One unfortunate but inescapable fact for anyone hoping to open a new restaurant is that restaurant owners historically have had difficulty obtaining financing. It takes a great deal of startup capital and operating funds to open the doors of a new restaurant and keep it going until it produces a reliable income stream and becomes profitable.
Unfortunately, many new restaurants never make it to that point. The failure rate of new restaurants is nowhere near the 90% you sometimes hear about, which is based on some old, flawed research.
A 2014 study found that the first-year failure rate for new restaurants is actually only about 17%, which is in the same ballpark as early failures for landscaping and real estate businesses.
Apparently that news hasn’t caught up with lenders yet, as many of them are still notoriously quick to turn down restaurant business loan applications from restaurants, particularly for start-ups and relative newcomers.
What Do You Need the Money For?
The truth is that aspiring first-time restaurateurs aren’t the only ones looking for restaurant business loans. Established eateries also need financing, to upgrade their kitchens with new equipment, redecorate the dining areas, remodel an entire restaurant, or add a second or third restaurant to a growing culinary enterprise.
Industry experts recommend that ever restaurant undergo a facelift every five to seven years. That alone creates a large demand for restaurant business loans.
There are many reasons why a restaurant business loan might be needed to provide working capital, and some of those reasons suggest a specific kind of financing, most notably equipment and inventory financing.
Perhaps your need is to buy new kitchen equipment. That can be a very expensive proposition. A recent industry survey pins the average amount spent on kitchen and bar equipment for new independently owned restaurants at $115,655.
The same survey found the average cost to do a complete remodel of a 1,000 square foot bar and kitchen to be around $75,000. Simply installing a high-end commercial stove can cost as much as almost $50,000, though the average price range is $1,500-$10,000. That price range can be lower if you lease equipment rather than buy it or purchase gently used equipment rather than new.
One option for restaurateurs installing or renovating a kitchen is equipment financing. When the purpose of a restaurant business loan is equipment financing, you should be able to finance up to the full value of the equipment because the equipment serves as collateral.
Equipment financing loans are often designed to spread the amount borrowed over the expected life of the equipment. That can mean that by the time one equipment loan is paid off, you’ll need another one to replace the pieces that have become obsolete or have worn out by then. Bear in mind that equipment financing can also have tax implications in terms of how new equipment is depreciated.
Equipment suppliers often offer their own financing, and may do so for restaurant owners you don’t qualify for a loan from a bank. The application process is quick and simple, and typically doesn’t require an in-depth credit investigation.
The trade-off for easier credit comes in the form of higher rates and fees and limitations on what brands can be purchased using supplier financing.
Another common reason to seek a restaurant business loan is to cover the cost of food. In 2014, the National Restaurant Association found that the cost of food was considered to be a moderate or significant challenge by nearly three-quarters of table-service restaurant owners surveyed.
This is another case in which the items you purchase serve as collateral for the loan, though that applies primarily to non-perishables like wines that have resale value. Nobody is going to consider fresh fish or lettuce as good collateral!
Inventory financing is typically accomplished through short- or medium-term loans or a line of credit designated specifically for purchasing inventory.
Restaurant Business Loan Options and Providers
Traditional and nontraditional lenders alike offer a number of options for obtaining funds for working capital or for special purposes, such as purchasing equipment and inventory. There are secured or unsecured loans with short-, medium-, or long-term repayment terms and lines of credit.
Even loans secured by equipment or inventory can be difficult for restaurant owners to obtain unless they have been in business for at least a year and are deemed creditworthy. And unsecured loans require very good credit and a solid sales history. Roughly a third of restaurant owners surveyed by the National Restaurant Association indicated that they found obtaining financing to be a moderate or significant challenge.
Another option for meeting a restaurant’s general financing needs is accounts receivable financing, also known as merchant cash advances or factoring. This type of financing is intended specifically to improve a business’s cash flow.
Accounts Receivable Financing
Cash flow can be problematic in the food and beverage industry, particularly for restaurant owners with poor credit or little credit history. There may be seasonal ups and downs in revenues, and during periods of growth it can be difficult to keep up with expenses and pursue expansion opportunities at the same time.
Factoring has long been an important financing method in the manufacturing sector because of the cash flow issues arising from needing to purchase materials and supplies and cover operating expenses well in advance of collecting payment for products sold. Factoring is becoming an increasingly popular way for restaurants and other businesses in the hospitality industry to resolve their cash flow problems.
This kind of financing differs in some key ways from traditional restaurant business loans. Essentially, factoring gives you money today for future credit card and debit card transactions in exchange for a percentage of sales (usually 2-5%) plus a service fee, which is typically charged monthly.
The amount that the business receives depends on its average monthly credit and debit card sales and is usually somewhere between 40% and 90% of that figure. The company providing those funds is known as the factor and is giving the restaurant owner an advance against future accounts receivables.
When credit or debit card payments come in, they go through the factor. Whatever is left over after the factor’s fees have been deducted, it goes to the restaurant owner.
Because the money the restaurant owner receives is an advance, not a loan, it doesn’t add to the restaurant’s debt burden. Another advantage is that because what you pay the factor is based on a percentage of sales, you won’t be scrambling to cover a fixed payment amount during periods when sales are lower than usual.
And, unlike equipment or inventory financing, factoring imposes no restrictions on how the money can be used. Another key difference between factoring and traditional restaurant business loans is that applying for restaurant factoring doesn’t necessarily require a credit check. There is a downside to this type of financing.
You give up a chunk of your profits, and you’ll pay more in fees than you would with other financing methods. The annual percentage rate you end up paying can be 50% or even higher, much more than the APR on a term loan.
You could also find that your future credit card sales are much lower than anticipated, which can have an effect on how much the factor is willing to advance.
Maybe none of the traditional restaurant business loan or financing options is a comfortable fit for your particular situation. That doesn’t mean you can’t get the funds you need for your restaurant. More and more these days, restaurant start-ups, expansions, and renovations are being funded through peer-to-peer (P2P lending).
P2P lending is essentially a hybrid that combines features of crowdfunding and marketplace lending. Rather than borrow from a bank or other lender, a restaurant owner can seek smaller amounts from a number of individual investors who are looking for a good return on their money.
P2P lenders have been operating online since 2005, matching investors with companies that need to raise cash. Restaurant owners who don’t meet a traditional lender’s credit standards or who would otherwise pay too much in fees are increasingly turning to P2P lending.
P2P lenders use proprietary credit scoring algorithms that take into consideration an applicant’s online sales and banking records and social media accounts when making a lending decision. Traditional lenders aren’t about to give you a lower interest rate for having a lot of positive feedback from Facebook and Twitter users the way that P2P lenders do!
P2P lending is a way for small businesses to obtain the capital they need even if they wouldn’t be able to qualify for traditional types of financing, and to do so very quickly. P2P loans are typically funded within 24-48 hours.
It can take weeks to obtain a restaurant business loan from a bank, and potentially months to obtain a loan from the Small Business Administration. If time is of the essence for taking advantage of an opportunity or meeting an immediate cash crisis, P2P lending may be the way to go.
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