Methods for Raising Money for a Restaurant, Bar and/or Club Acquisition – Part I
Methods for raising money for a restaurant, bar and/or club acquisition is a two part series and in this first part I will discuss the following topics: 1. raising you own money, 2. seller financing and 3. third party financing. The second part which I will discuss in the next edition of Restaurant Rap will include investor financing
1. Raising Your Own Money. If you are fortunate to have your own financial resources this is usually the easiest way to raise money for your investment. A good source for creating liquidity for an investment is to take an equity line of credit from your home as the interest expense is tax deductable. Make sure that you can easily pay back this loan should a worse case scenario occur and your investment becomes unsuccessful. Other sources for raising cash yourself include selling your stocks and bonds and cashing in your retirement fund although there could be stiff penalties for doing so. I strongly recommend to not accept investment money from family member or close friends. The risk factor is so high in the restaurant, bar and club business that there is a strong possibility that they could lose their money and you might not be able to pay them back which will most likely damage your relationship with them in the future.
It is important to maintain good relationships with your family and with your close friends and in many cases it is already challenging enough to maintain good relationships with them without having financial problems muddy the waters. If your uncle invests $50,000 with you and your business becomes unsuccessful and you can’t pay him back this could have a detrimental impact on your relationship with him and the family in the future. I have had first hand experience with this situation and I strongly recommend staying away from accepting investment money from family and friends.
2. Seller Financing. In this case the seller carries back a negotiated amount of the purchase price in the form of a seller carry back promissory note secured by the assets of the business and personally guaranteed by the buyer individually. In California this lien against the business assets is in the form a UCC1 security agreement which is recorded with the Secretary of State and will appear as a cloud against the title of the business should the business owner decide to sell the business before the lien is paid off. This means that if the business fails the seller can take legal action against the buyers and regain control of the business and its assets. For example, lets assume that the selling price of the business is $250,000 with $100,000 cash down at the close of escrow and the seller agrees that he’ll carry back the $150,000 balance in a seller carry back note. Furthermore the terms of the seller carry back note are 8% per annum interest computed from change of possession of the business so as to fully amortize over 60 months (i.e. $3,041.96 per month), payments to begin one month from change of possession, secured by a security agreement on the assets of the business and personally guaranteed by the buyer with the right to prepay without penalty. Many of my business broker associates in California who sell businesses other than restaurant, bar and clubs tell me that seller carry back financing is a common technique used in selling businesses. However, from my experience in selling restaurants, bars and clubs I have found few sellers that are willing to carry back a portion of the purchase price using a seller carry back note due to the high risk factor in this industry. Most sellers I have dealt with would rather get a lower all cash price than carry back a seller note. In the limited transactions where I had sellers willing to finance a portion of the price in the form of a seller carry back note the seller, in many cases, required the note be secured by real property owned by the buyer in addition to securing the note with a UCC1 security agreement against the business and assets being sold and having the note personally guaranteed by the buyer. In these cases where real property was being used to secure the sellers note the seller usually specifies that the total debt on the real property being secured including the seller carry back note does not exceed seventy percent of the fair market value. A current appraisal is usually requested by the seller to approve the buyer’s real property as additional security. The sellers insist on this conservative loan to value ratio to assure themselves that if the buyer fails there is enough equity in the property to handle the foreclosure costs, legal costs, etc required for the seller to take title of the property in case the buyer defaults.
3. Third Party Financing
a). SBA Loans – SBA stands for Small Business Administration which is a United States government program whereby the government guarantees loans made by banks to small businesses. The major SBA program for small businesses is called 7(a) loans which are the most basic and most used type loans of SBA’s business loan programs. All 7(a) loans are provided by lenders who are called participants because they participate with SBA in the 7 (a) program. Not all lenders choose to participate, but most American banks do. There are also some non-bank lenders who participate with SBA in the 7(a) loans. The lender and SBA share the risk that a borrower will not be able to repay the loan in full. Repayment ability from the cash flow of the business is a primary consideration in the SBA loan decision process but good character, management capability, collateral and owner’s equity contribution are also important considerations. All owners of 20- percent or more are required to personally guarantee SBA loans. The guaranty is a guaranty against payment default. Eligibility factors for all 7(s) loans include: size, type of business, use of proceeds, and the availability of funds from other sources. The maximum loan available in this program is $2 million of which the government will guarantee 75% of the loan. For more information on SBA loans look up SBA on the internet and in particular check our the following websites: www.sba.gov and www.sba.org.
b). Small Minority and Woman-Owned Business Loans – There are numerous loan programs available for small minority and woman owned businesses and to get information for the particular loan program you are looking for go to the internet and search Small Minority and Woman-Owned Business Loans.
c) Bank Loans – If you have had a pre-existing relationship with a bank you may be able to have the bank provide the necessary financing to purchase the business. Usually the bank will want to secure the loan with other tangible property such as real estate and securities.
