Emerging operators have plenty of incentive to grow their business now as the industry starts to normalize after three years of tumult and as consumer demand remains high. Of course, the challenge is they need capital to grow, and capital is more expensive than it’s been in a long time.
This presents a bit of a pickle; consider that most businesses that fail do so because they’re undercapitalized, said Lauren Fernandez, founder and CEO of investment and development group Full Course.
“Undercapitalization of your business past that first unit could be the death knell,” Fernandez said during Nation’s Restaurant News’ recent CREATE: The Experience event in Palm Springs, Calif.
There are workarounds and there are solutions for small and emerging brands. Before examining your options, however, experts say it’s important that you have your house in order. Do you have the right culture and leadership? Are your finances humming along? Are your margins high enough to provide a cushion?
Andrew K. Smith, managing director of private equity firm Savory Fund, said his company focuses on funding businesses that have a long-term vision to build something special.
“If you’re just focused on getting in, making as much money as you can, and then getting out, that’s going to be a short conversation for us,” he said.
Smith also cautions against growing for growth’s sake and noted it’s more important to focus on building the economics and traffic within your four walls.
In addition to culture and economics, Fernadez’s Full Course also looks at the simplicity of the business. “Not every investment can be a super heavy lift, so operational efficiency is what we’re looking for if a brand is wanting to scale,” she said.
Strong unit economics? Check. Operational simplicity? Check. Culture and leadership? Check. So, what happens then? That’s where operators need to conduct a deep dive into their unique needs — and that can also be a challenge, as the market is always changing.
“We have tons of things to be thinking about outside of our restaurants that could impact capital structures. Think of the macro factors — a pandemic, the political climate, economic conditions like interest rates,” Fernandez said. “The thing with macroeconomic factors is you have to constantly monitor them. This isn’t a once-a-year conversation.
There is also a need to zoom into the microeconomic factors; for example, what stage is your company in? What is your run rate and your unit-level economics? All of those factors are going to matter when it comes to the type of funding you need.
Types of funding
There are multiple approaches operators can take when it comes to that funding and, as Anand Gala, founder and managing partner of Gala Capital Partners, noted, “capital is everywhere. That doesn’t mean it’s readily available, and you have to decide if it’s worth it to you.”
Here’s what “everywhere” looks like: equity, or money provided to the business in exchange for some shares in the company; debt, or loans you take that usually come with an interest rate; and gifts, or money given to you for free.
For emerging operators, Fernandez recommends a blended capital structure. Such an approach, however, should be done with a deep understanding of risk versus reward.
“For most entrepreneurs, the biggest risk besides failing is having someone else coming in and taking over your business,” she said. “We didn’t start these companies so someone else could tell us what to do. When you’re thinking about risk versus reward, you want money to grow the business, but not give up control, and we always have to evaluate capital structures in this way.”
For instance, debt funding usually doesn’t come with any additional advisory or consulting help. Further, traditional banks and SBA loans come with a fairly high risk for small businesses because you’re going to have to personally guarantee paybacks, Fernandez said.
“This exposes all of your assets,” she said. “But it does come with help in the form of small business development centers around the U.S. They’re amazing and you should tap into those.”
Operators considering gifts or crowdfunding can better control terms of that debt, so it is usually lower risk. This approach tends to work well for brands with big networks and social media followings. Fernandez also recommends independent operators look at gift funding.
“The vast majority of restaurants are single locations, and that’s where the majority of the industry’s diversity of ownership lives. So, women, minorities, veterans, single parents, immigrants — you may be eligible for government grants, private grants, sponsorships, scholarships or gifts,” she said. “You should always include this as part of your blended structure. It’s important not to leave free money on the table, and this is often one of the overlooked areas of sources of capital.”
Creativity is key
Fernandez’s blended capital recommendation embraces a bit of creativity in a difficult environment. Without such creativity, growth will be hard to come by, according to Rick Ormsby, managing director of Unbridled Capital.
“With interest rates as high as they are, small businesses just can’t afford to build and operate and pay 8% on a loan. That is going to curtail some growth with smaller operators because they’re living off the profits that come out of these stores and it doesn’t take a lot of math ability to know that 8% versus 3% is going to impact the bottom line and an ability to grow,” he said. “They have to think of new ways to go about financing their business.”
Ormsby said this challenge has driven more people to pull their money out of banks to avoid interest rates and instead put it into treasury and government bonds. However, this trend has affected deposits and, therefore, loans. What’s most important in such an environment, Ormsby said, is to clearly communicate any challenges you’re facing.
“Don’t run and hide from your lender. Be transparent and talk about your challenges and see if they can seek variances or increase the terms of your loan,” he said.
Challenges aside, Ormsby remains optimistic about the industry, including small and emerging concepts.
“Whatever is happening now with the banks and interest rates and so forth, I don’t think we’re in for dire times,” he said. “I think our country and industry has the backbone to get through anything. I think we have crazy amounts of technology that will increase our productivity and a generation of young people that are underestimated. Franchising and growth and everything related will continue to exceed and excel. I’m bullish.”
Contact Alicia Kelso at [email protected]