Methods for raising money for a restaurant, bar and/or club acquisition is a two part series and in this first part I will discuss the following topics: 1. raising you own money, 2. seller financing and 3. third party financing. The second part which I will discuss in the next edition of Restaurant Rap will include investor financing.
- Raising Your Own Money. If you are fortunate to have your own financial resources this is usually the easiest way to raise money for your investment. A good source for creating liquidity for an investment is to take an equity line of credit from your home as the interest expense is tax deductable. Make sure that you can easily pay back this loan should a worse case scenario occur and your investment becomes unsuccessful. Other sources for raising cash yourself include selling your stocks and bonds and cashing in your retirement fund although there could be stiff penalties for doing so. I strongly recommend to not accept investment money from family member or close friends. The risk factor is so high in the restaurant, bar and club business that there is a strong possibility that they could lose their money and you might not be able to pay them back which will most likely damage your relationship with them in the future. It is important to maintain good relationships with your family and with your close friends and in many cases it is already challenging enough to maintain good relationships with them without having financial problems muddy the waters. If your uncle invests $50,000 with you and your business becomes unsuccessful and you can’t pay him back this could have a detrimental impact on your relationship with him and the family in the future. I have had first hand experience with this situation and I strongly recommend staying away from accepting investment money from family and friends.
- Seller Financing. In this case the seller carries back a negotiated amount of the purchase price in the form of a seller carry back promissory note secured by the assets of the business and personally guaranteed by the buyer individually. In California this lien against the business assets is in the form a UCC1 security agreement which is recorded with the Secretary of State and will appear as a cloud against the title of the business should the business owner decide to sell the business before the lien is paid off. This means that if the business fails the seller can take legal action against the buyers and regain control of the business and its assets. For example, lets assume that the selling price of the business is $250,000 with $100,000 cash down at the close of escrow and the seller agrees that he’ll carry back the $150,000 balance in a seller carry back note. Furthermore the terms of the seller carry back note are 8% per annum interest computed from change of possession of the business so as to fully amortize over 60 months (i.e. $3,041.96 per month), payments to begin one month from change of possession, secured by a security agreement on the assets of the business and personally guaranteed by the buyer with the right to prepay without penalty. Many of my business broker associates in California who sell businesses other than restaurant, bar and clubs tell me that seller carry back financing is a common technique used in selling businesses. However, from my experience in selling restaurants, bars and clubs I have found few sellers that are willing to carry back a portion of the purchase price using a seller carry back note due to the high risk factor in this industry. Most sellers I have dealt with would rather get a lower all cash price than carry back a seller note. In the limited transactions where I had sellers willing to finance a portion of the price in the form of a seller carry back note the seller, in many cases, required the note be secured by real property owned by the buyer in addition to securing the note with a UCC1 security agreement against the business and assets being sold and having the note personally guaranteed by the buyer. In these cases where real property was being used to secure the sellers note the seller usually specifies that the total debt on the real property being secured including the seller carry back note does not exceed seventy percent of the fair market value. A current appraisal is usually requested by the seller to approve the buyer’s real property as additional security. The sellers insist on this conservative loan to value ratio to assure themselves that if the buyer fails there is enough equity in the property to handle the foreclosure costs, legal costs, etc required for the seller to take title of the property in case the buyer defaults.
- Third Party Financing.
- SBA Loans – SBA stands for Small Business Administration which is a United States government program whereby the government guarantees loans made by banks to small businesses. The major SBA program for small businesses is called 7(a) loans which are the most basic and most used type loans of SBA’s business loan programs. All 7(a) loans are provided by lenders who are called participants because they participate with SBA in the 7 (a) program. Not all lenders choose to participate, but most American banks do. There are also some non-bank lenders who participate with SBA in the 7(a) loans. The lender and SBA share the risk that a borrower will not be able to repay the loan in full. Repayment ability from the cash flow of the business is a primary consideration in the SBA loan decision process but good character, management capability, collateral and owner’s equity contribution are also important considerations. All owners of 20- percent or more are required to personally guarantee SBA loans. The guaranty is a guaranty against payment default. Eligibility factors for all 7(s) loans include: size, type of business, use of proceeds, and the availability of funds from other sources. The maximum loan available in this program is $2 million of which the government will guarantee 75% of the loan. For more information on SBA loans look up SBA on the internet and in particular check our the following websites: www.sba.gov and www.sba.org.
- Small Minority and Woman-Owned Business Loans – There are numerous loan programs available for small minority and woman owned businesses and to get information for the particular loan program you are looking for go to the internet and search Small Minority and Woman-Owned Business Loans.
- Bank Loans – If you have had a pre-existing relationship with a bank you may be able to have the bank provide the necessary financing to purchase the business. Usually the bank will want to secure the loan with other tangible property such as real estate and securities.
In the next edition I will discuss several methods of how to purchase a restaurant, and/or club using investors money to create a win win situation for both parties.