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Investors at CREATE: The experience said it's important to strengthen your unit economics and culture before thinking about scaling.

Want to grow your restaurant business? Start within your four walls

Investors at CREATE: The Experience said they now look at culture as much as financials, and they’re bullish on the industry’s long-term potential.

So, you want to grow your emerging restaurant business? It’s a logical goal, no doubt, but understanding how to do it – and do it right – can be downright paralyzing. For starters, you need capital. According to Lauren Fernandez, CEO and founder of investment firm Full Course, most small businesses fail because they’re undercapitalized.

During the CREATE: The Experience event in Palm Springs, Calif., earlier this month, she outlined three types of financing restaurateurs should consider for their capital strategy, including debt, equity and gifts. Of course, each comes with their own reward/risk implications, but none are even worth considering if the business itself isn’t on solid ground. Accordingly, a recurring theme presented by investors at the event was the importance of focusing on growth within your four walls, versus scaling the business just for growth’s sake. This is particularly true now, as cost pressures throughout the P&L persist.

“What’s important now is knowing if your business is fundamentally sound; HR, leadership, culture … Does everything have to be perfect? No, this is an imperfect business. But don’t be offended when we dig in. We want to know that we’re not giving you money to augment an existing problem,” said Andrew K. Smith, managing director of Savory Fund. “Our non-negotiables (for an investment) are unit economics and financials.”

That said, Savory Fund is also focused on businesses that have a long-term vision to build something special.  

“If you’re just focused on speed – 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. “Culture and values are more important than ever.”

Fernandez agrees, noting that Full Course looks at culture and leadership first, while the strength of the brand comes second. The trick is finding a middle ground between culture and the balance sheet. On the financials side, store-level profitability outweighs growing more units to gain more traffic, Smith said, acknowledging that it’s tougher than ever to achieve a workable margin. What does that margin look like in this environment? Fernandez said 17-to-24% profit margin is Full Course’s basis to franchise a brand, as it provides sufficient wiggle room for emerging brands to charge 5% royalty rates. Jim Balis, managing director of CapitalSpring, agrees that a high-teen margin needs to be the starting target for brands looking to grow.

“If you get into the low-to-mid-single digits on profit margins, that’s dangerous. You need a cushion when you start paying royalties, marketing, fees, and your SBA loan,” he said.

During a financing/growth roundtable discussion, Anand Gala, founder and managing partner of Gala Capital Partners, said finding the right margin is especially critical for brands looking to growth via franchising.

“If you’re going to franchise, make sure it’s compelling. If your margins aren’t covering royalties and your franchisees can’t make a living, they’ll fail and you’ll also have to include that in your disclosures,” he said. “If you’re an emerging brand, make a deal with those who started with you and took a risk, maybe at 3% royalties, and then scale up over time.”

In addition to navigating wage/food inflation, Anand added that another reason to focus on four-wall growth right now is because “commercial real estate is batshit crazy.”

“It is bizarre and that is why it’s important now to invest in your existing locations. Think of all the ways you can grow, through new channels like catering or whatever other ways,” he said. “If you don’t think you can do volumes consistently and make money, don’t do the deal.”

This four-wall growth is what Smith calls “scrappy growth.”

“It’s extremely powerful. It’s also less risky. Pause and perfect,” Smith said. “Sometimes you have to slow down to speed up. It’s OK to slow down and think about your next moves.”

Investors are optimistic

Despite relentless challenges and “batshit crazy” conditions, investors at CREATE remain wildly optimistic about the restaurant industry.

“We came back to this industry as investors because we believed in it,” said Fernandez, a former Chicken Salad Chick franchisee and Focus Brands general counsel. “There are always headwinds. You can’t take your foot off the pedal because of headwinds.”

Balis said his company is leaning into restaurants more than ever, though from a slightly different lens than in the past.

“We’re looking for alignment, great operators, great culture, great leadership, store-level economics,” he said. “In 2019, everything was going great. Now, we’re more surgical and careful about nurturing brands.”

Satya Ponnuru, general partner of NewSpring Franchise, said his company is also “leaning in” on the industry and is excited about its continued potential.

“We think investment in the sector is predicated around long-term consumer tailwinds,” Ponnuru said. “It’s a fairly stable segment of the economy, irrespective of macroeconomic factors. There are always major challenges, but if you can execute, you’ll get great returns. We think there is a huge long-term opportunity in this industry, and we think most of the growth is occurring in emerging brands.”

Contact Alicia Kelso at [email protected]

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