Starting A Restaurant Business

Introduction

Opening a financially successful restaurant requires much more than simply having a good recipe. A potential restaurant owner has to first satisfy the myriad regulatory requirements of their State and City Governments. For example, if you are opening a restaurant in New York City, there are requirements from the following: New York City Department of Health, Department of Buildings, the Fire Department, Department of Consumer Affairs and the Department of Transportation.

Once a person has cooked up the idea of opening a restaurant, he or she should realize this: opening a restaurant is no form of retirement. Long hours and serious financial investment are required to make your restaurant succeed.

This article aims to introduce the potential restaurant owner to many of the factors he or she should consider when deciding whether to open a restaurant.

Getting Started

There are several ways to get started in the restaurant business:

 

  1. Buy out a restaurant that is in financial trouble and has filed for Chapter 11 bankruptcy
  2. Purchase an existing restaurant's lease from the landlord
  3. Lease an existing structure and make renovations
  4. Build a restaurant from the ground up

Buying out a restaurant that has filed for Chapter 11 bankruptcy is probably the least expensive way to get into the restaurant business, but this method has several disadvantages. There is probably a reason that the restaurant has been financially unsuccessful, such as bad management or bad location. The restaurant may have a poor reputation in the area. Therefore, before buying out a bankrupt restaurant, one should investigate the circumstances of the restaurant's bankruptcy.

Purchasing an existing restaurant's lease is another method to getting started in the restaurant business. Many restaurant owners want to sell their restaurants for any number of reasons, including retirement or they are just tired of the restaurant business. In such a case, the buyer would probably have to pay the "good will" that the previous owner earned as a result of his or her development of the restaurant's business. The new restaurant owner would have the benefit of having an already established customer base.

Another way to start in the restaurant business is to lease an empty space and turn it into a new restaurant. This method gives the potential restaurant owner wide latitude in designing and developing a restaurant as his or her own "creation." This method requires substantial financial investment including hiring an architect, contractor, plumber, as well as purchasing equipment, making renovations, etc. Goodwill will also have to slowly be developed. Also, the length of the term of the lease is an important consideration. In New York City, there is no commercial rent control. A restaurant owner may face serious problems when, after his or her lease expires, the landlord decides to dramatically increase the rent. Moreover, the longer the lease, the easier it is to obtain a business loan.

Perhaps the most expensive way to get started in the restaurant business is to buy land and build a restaurant "from the ground up." In New York City, this method is the least common. Depending on the size, location and concept of the restaurant, this method could be extremely expensive, including costs such as purchasing the land and constructing a building.

Financing

For all cases, a person considering opening a restaurant should write a "business plan." A written business plan helps a restaurant owner manage and operate his or her own business and work toward its success. The business plan is also a tool to communicate about your business with others -- business people, bankers and partners. If one seeks financing for the restaurant, the business plan will become the basis for the loan proposal.

Many people have never raised capital before, so how does the "average person" go about seeking financing to open a restaurant? Simply, one can try to have others raise the capital for him or her, or one can try to seek financing by him or herself.

Generally, if one seeks financing from one large investor, the restaurant owner may end up with a much smaller piece of his or her own business. If one attempts to seek financing him or herself, such as by raising money from relatives or close acquaintances, one can normally arrange a much better deal for him or herself.

The best method of financing a start up a restaurant is probably with one's own money because this is the quickest form of capital to acquire, there is no interest to be paid back and one does not have to surrender equity in the business. But opening a restaurant may be beyond one's immediate cash reserves, so often one must look to other sources of financing:

 

  1. Loans from relatives and friends
  2. Borrowing from banks
  3. Obtaining a loan from the Small Business Administration
  4. Obtaining a loan from a financing company
  5. Using suppliers as loan resources
  6. Using your credit cards
  7. Selling equity
  8. Obtaining venture capital

Selecting a Market and Location

Selecting a market and location for your restaurant depends in great deal on the type of restaurant and the menu you'll be offering. Zoning laws and the ability to sell alcoholic beverages in a particular area are also often important factors in selecting a location for your restaurant.

New York City perhaps has the most diverse array of restaurants in the entire world. Restaurants in New York City range from McDonald's to exotic kosher Chinese food. Semi-vegetarian restaurants are increasingly popular among the "Baby Boomer" generation, as well as restaurants that specialize in foods with low amounts of cholesterol, sodium and sugar. In New York City, to name only a few, one can find restaurants that specialize in Ukrainian, Portuguese, Thai, Puerto Rican or Ethiopian food.

A potential restaurant owner should conduct "market research" to determine whether a particular type of restaurant will be successful in a certain area. Market research may include establishing product differentiation (creating an identity for your restaurant that separates it from your competitors') and studying the population within the area to determine its potential spending characteristics. A good starting point may be the chamber of commerce or other business development associations, which encourage new businesses in their communities.