In the next edition I will discuss several methods of how to purchase a restaurant, and/or club using investors money to create a win win situation for both parties.
Methods for Raising Money for a Restaurant, Bar and/or Club Acquisition – Part 2
In the first part article on this topic I discussed how to raise money through raising your own money, seller financing, third party financing including SBA loans, small minority and woman-owned business loans and bank loans. In this article I will discuss the various ways investors can be helpful in investing into your business and various fomulas that I have seen used by owner/operators to raise money for their busineses.
Investor Financing. A common source of raising money for one’s business is from third party investors. These are people, other than family members or close friends, who know of your track record either as a customer or reputation from others who have seen you in operation or have read reviews about you. Since this is high risk business I would only accept investments from individuals who are financially strong and can afford to lose their investment. Many investors are driven to restaurant, bar and club investments for ego gratification so they can brag to their friends that they own a piece of hopefully a well know business. Usually the investors principal is returned to him over a number of years from the cash flow of the business. After the investor recovers his initial capital back then profits are split on a pre negotiated formula between the investor partners and the managing partner. There are various economic structures for investors coming into deals but in most cases they limit their financial and overall liability exposure by either becoming a limited partner in a limited partnership, a shareholder in a corporation or a member in a limited liability company. In these entities usually the managing partner gets a salary for running the business before there is any return of original capital or profit to the partner.
Examples of Formulas to Use for Investors Investing Money for Purchase of a Business.
Formula 1 – This is a situation where 100% of the money needed for the purchase of the business is provided by an investor(s) and the managing partner does not make an investment but receives a market rate salary for running the business and the opportunity to share in the profits in the future after the investor(s) get their investment back. In this situation it is agreed that the profits would be split 50% to the investor(s) and 50% to the managing partner after the investor(s) get back their original investment. In reviewing the profit and loss statement and after the managing partner of the business gets a market rate salary as a working owner the remaining money is distributed to the investor(s).
Please find below an example of Formula 1. At the end of the fiscal year there was a profit of $250,000 after the managing partner received a salary of $60,0000 for running the business. In some cases included with the salary for the managing partner will be health insurance, a food allowance plus a car allowance, etc. for business purposes. The total investment made by the investor(s) was $200,000 so after the first $200,000 was distributed to the investors(s) there was remaining $50,000 which is split 50/50, or $25,000 of the profits distributed to the managing partner and $25,000 distributed to the investor(s). So in this given fiscal year the total compensation paid to the managing partner was $85,000 ($60,000 salary + $25,000 profit distribution = $85,000 total compensation). In subsequent years since the investor(s) investment has been paid back any future profits would be split 50% to the managing partner and 50% to the
investor(s). Let assume the next year’s profits were $150,000. The distribution of these profits would be $75,000 to the managing partner and $75,000 to the investor(s) so the total compensation to the managing partner would be $135,000 ($60,000 salary + $75,000 profit distribution = $135,000 total compensation). If there is an additional investment required by the investor(s) again in the future the same formula indicated above will apply.
The summary of the above is as follows:
First Operating Year Calculation
$250,000 profit
-200,000 return of investor(s) investment
$50,000 remaining profit
-25,000 to managing partner
-25,000 to investor(s)
0 remaining balance
Second Operating Year Calculation
$150,000 Profit
-75,000 to managing partner
-75,000 to investor(s)
0 remaining balance
Formula 2. This is a situation similar to Formula 1 above however the investor(s) receives a yearly preferred return on their investment until their investment is paid back in full before profits are split between the managing partner and the investor(s).
A preferred return is a pre-negotiated percentage return on the investor(s) investment when the deal is put together. Lets assume that the preferred return is 10% of the investor(s) investment. Lets assume that the investor(s) investment is $200,000 so the yearly preferred return to the investor(s) would be $20,000 ($200,000 original investment x 10% = $20,000 preferred return). If there was a $250,000 profit after the managing partner received his salary of $60,000 the profit distribution would be as follows: the original investor(s) investment of $200,000 + $20,000 preferred return or $220,000 would go the investor(s) first so the remaining profit to be distributed is $30,000 ($200,000 investor(s) investment + $20,000 preferred return = $220,000 less $250,000 profit = $30,000 remaining profit to be distributed). This remaining profit would go 50% or $15,000 to the managing partner and 50% or $15,000 to the investor(s).
