Starting and running a restaurant is a major financial undertaking. From securing the right location to investing in equipment, staff, and marketing, restaurants require substantial capital. While many restaurateurs rely on financing to kickstart or grow their business, not all forms of financing are created equal. In fact, certain types of financing can do more harm than good, ultimately hurting your business in the long run.
This in-depth guide explores different types of restaurant business financing that can potentially harm your restaurant. It will discuss why these options can become detrimental and offer alternatives that might be a better fit for restaurateurs looking to grow sustainably.
1. Merchant Cash Advances (MCAs)
What They Are
Merchant cash advances are a type of financing where you receive an upfront sum of money in exchange for a percentage of your daily credit card sales. They’re often touted as a fast way to get cash, and approval rates are high since the lender focuses on your revenue stream rather than your credit score or business history.
Why It Hurts Your Business
While MCAs offer quick access to capital, the costs are exorbitant. The effective annual percentage rate (APR) can soar to 70% or even 350%, depending on how quickly the advance is repaid. Since repayment is based on a percentage of your daily sales, cash flow becomes unpredictable. On slower days, a significant portion of your revenue still goes toward repayment, leaving you little room for operational expenses or emergencies. Over time, the stress on your daily cash flow can lead to bigger problems like defaulting on payments, deteriorating vendor relationships, and operational inefficiencies.
Alternative
Instead of an MCA, look for a traditional business loan from a bank or credit union. These loans often come with more favorable interest rates and predictable repayment terms, making it easier to manage your restaurant’s cash flow.
2. High-Interest Business Credit Cards
What They Are
Business credit cards are a common financing option for restaurants. They’re easy to obtain and can be a helpful tool for short-term financing needs, particularly for buying supplies or covering payroll in a pinch.
Why It Hurts Your Business
Business credit cards often come with high-interest rates, particularly if you’re only making minimum payments. The average APR for business credit cards ranges between 13.99% and 20%, and it can be even higher for restaurateurs with less-than-stellar credit. If your restaurant’s margins are already thin, carrying a balance on a high-interest credit card can significantly eat into your profits over time. What starts as a manageable short-term solution can quickly snowball into long-term debt.
Alternative
Look for low-interest business credit cards or, better yet, a line of credit from a bank or lender. Lines of credit typically offer lower interest rates and more flexible repayment options.
3. Short-Term Loans with Hidden Fees
What They Are
Short-term loans are designed to provide fast access to cash, with repayment terms that typically range from three months to three years. These loans are often marketed as a quick solution to cover immediate expenses or opportunities, such as upgrading equipment or handling unexpected repairs.
Why It Hurts Your Business
While short-term loans can be tempting, they often come with hidden fees and high-interest rates, particularly if they’re offered by online or non-traditional lenders. Origination fees, prepayment penalties, and other hidden costs can dramatically increase the cost of borrowing. Furthermore, because the repayment period is so short, the monthly payments can be quite high, putting a strain on your restaurant’s cash flow. Failing to meet these payments can result in compounding fees and potential legal action from the lender.
Alternative
Instead of short-term loans, explore Small Business Administration (SBA) loans or other government-backed options. These loans typically offer more favorable terms and lower interest rates, providing a more sustainable solution for your restaurant.
4. Personal Loans and Mixing Personal and Business Finances
What They Are
Many restaurant owners, particularly those just starting, turn to personal loans or personal credit cards to finance their business. Mixing personal and business finances is a common practice, especially for smaller restaurants or those with limited access to traditional financing.
Why It Hurts Your Business
Combining personal and business finances can lead to several issues. First, if the restaurant struggles or fails, your personal assets—such as your home or savings—are on the line. Second, it becomes much harder to track your business’s financial health when personal and business expenses are intertwined. This can lead to poor financial decision-making, tax complications, and difficulty securing future financing. Lastly, personal loans often carry higher interest rates than business loans, further straining your restaurant’s cash flow.
Alternative
Establish separate business bank accounts and seek financing through business loans, lines of credit, or investor capital. Maintaining a clear divide between personal and business finances helps protect your assets and makes it easier to manage and grow your restaurant.
