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BE CAREFUL WHAT YOU WISH FOR!

A primer on Restaurant Ownership By David W. White, CPA, CFE, ISHC

Many people find the idea of owning and operating a restaurant appealing. However, there is often wide disparity between the perception of what the business is like and reality. The following are some observations about the restaurant business aimed at those considering ownership and operation, based on my nearly 30 years experience in the hospitality industry, including free-standing restaurants as well as those operating within hotels, resorts and clubs.

Are you sure?

At a minimum, anyone considering owning and operating a restaurant should ask themselves the following questions:

  • Do I want to work "9 to 5"?
  • Am I looking for a steady income?
  • Do I think establishing a loyal repeat customer base for my restaurant will be easy because it will offer a product no other restaurant in the competitive market is offering?

If you answered "yes" to any of the questions above, please think again. There is a good chance you will never work harder for less.

Perception vs. Reality

Here are some key points to consider:

  • If a professional market study is not done, do your own market research. Talk to management and staff at restaurants in the general area to determine competitive market boundaries. Physically walk or drive the identified competitive market. Visit and eat at each restaurant. Obtain menus for each restaurant. Count the number of tables and seats in each restaurant. Monitor each restaurant in the competitive market each day of the week on an hourly basis to get an overall picture of activity levels. Consider seasonality if it is a factor in the market. Also note parking locations and rates. This information should provide a good picture of the competitive market and will be useful in developing an operating budget for a new restaurant.
  • Be clear about your restaurant concept. For example, will your restaurant be a café or offer fine dining? It also helps to become known for a particular dish (the burgers, the salads, the steaks, etc.).
  • Payroll and employee benefits will be the largest expense. Trying to maximize flexible or part-time staffing to minimize labor costs will be an ongoing challenge, particularly if workers are unionized.
  • Staff turnover will be a constant issue, particularly as related to servers. As a result, staff training will be ongoing and necessary to maintain consistency in customer service.
  • To a greater extent than many owners or operators are willing to admit, the customer experience during the initial visit is absolutely critical. If a customer has a bad experience, irrespective of the cause or circumstances, their likelihood of returning declines significantly, if not entirely. This is particularly true if there are multiple dining alternatives in the competitive market serving the same cuisine.
  • Hosts and servers are normally the face of the business as they have the most contact with customers, yet they are typically among the least compensated positions in terms of base pay and servers will leave if tip income is below their expectations. Service staff look to ownership/management to keep the restaurant filled with customers.
  • Marketing is a continuous and expensive activity, without which restaurant failure is almost assured. It should begin before a restaurant opens, and it often takes months for the benefit of the expenditures to be realized.
  • Menu item sales activity should be reviewed at least annually, and preferably every six months, with infrequently ordered items dropped and replaced with new items, ideally based on customer input. Menu prices should be reconsidered each time a menu is updated. Menu prices should be based on the total item cost, budgeted or target food or beverage cost percentages, and current prices for the same or similar items among competitive restaurants. It may be necessary to revise menu recipes (e.g., portion sizes, ingredients) in order to offer a desired menu item at an attractive price.
  • It may be difficult to increase menu prices as quickly as operating expenses increase. If repeat customers see frequent menu price increases (e.g., more frequent than suggested above), they will likely remember and either not come as often, or not return at all. While daily specials can provide some relief at least in terms of food cost, they won't be the silver bullet that solves the problem.
  • When the doors close, the work continues. Restaurants must be prepared for each day's business, including the kitchen and public areas. Sweeping, mopping, scrubbing, disinfecting, receiving goods, food preparation, the list goes on. Typically restaurant operations begin two or more hours before opening the doors to the public, and end one or more hours after the doors are closed.
  • If credit cards are accepted for payment (a necessity that will cost roughly two to four percent of sales paid by credit card), compliance with the Payment Card Industry Data Security Standard ("PCI-DSS") and related standards will be required in order to protect customer payment card data. These standards are difficult to comply with; compliance must be ongoing; compliance is expensive; and financial penalties for non-compliance are staggering. Noncompliance can also result in losing the ability to accept payment cards, which will cause any restaurant to close.