The summary of the above situation would be as follows: the managing member would receive $75,000 ($60,000 salary for running the business + $15,000 profit =$75,000) and the investor(s) would receive $235,000 ($200,000 investment + $20,000 preferred return + $15,000 profits = $235,000 investor(s) return).
The summary of the above is as follows:
$250,000 profit
-20,000 preferred return to investor
-200,000 return of investor(s) original investment
$30,000 remaining profit to be distributed
-15,000 distributed to managing partner (50%)
-15,000 distributed to investor(s) (50%)
0 remaining balance
Formula 3. In this situation the managing partner makes an investment into the business as well as the investor(s). In this situation the deal is structured as follows:
1) there is a total investment of $300,000 and the managing partner puts in $150,000 and the investor(s) puts in $150,000,
2) the managing partner receives a $60,000 yearly salary which is adjusted annually for cost of living for running the business which comes out of the business before profits are divided,
3) the agreed profit split after the partners receive a ten percent preferred return on their investment is 60% to the managing partner and 40% to the investor(s).
Please find below an example of the above. The profits of the business are $150,000 after the managing partner receives his yearly salary of $60,000. The $150,000 yearly profit would be split as follows: preferred return to partners of $15,000 each ($150,000 investment x 10% = $15,000 preferred return) then remaining profits would be split 60% to the managing partner and 40% to the investor(s).
The summary of the above is as follows:
$150,000 profit
-15,000 preferred return to managing partner
-15,000 preferred return to investor(s)
$120,000 remaining profit
-$72,000 distributed to managing member (60% profit)
-$48,000 distributed to investor(s) (40% profit )
0 remaining balance
Other Formulas. There can be many other variations of the above formulas depending on the priorities of the parties involved. Please find below some common variations for profit distribution. In a situation where the managing partner puts no money up and the investor(s) wants to give the managing partner an extra incentive to increase profits a formula can be set up as follows: after the managing partner gets his salary he also gets a performance bonus which can be set up in a number of ways. One common method is to have part of the bonus tied to increased sales versus budgeted sales and a larger part of the bonus is tied to increased profits versus budgeted profits. Lets assume that the bonus formula is that the managing partner receives 5% of increased sales versus budgeted sales and receives 10% of increased profit versus budgeted profit. For example if the budgeted sales were $1 million and the actual sales were $1.1 million and the budgeted profit was $150,000 and the actual profit was $200,000 the yearly incentive bonus to the managing partner is as follows: a. he gets a $5,000 sales bonus ($100,000 increased sales versus budgeted sales x 5% = $5,000) and b. he gets a $5,000 profit bonus ($50,000 increased profit versus budgeted profit x 10% = $5,000). In the above example we will assume that after the managing partner receives a yearly $60,000 salary adjusted yearly for inflation and receives a performance bonus, if applicable, then the investor(s) gets their original investment back and then profits are split 50/50 between the managing partner and the investor(s). Further we will assume that the investor(s) invested $250,000 and that the profits of the business are $200,000.
The summary of the above is as follows:
$200,000 yearly profit
-10,000 performance bonus paid to managing partner
($5,000 sales bonus + $5,000 profit bonus)
-190,000 profit paid to investor(s)
0 remaining balance
In the second year of operation the profits are $250,000 and the managing partners performance bonus is $15,000 and the summary is be as follows:
$250,000 yearly profit
-15,000 performance bonus paid to managing partner
-60,000 profit to investor(s) to get 100% of their
original investment back (the investors
investment is $250,000 and they have
previously received $190,000 back of their
original investment so their remaining
investment is $60,000.)
$175,000 profit to be split
-87,500 50% paid to managing partner
-87,500 50% paid to investor(s)
0 remaining balance
In the above example the managing partner would have received in addition to his $60,000 yearly salary he would receive a $15,000 performance bonus plus 50% of the remaining profits or $87,500 so his total compensation would be $162,500 ($60,000 salary + $15,000 performance bonus + $87,500 profit split = $162,500). The investor(s) would receive $147,500 made up of $60,000 which is the remaining return of their original capital plus 50% of the remaining profits or $87,500 ($60,000, the remaining return of their original capital + $87,500 profit split = $147,500).
These methods are just a few of the many formulas that can be used to raise money for a new investment opportunity. If you would like to discuss additional creative methods for financing your new business opportunity please contact us.