Why do most restaurant owners choose alternative financing over bank loans? It is easy to answer the question once readers understand the concept of restaurant profit margins and the traditional banking industry’s rejection of nearly all applicants who want to fund their restaurant dreams.
Walk into a bank with a request for a loan to fund a restaurant and the usual outcome will be a politely worded refusal slip. Perhaps the banker will blame “industry risk factors” or “not enough collateral.” Most owners will just sit there thinking that their idea sounds fantastic that their new business will thrive; that restaurant owners do not invent the world’s favoritehangout spots. All they want is money to finance a well-accepted business.
Benevolent as their rejection letters are, banks have never been friendly toward restaurant owners. The statistics they quote are impossible to argue with. 60% of all restaurants fail within the first year of operations. The three-year failure rate is even higher. For a bank, financing a restaurant is a high-risk activity with a low probability of repaying the initial loan. The collateral restaurants may offer as part of any loan agreement depreciate quickly. This collateral has nowhere near the repayment period that banks expect to receive financing as a form of a loan.
So why is it so difficult to get a bank to approve a loan?
Bank Refusals Are SOP for Restaurant Owners
What makes getting a bank loan so difficult for restaurant owners? Banks usually expect to see two years of profit before they will even consider a loan application from an owner for a restaurant they want to establish. This requirement removes the possibility of getting a bank loan if the restaurant does not yet exist. Even if it does exist, these owners will still have trouble getting a loan. The bank will expect to see a profit to income ratio that most restaurants cannot achieve while still leaving an income reserve for their other operating expenses.
The application procedure is also laborious. Restaurant owners have to retrieve the last few years of their tax filings, financial accounts, business plans, and personal financial records over several weeks. Then, they have to wait for about 30 days before the bank will respond to their application. Other business owners may have time to spare. Restaurant owners needing immediate cash for working capital, ingredients, or seasonal staff increases do not.
The bank wants a personal guarantee before they issue financing. They also want the bank account holder to pledge an asset of value. The thought of risking someone’s home and life savings on top of the money already invested in the bank to start a new restaurant idea daunt most owners.
Alternative Financing Options Have Disrupted the Restaurant Financing Process
The alternative financing options for restaurant owners today greatly alter the restaurant funding landscape. They include revenue-based financing, merchant cash advances, equipment financing, and other short-term loans that private firms offer.
These financing options differ from other financing products because they place less importance on credit scores and scores. They emphasize the real performance metrics of the restaurant. Revenue-based financing has proven popular. The amount that owners have torepay varies by season. Their amount of sales has seasonal peaks and troughs. The revenue is always much lower in winter than the summer restaurant months when people flock to restaurants to get cooled down.
A deep dive into different types of financing designed specifically for restaurant owners is available in the restaurant financing guide on this site.
Equipment financing can help restaurant owners acquire expensive kitchen equipment without depleting their capital reserves. A new industrial oven or refrigeration unit can set a restaurant owner back up to $40,000 in cash. If the owner finances the purchase, he or she has cash available for any immediate use that working capital requires, such as paying staff or making emergency repairs.
The speed at which alternative financing options for restaurants process applications is another reason to choose them over a bank loan. Many firms that provide alternative financing options can take as little as 24-48 hours to approve an application. A bank can take weeks to respond. There are far fewer hurdles to jump over, too.
Most options require only three to six months of credit card processing statements or bank statements to assess the ability of owners to repay their loans. Banks are more interested in the long-term history of profitability. They expect tax returns or profit-and-loss statements. They will not consider an application unless an owner presents years of data.
The alternative lenders’ expectations of credit scores are much lower than banks, too. A good score of 650 or higher is generally required to get a loan from a bank. A restaurant owner looking for alternative financing can score in the high 500s and still expect offers from multiple sources.
In facing what must seem like insurmountable hurdles to most restaurant owners who apply for a loan from a traditional bank, the option of alternative loans must exist.
Cost of Alternative Financing Loans Is Higher
Alternative financing options are not miracle cures for the funding challenges that restaurant owners face. The cost of loans obtained through these alternate pathways is much higher than the loans that a person would receive from a bank. Paying a higher cost per dollar borrowed is simply a fact that all borrowers should accept.
The interest rates on alternate loans range between 5% and 10% of the amount loaned to the borrower. The repayment cost for merchant cash advances is even higher than what hard money lenders charge.
Differentiate between financing options is also an important concept for restaurant owners. The repayment periods for loans from alternative sources are much shorter than what owners are used to with banks. A bank may offer loans with repayment periods of five years or even ten years.
Financing through alternate lenders happens over a period of three months to three years.
Choose Carefully Before Accepting Alternative Financing
The shift toward alternative financing options has many benefits for the restaurant owner and will be explored by those interested observers in later articles.
It should be noted in this article, though, that this shift has taken place because traditional banks reject loan applications from most deserving, qualified applicants without exception simply because they operate in the high-risk food-service industry.
Alternate lenders have taken these needs into account when they designed their loans and other financial instruments in a careful way so that it fits with how restaurants function across industries and societies in different locations.
All interested observers should make sure that they understand the different kinds of loans or advances that alternate lenders have on offer and what the costs of those loans might be.
These costs might be higher than the traditional banking system offers, yet many restaurant owners today have chosen to turn to them because they at least, unlike the banks, are willing to take a gamble on a businessman’s dream, provided that businessman has shown himself worthy of such an investment.
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