Three Methods of How to Finance a Restaurant
One of the biggest concerns people face in buying a restaurant is how to finance the restaurant purchase. You may already have your eye on a restaurant for sale and met with the owner. The opportunity seems right, but you’re not sure how you can raise the money to make the purchase. Whether it's through a traditional bank loan, raising money on your own or seller financing, each method has is pros and cons. The more you understand about each of these methods, their risks and requirements, the wiser your decision will be.
1. Obtain Third Party Financing from a Bank or Lender
A third party loan to finance a restaurant can come from anyone other than the buyer or seller. The most common source is an institution where you already have an established relationship, such as a bank or credit union.
Qualifying will depend on a number of factors, such as your credit rating, equity contribution, management capability or if you have minority status. One of the primary concerns of the lender is your ability to repay the loan from the cash flow of the business.
Third party lenders offer several types of loans to finance a restaurant:
- SBA Loans. The SBA or Small Business Administration has developed a program to offer government-backed small business loans through participating third party lenders. The most well-known is the 7(a) loan, which is most suitable for small businesses that need working capital up to 5 million dollars. These loans have low interest rates and have repayment terms of up to 25 years. Since SBA loans protect the lender, this program helps ensure that lenders will be willing to loan money to small businesses that may otherwise not qualify. Several factors are evaluated when an individual applies for an SBA loan:
- What type of business will it be?
- How big will the business be?
- What is the plan for using the business proceeds?
- Are there any funds available from other sources?
- Bank Loans.Your best bet is go to your local bank or credit union where you already have an established relationship and ask them what type of loans they have available. Usually banks will require some sort of tangible property to secure the loan, such as real estate or other securities.
- Minority Business Loans. There are also loan programs that are specifically tailored to minorities or women, including nonprofit microloans, minority business grants, as well as alternative loans for poor credit. A recent study, published by the Minority Business Development Agency, found that would-be business owners who are a minority or a female are much less likely than their counterparts to get approved for business loans.
2. Raise Money from Friends or Family to Open a Restaurant
Of course, using your own money to finance a restaurant enterprise is the quickest and easiest route. Yet, those who do not have enough money to successfully fund the venture might consider reaching out to friends and family. A good approach is to incentivize them by offering a small piece of the business in exchange for initial capital.
As with any type of investment, there is always a level of risk. It’s important to make this point clear before accepting funds from anyone interested in investing in your restaurant. It’s also important to seek funding only from those who can afford to lose their investment should the venture fail. You certainly don’t want to plan on failure, but those who can afford to invest are frequently more familiar with the risks of the restaurant business.
3. Obtain Seller Financing from the Current Owner
Seller financing is another option for financing part of a new restaurant venture. In such cases, the seller agrees to cover or hold a promissory note for part of the cost of the restaurant purchase using the assets of the business as security. This way, the seller will earn interest on the money that he is loaning to purchaser.
A seller financed loan generally has a 60-month term. When real property is used to secure the note, sellers who are willing to help finance a restaurant purchase will most likely look carefully at the total debt on the property. In order to decrease the risk they are taking on, they want to make sure the total debt, including the seller’s carry-back note, does not exceed 70% of the fair market value.
4. Raise Money from Third-Party Investors
Third party investors are another common source for raising money to finance a restaurant purchase. These are typically acquaintances or associates that are not close enough to be considered family members or close friends, but who know you well enough to trust your business track record. This may be based on interactions they have had with you, positive reviews they have read about you or even by word of mouth.
Third-party investors do not step into transactions as a friendly gesture. Instead, they are often driven by their interest in being part owner of a restaurant, bar or night club. Restaurant investment deals can be structured in a number of different ways. In most cases, investors are part of a limited partnership, a shareholder in a corporation, or a member of a liability company. This limits their exposure to financial liability. Once they have recovered their initial investment, profits are then split between the various investment partners.
Take the First Steps to Owning a Restaurant
Your dream of owning a restaurant will not come to fruition until you take that first step. If you do the proper legwork of developing a strategy and determining the cost in launching and running a successful restaurant, your knowledge will be reflected in your business plan.
Your business plan should also include exactly how much of your own money (how much risk) you are willing to put into your new venture. Finally, determine the best way to fund your restaurant venture and the sources you will use to obtain it. Each step is a step closer to making your dream of restaurant ownership a reality.