5. Equity Financing with Unfavorable Terms
What It Is
Equity financing involves selling a stake in your restaurant to investors in exchange for capital. This can be an attractive option for restaurateurs who want to avoid taking on debt, and it can also bring in experienced partners who add value to the business.
Why It Hurts Your Business
The downside of equity financing is that you’re giving up a portion of ownership in your business, often permanently. If the terms of the equity deal are unfavorable, you may end up with less control over your restaurant’s operations and future decisions. Additionally, if your restaurant becomes highly successful, you’re essentially giving up a large portion of future profits to your investors. This is particularly harmful if you agreed to equity financing under duress or with limited understanding of the long-term implications.
Alternative
Before entering into any equity financing agreements, work with a financial advisor or attorney who specializes in small business or restaurant deals. They can help you understand the terms of the agreement and negotiate better conditions. Additionally, consider other funding options like venture debt or convertible notes, which can give you access to capital without giving away ownership right away.
6. Sale-Leaseback Arrangements
What It Is
A sale-leaseback arrangement involves selling your restaurant’s property or assets (such as equipment or real estate) to a financial institution and then leasing it back from them. This is often marketed as a way to unlock capital while still retaining the use of your assets.
Why It Hurts Your Business
While a sale-leaseback can offer immediate liquidity, it often leads to higher long-term costs. You’re essentially trading ownership for ongoing lease payments, which may become a significant financial burden over time. Additionally, if your restaurant faces financial difficulties, you may find yourself unable to make lease payments, putting you at risk of losing essential assets or your business location.
Alternative
Rather than a sale-leaseback, consider negotiating better loan terms or securing a business line of credit to free up capital. This allows you to retain ownership of your assets while still accessing the funds you need.
7. Crowdfunding without a Solid Plan
What It Is
Crowdfunding involves raising small amounts of money from a large number of people, typically through online platforms like Kickstarter, GoFundMe, or Indiegogo. Many restaurateurs turn to crowdfunding to finance new ventures, renovations, or expansions.
Why It Hurts Your Business
While crowdfunding can be a great way to build community support and raise capital, it’s not a guaranteed success. Many crowdfunding campaigns fail to meet their goals, leaving restaurateurs without the funds they need. Worse, if you offer rewards or equity in exchange for donations and fail to deliver on promises, you can damage your reputation and relationships with potential customers and investors.
Alternative
Before launching a crowdfunding campaign, make sure you have a clear plan, realistic goals, and a solid marketing strategy. Consider working with a crowdfunding consultant or marketing expert to maximize your chances of success.
8. Taking On Too Much Debt Too Quickly
What It Is
Debt financing is common in the restaurant industry, but taking on too much debt too quickly can spell disaster. This often happens when restaurateurs open multiple locations, invest in expensive renovations, or purchase high-end equipment without fully assessing their cash flow or revenue projections.
Why It Hurts Your Business
High debt levels can lead to significant interest payments, which eat into your profits and limit your ability to invest in growth or handle unexpected challenges. If your restaurant experiences a downturn, high debt can quickly become unmanageable, leading to missed payments, damaged credit, or even bankruptcy.
Alternative
Instead of relying heavily on debt, focus on growing your restaurant incrementally. Explore alternative financing options like strategic partnerships, equity financing, or reinvesting profits to fund growth. Always conduct a thorough financial analysis before taking on new debt to ensure it’s manageable based on your current and projected cash flow.
Conclusion
While financing can be a powerful tool for growing your restaurant, the wrong type of financing can have devastating consequences. Merchant cash advances, high-interest credit cards, short-term loans with hidden fees, and equity deals with unfavorable terms can all hurt your business if not managed properly. Likewise, mixing personal and business finances or relying too heavily on debt can create long-term financial strain.
The key to sustainable restaurant financing is careful planning and a clear understanding of the terms and costs associated with each type of financing. By exploring alternatives and seeking professional advice when needed, you can secure the funding you need without jeopardizing the future of your restaurant.