  • Related to PCI-DSS compliance is the issue of data breaches, which can also be incredibly expensive to deal with if they occur. Information security and privacy insurance (also referred to as PCI insurance) with broad coverage for the expenses that would arise in the event of a data breach should be obtained (including, but not limited to, compliance with applicable notification laws; credit monitoring services for victims; forensic investigations; stolen computer equipment; hacking; crisis management; public relations; accidental release of private information; legal defense for noncompliance with applicable laws and related liability and penalties, etc.).
  • Changes in the competitive market can occur quickly and have a significant negative impact on an existing (or proposed) restaurant. While you may start out offering a product no other restaurant in the market offers, before you know it a new competitor can enter the market offering a product that is essentially the same as yours. Customer loyalty programs will probably be ineffective in overcoming the desire among existing customers to try out the new restaurants.
  • If the restaurant is located in a seasonal market, you will have to manage money such that you can survive during the off-season period. In some locations, seasonality is so pronounced that hospitality-related businesses including restaurants and hotels close during the off-season period. Seasonal markets can also present labor pool problems impacting employee hiring, staffing and training.
  • Euphoria surrounding the process of opening a restaurant often dissipates quickly afterwards, especially if it becomes obvious that profitability is not something that will be achieved as quickly as anticipated. Assuming all goes well, it can still take several years for a new restaurant to become profitable, let alone profitable at a level that will generate a desired return on investment. Owners should expect this will be the case and be prepared to fund cash shortfalls for an extended period of time.
  • Restaurants are a discretionary expense, which makes them riskier from the viewpoint of lenders. Depending on market conditions, if financing is available it may be more expensive than anticipated or unavailable at the level desired. Similarly, it may be difficult to refinance existing debt even if there have been no defaults.
  • If operating results are insufficient to meet desired return on investment or other goals, litigation involving owners, investors, franchisors and management companies can result. The various agreements establishing ownership structure and management (perhaps best approached in the same way as "prenuptial" agreements) should address key issues in this realm, including, but not limited to: What if the restaurant is unprofitable or can't pay its bills currently? What if there are significant changes in the competitive market? What if the general economic climate turns bleak? What if one or more parties involved believes the restaurant is being mismanaged? Who has the ability to sell or close the restaurant? What conditions must be present in order for the restaurant to be sold or closed? How will litigation expenses be funded? Are there income tax considerations that should be addressed in the agreements? What if...? All such agreements are best drafted by legal counsel with industry experience. Additionally, it is extremely helpful to have agreements include sample calculations to eliminate disputes regarding how specific calculations outlined or referenced in them should be performed. Also remember that litigation will take time away from running the business.
  • Your accounting system shouldn't be an afterthought. It is important to properly set up an accounting and internal management reporting system such that proper internal controls are in place to safeguard assets and provide reliable financial and nonfinancial information. The cost to do this will likely be more than you expect, but is money well spent as restaurants are more susceptible to fraud than many other types of businesses, and you will need the information to refine your operations.

If you do become an owner/operator, try to avoid these hazards:

  • Although very difficult to do due to the capital costs involved, try not to take on partners or investors. If problems arise, they will be easier to address if you can make all critical decisions yourself.
  • Don't work seven days a week. Owners can, and should, have lives away from the business.
  • Don't fall in love with your restaurant. It is a business, and should be treated that way. If things aren't going well and it becomes obvious that recovery will not be possible within an acceptable time frame, do what you need to do to get out as soon as possible. Yes, it will cost you money, but you'll most likely be better off financially than if you continue to feed the business.

There is money to be made in the restaurant business. Just don't lose sight of the fact that restaurants are capital- and management-intensive businesses requiring a high level of management agility and unemotional decision-making.

David W. White, CPA, CFE, ISHC is a sole practitioner based in San Diego, California. He can be contacted via his website www.davidwhitecpa.com or the ISHC website www.ishc.com .

© Copyright 2011


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