How To Avoid Common Restaurant Financing Mistakes

December 7, 2022

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Avoiding common restaurant financing mistakes comes down to an objective understanding of where your particular eatery stands, what it needs, and what lenders are willing to give you. The restaurant business is risky, after all. A recent CNBC report stated that about 60% of all restaurants fail within their first year, while 80% don’t make it through their fifth. While many factors contribute to a restaurant’s success or failure (location, market fit, seasonality…), small business owners can make huge financial mistakes while seeking financing, and those mistakes can spell doom. This article will explore some of the most common mistakes restaurateurs make when seeking funding and how to avoid them.

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Not doing your research

One of the most common mistakes restaurant owners make when seeking funding is not doing their homework. There are nearly endless funding options available to help cover restaurant costs, from traditional bank term loans and credit cards to online lenders and venture capitalists. Each option has its own set of pros and cons.

Why do you need funding right now? For many entrepreneurs, that’s the first big question that needs a firm answer. Are you looking to hire an assistant manager? Replace the walk-in cooler? Stock up on ingredients or liquor? Are you launching new branding on social media or renovating your dining area? Knowing the parameters of your project leads to knowing the size of the loan you need.

Once you know what you’re doing with your money, you need to ensure that you’re looking for the right loan. Some forms of restaurant financing, like equipment loans, can only be used for equipment purchases, repairs, or upgrades. SBA loans require a precise explanation of your plans, while merchant cash advances, a non-loan type of business financing, are a form of funding that requires no declaration of intent.

Which is best? That depends on your needs, your restaurant, your credit score, and your ability to offer collateral. But make sure to look around. If you’re buying a new ventilation system for the kitchen, you may not want to use a merchant cash advance just because it’s easiest and fastest, for example. There’s a right fit for every project. It’s important to do your research and choose the option that makes the most sense for your business.

Not focusing on the product

You can focus all you want on market research and working capital and interest rates; people don’t come to restaurants to enjoy your business acumen, though. They come to restaurants to eat great meals.

The business side of the restaurant is important to keep the doors open, but you can’t lose focus on the two biggest things that make a great restaurant great:

  • A great staff. According to the National Restaurant Association, about 90% of restaurants employ fewer than 50 people. That means that a guest on any given night is likely to interact with 10% of your team. Is your team well-trained, knowledgeable, personable, and prompt? Do you have sufficient staffing? Are there any bad eggs that create poor first impressions for your customers? Do your managers keep things moving, guests happy, and numbers looking good? Open Yelp and look at any restaurant. The factor most likely to cause guests to declare that they’ll never return is nearly always the staff. Keep an eye on the team.

  • Fantastic food. It doesn’t matter how friendly your staff is if your guests are eating bad food. It’s unlikely that your restaurant will be successful if your energy is focused on everything but the food. Don’t let financial planning get in the way of the experience you provide for your customers. There are ways to save money. But putting poor-quality ingredients or knock-off drinks on the table in front of your customers is a great way to ensure that your financial planning won’t matter at all.

Failing to understand the terms of your loan

Whether you’re taking out a loan from a bank or an online lender, it’s crucial that you understand the terms of the loan before you sign on the dotted line. It can be easy to let the funds hit your account and move along with your business. However, you’ll want to look through the terms of your loan carefully to ensure you don’t create future financial problems for your restaurant. There are a few fees and expenses you will want to consider when you accept the terms of a loan:

  • Interest. Make sure you know how much interest you’ll be paying when the loan needs to be repaid. On top of simply knowing your interest rate, you should also make sure you know if your interest rate is fixed or variable. Will your payments be larger if the Fed raises rates? What plans do you have in that situation?

  • Repayment Terms. How long do you have to pay back the loan? Are your payments monthly, and on what day of each month? Make sure you know the lender’s exact expectations for how they’re expecting to be repaid to ensure you don’t add any additional fees to your ledger.

  • Prepayment Penalties. The longer you carry a business loan, the more money the lender earns via interest. If you pay those loans back too quickly, the lender loses the opportunity to make money, leading to prepayment penalties. If you find yourself in a situation where your business is capable of paying off its business loans, look at whether interest savings is greater than your prepayment penalty to determine if early repayment is the right choice.

  • Late Fees. How stiff is the penalty for a late payment on your loan? Is it a comparatively small amount, like $40? Or is it based on a percentage of your outstanding balance? 

  • Other Fees. Loans have many other fees associated with underwriting. Make sure you know which fees you’re expected to pay, how much they are, and when you’re expected to make those payments.

Make sure you know how much interest you’ll be paying when the restaurant financing needs to be repaid, and what will happen if you can’t make your payments on time. It’s also important that you have a solid plan in place for repaying the loan so that you don’t put your business at risk.

Borrowing the wrong amount

Another mistake restaurateurs often make is borrowing more money than they can realistically afford to repay. Cash flow in the restaurant industry is already a precarious thing. Hamstringing your finances by taking on too large a loan simply exacerbates the problem even if you’re receiving a significant lump sum.

Just because a lender is willing to give you a loan doesn’t mean you should take it—especially if it means putting your business in jeopardy down the road. Be mindful of how much debt your business can handle and only borrow what you need. A business line of credit can be helpful in this regard since you’ll only make payments and pay interest on what you borrow.

On the other hand, being too conservative and not borrowing enough can also be a huge problem. Restaurant financing that doesn’t meet your restaurant’s needs simply adds to the monthly payment schedule without providing a sufficient benefit to justify the application.

Any time you’re considering restaurant financing, think about what would happen if you didn’t get the loan. Would operations continue? Would you still be able to turn a profit? And if you do get the loan, will the increase in income be greater than the total cost of the loan? Generating new business is one key way that a small business loan can help your company.

Make sure that the loan you’re going after is the right size, and that it’ll lead to increased income. That way, the monthly payments don’t cause additional financial headaches instead of solving them.

Not having a backup plan

You should always have a backup plan in place in case something goes wrong with your primary funding source—whether that’s failing to secure a loan or not reaching your crowdfunding goal. Having a Plan B will give you peace of mind knowing that even if things don’t go as planned, your restaurant will still be able to open its doors.

If you take out a significant loan to purchase new equipment to offer brand-new menu items, what’s your plan if your customers reject the pivot? A successful restaurant isn’t going to bet the farm on a single debt-funded project, but you do need to make sure that if your loan or funding doesn’t end up fueling the growth you need, you’ve still got a way forward.

The Bottom Line

Raising capital for a new restaurant is no small feat—but it’s not impossible either. By avoiding these common funding mistakes, you’ll put yourself in a much better position to secure the financing you need to make your dream a reality.

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