Location is a key to creating the volume needed to run a successful restaurant. Make sure that your restaurant is in an area where you can take advantage of the breakfast, lunch and dinner crowds, since these are probably the periods where you'll encounter your highest seat turnover rate. For instance, some restaurants are looking for strong luncheon business, others are looking for dinner crowd business and yet others target post-dinner crowd business. One might choose a location that is in close proximity to a mall, which draws people for shopping, or one might choose a location where a lot of commercial office space development is taking place.

Equipment

Perhaps the biggest expense a potential restaurant owner will incur during start up is equipment. Equipment selection is a complex process; different kinds of restaurants will require different kinds of equipment. Consultants or food service equipment dealers are often good sources to tap for finding out what you need. Typically, equipment needed to open a restaurant include a service kitchen (oven, microwave, heat lamps, prep tables, meat grinders, etc), ventilation equipment, dishwasher, refrigerators, bar equipment and dining area equipment (tables, chairs, spoons, glasses) and cash registers.

One option a potential restaurant owner may undertake is to lease equipment instead of purchasing it. If your start up capital is limited, leasing may be a reasonable alternative. The advantage of leasing is that your initial cash outlay can be significantly less than when you buy equipment on an installment contract. The disadvantage, if you have a legitimate tax-deductible lease, is that you do not acquire equity in your equipment.

Inventory

Purchasing food and beverage inventories is an area that must be managed well. Improper purchasing and inventory control practices result in food and beverage spoilage which ultimately will cut into your profit margin to such an extent that your restaurant can fail.

You should adopt good purchasing procedures along with a system that will accurately control your inventory from the point you receive it all the way through preparation. This will allow you to limit waste as well as plan your needs so that you won't develop an inventory shortage.

There are several kinds of suppliers that you will come into contact with. Wholesale grocers are merchants who sell all kinds of dry goods ranging from sacks of sugar to napkins. Fruits and vegetables will usually be ordered through a fresh produce supplier. Purchasing inventory for your bar can be done only through companies that have had their wholesaling privileges granted by the Alcoholic Beverage Control(ABC). You can purchase non-alcoholic beverages through any distributor dealing in them, but liquor, beer and wine has to be bought through an approved distilled spirits wholesaler.

Legal Requirements

Because a restaurant is a business, the potential restaurant owner must decide the legal form under which the business will operate. A restaurant, like all businesses, may be a 1) sole proprietorship, 2) partnership, 3) limited partnership or 4) corporation.

A sole proprietor means that there is only one owner of the restaurant. A sole proprietorship is the easiest and most versatile way of starting a restaurant. No legal papers are required except a business license and a fictitious name filing with the county clerk. No separate income tax returns are necessary, as with other forms of business. All your income and expenses are reported on Schedule C of IRS Form 1040. FICA taxes for the owner are less than in other forms as well.

A sole proprietorship has one major disadvantage: personal liability. Creditors of your restaurant can go after you personally and attach your personal property, bank account, etc. You can be harassed for years after you abandon your business and your personal credit can be ruined.

A general partnership occurs whenever two or more people engage in a business for profit. Like a sole proprietorship, no legal papers are required to form a general partnership; however, a written partnership agreement is highly recommended. Each partner has agency status to bind the partnership and other partner(s). In short, each partner is liable for the other's actions. In any legal or creditor action, each partner can be sued personally, with the property and bank accounts of each attached.

A general partnership must secure a Federal Employee Identification number from the IRS using Form SS-4. Then it must file Form 1065 each year as its tax return. Each partner reports his or her share of partnership profits or losses on an individual tax return and pays the tax on those profits. The partnership itself does not pay any taxes with its tax return.

A limited partnership is a business vehicle with at least one general partner and one limited partner. The limited partner is liable only up to the amount of his or her investment in the business, but has no management authority over the business. The limited partner may also be subject to special tax liabilities that can, in certain cases, offset tax shelter advantages. The IRS tends to look at these facts on a case-by-case basis. The 1986 Tax Reform Act now limits the amount of losses a limited partner can deduct on his or her personal tax return. The general partner, usually the operator of the restaurant, can be either a sole proprietor or a corporation. The general partner manages the business and is personally liable for the business's debts.

A Corporation is a business vehicle whereby a shareholder of the corporation is liable only up to the amount of his or her investment. In other words, a shareholder is not personally liable for the corporation's contractual debts or torts. The shareholders of a corporation elect the corporation's directors; therefore, shareholders have indirect control over the management of the corporation. A restaurant that seeks to form itself as a corporation will probably choose to be a close (small) corporation. It is highly recommended that there is a written shareholder agreement. A restaurant that seeks corporate status must file articles of incorporation.

Conclusion

Making a profit in the restaurant business is a slow and often hard fought process, and most of the time all the hard work alone will not make a successful establishment. Success is composed of many things such as good management, merchandising, sanitation, service and, of course, the viability of your concept.

 

Source: Business Start-Up Guide, Entrepreneur Group, Irvine, California, 1990.



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