Editor’s note: The following is a guest post from Christopher Cornella, vice president of business development at US Professional Funding and US Medical Funding, specializing in business loans for small businesses across all industries. Opinions are author’s own.
The shuttering of our neighborhood bistro, family-run diner, and promising fast casual joints showcases some of the pandemic's fallout. Many blame the economic impacts of inflation, labor shortages and changing consumer behavior. While these factors impact most industries, based on my experience with small business owners across all industries in the U.S., I believe the restaurant industry's most significant challenge comes from a different source. The mainstream lending ecosystem is failing to support restaurant owners.
Most restaurants operate on very narrow margins, with profitability fluctuating between 3% and 5%. Break-even survival of a restaurant hinges on the thinly stretched resources on hand. When a restaurant's walk-in cooler dies, when the annual cash flow of the restaurant switches from a profit in December to a loss in January, or when a landlord requires the restaurant to prepare an additional security deposit for a second lease, restaurants often operate on even thinner margins.
The restaurant may make the decision to close because the owner lacks the ability to secure a $50,000 loan to pay for unplanned expenses. The sad outcome is that the capital is often unavailable when needed.
Restaurant lending is high risk for most traditional banks. They focus on restaurants’ high failure rates, low margins and unpredictable cash flow. When restaurant owners meet the lending criteria, the bank still classifies the loan in the high-risk category. Independent lending operators often meet the bank's requirements of a detailed business plan and a history of secure collateral, but the outcome is the same.
Discrepancy between restaurant operations and banking operations
The issue is the process of lending itself. Traditional bank lending does not accommodate the unique cash flow of businesses that rely on daily credit sales. A business that absorbs the majority of its operating value in equipment and leasehold improvements does not present easily identifiable collateral for a banker’s lending decision.
Running a restaurant bears little resemblance to traditional bank lending requirements. Food and labor costs are typically 60% to 70% of revenues. Many restaurants do 50% of their sales in a four-month summer season.
Restaurants that cater to the downtown office crowd experience a drop in business during the holiday season. These are not indicators of business failure; they are just the nature of the business. Traditional lending underwriters see these variances as a failure to achieve performance consistency, and these variances become the basis for a lending decision denial.
A bank may refuse to lend to a business that accrues a consistent $50,000 sales a month; however, that business would have a greater ability to repay the bank than many businesses that meet a bank’s lending criteria. The restaurant industry is not the problem. The lending processes and qualifications are.
What does smart financing look like?
The financing world has matured a lot in recent years, and there are financing options available that most restaurant owners are unaware of. Working capital loans, business lines of credit, equipment financing and revenue-based financing all serve a different purpose, and finding the right option depends on the purpose of the capital and how quickly it is needed.
Restaurant operators often miss out on equipment financing for restaurant operations. If a restaurant’s commercial oven or refrigeration breaks, equipment financing can cover the cost and the restaurant can pay for the oven in installments by taking a loan secured by the broken commercial oven. A business that is unable to obtain a general business loan is often able to obtain the equipment loan to purchase the $25,000 oven, as the restaurant can’t secure a loan for a business’s kitchen.
A business line of credit is another great option. A line of credit allows restaurant operators to withdraw the amount they need to pay for something and they only pay interest on the amount they withdraw. Closing cash flow gaps with a line of credit is a better option than a high-cost funding advance.
The most important point is finding the financing that meets the need, as the best financing option is often cheaper and more sustainable than emergency options in a cash crunch.
You want to research all your financing options when there is some level of comfort and space as opposed to when you are nearing your limit.
What the restaurant industry needs to understand
Restaurant operators deserve supportive lenders who understand the industry's tempo and risks and see its real potential. It is insufficient for an entire sector of the American economy when all small businesses have the same bank application process and are submitted to the same superficial review.
For independent operators, it is especially important for them to understand that better options are available, that some non-bank lenders are not predatory, and that the ability to identify a trustworthy working capital partner from a predatory one is a valuable skill that should be developed before an emergency makes it unavoidable.
The restaurant industry has the ability to feed everyone in the economy, create millions of jobs and build the outreach of all kinds of communities, from rural and suburban to urban and metropolitan. They deserve financing to help the industry function as it was designed to.
