right for you?

The next section helps you narrow down the funding options so you can get started on your restaurant financing goals.

How Can I Choose the Best Option for Me?

Check How Quickly You Get Your Capital

Always inquire with your lender about the timeline of when you can expect to get the capital and see if it aligns with your restaurant’s business plans. For example, if the financing you need is to buy new kitchen equipment to replace the broken ovens, but it will take 3 months to fund the capital from your small bank, then this is not the right option for you.

Remember, capital is a tool to accomplish your business goals, make it work for you, not against you.

Compare Total Financing Costs and Term Period

You learned above in the financing section that different kinds of loans mean different cost structures. Find out all your associated costs (payback amount, annual interest rate, upfront fees, penalties, etc.) and compare your options in order to choose the financing option for you.

Weighing the debt versus equity option is the hardest but remember, giving up ownership in the company means you also give up a portion of future profits and distributions. Another factor you can use to compare is the term of your loan. The repayment term is the total time you have in which you need to pay back the borrowed money. See what is realistic for you, rates also differ based on the repayment term, and some deals are more flexible than others.

Evaluating all your options when it comes to financing helps you find the right fit for your restaurant.

Fixed vs. Variable Rates

The amount you pay back consists of your principal amount (actual money loaned to you by the lender) plus some interest that you both agree on or the lender sets. This interest rate could be fixed or could fluctuate for the term of the loan depending on the agreed-upon terms.

Check both your rate options and see which is more affordable and suitable for your restaurant. 

Know Your Lender

The internet is full of stories about lenders pulling a fast one when restaurant owners could not repay on time, like changing rates, charging high penalties, taking over equity, and so on. This goes without saying, but let me repeat, you should have all terms with your lender documented and reviewed by legal counsel (not your sister’s boyfriend’s law student buddy, a really legal advisor).

It is also crucial to do a little research about your future lender. Ask for references, check out his or her reputation, the kind of clientele he deals with, the capital he usually provides, the source of this capital, years in business, and so on. Additionally, if you can find lenders who already invest in the restaurant industry, this is preferred as the understand the nature of your business, the ebbs, and flows (particularly the cash flow challenges of restaurants).

Experienced investors have the operating and expansion experience, industry credibility, and restaurant savvy to help you succeed.

Am I Ready for Restaurant Financing?

By now, you know some of the options at hand, and also how you can choose the most suitable solution for your restaurant.

Now, it is time to tell sell your story, craft the narrative of why you are the best candidate for financing. Share what drives you and your restaurant business, what makes your plans special, crafting a precise yet comprehensive pitch.

Creating that unique selling point of your restaurant and your leadership is the next step in winning over lenders and taking your restaurant business to the next level.