As an Austinite, I enjoy our city’s diverse food scene. Austin remains true to its roots with plenty of taco shops, BBQ joints and food trucks. And, since I first visited Austin 15 years ago, the city’s high-end restaurant scene has come into its own. It has the population and diversity to support just about any restaurant concept, making it an attractive option for new restaurant ventures.
Jumping into the hospitality business by owning a bar or restaurant is a dream for many people. Plenty of entrepreneurs have made their fortunes in the bar and restaurant business. In the U.S., there are over 570,000 drinking and eating establishments, which generate $375 billion in sales per year.
However, bars and restaurants are both tough businesses. The hours can be long, managing the staff may be challenging and there’s a ton of competition everywhere, especially here in ATX. In 2016 alone, LaV, Mettle, Arro, Due Forni, Finn & Porter, East Side Showroom (more bar/cocktail lounge than restaurant) and Olivia all closed. Each of these was either a popular venue or, when it opened, showed every sign of reaching local cult status – well-financed, successful owner/operator, unique and timely concept or some other indicia of expected success.
The Failure Rate of Restaurants
You may have heard that 90% of restaurants fail within the first year. That’s not the right figure – it’s much too high. If that were true, you’d have to be crazy or delusional or both to open a restaurant. While it’s tough to find reliable statistics, it’s safe to say over 50% of bars and restaurants are outright failures – money-losing operations that are closed within a few years. Of the restaurants that fare better than that, most only do so-so, nothing super exciting, certainly not cash cows, and the owners ultimately close them, generally taking a loss of some amount.
While it’s not as bad as 90% failures in a year, it’s not encouraging. So, what does a would be restauranteur do to beat the odds and achieve success in this tough industry? I have never opened a bar or restaurant, although I have helped many clients launch restaurants over the years. Along the way, I’ve learned a few things, which I will share in this article. My goal is to give you some basic information to help start you on the path of being among the small pool of bars and restaurants that achieve outsized success. We’ll cover choosing a concept, startup costs, operational metrics and margins and whether to start a restaurant or acquire one (through M&A – mergers and acquisitions). I will focus primarily on starting or buying a restaurant with a little information regarding bars – these can be two very different businesses, depending on the mix of food and drink.
Choosing Your Restaurant Concept
You need a solid concept. In the Austin market, the options are nearless limitless – from food trucks to fine dining. All have the potential to be profitable and all carry the risk of losing money. The key is finding one that works for you and your target market – an idea that excites you and fits with local market demand.
Start by studying the competition. What’s being done? What’s working and what’s not working? Generally speaking, you should steer clear of the next hot thing unless you’re the first to your market with it. In other words, don’t chase fads and trends. If you lead by starting a fad or trend in your local market, there’s money to be made. The way to do this is to look at what works in other U.S. cities and in other countries. Howard Schultz famously imported the idea for Starbucks after soaking up Italian coffee culture. Launching Starbucks in Milan would not have been a good move for him. But, in Seattle in the 1980s, he was able to take a single shop and turn it into a coffee revolution.
On the other hand, launching another Tex-Mex restaurant in Austin carries plenty of risk. You know there’s an appetite for the cuisine – no question. But, there is a ton of competition. In our neighborhood south of Town Lake, two long-standing Tex-Mex restaurants closed their doors in the past six months. They may have closed because the owners eventually got tired of the hours and other challenges of managing a restaurant, although I’d take it as a reason to think twice about launching yet another same-old, same old Tex-Mex restaurant.
If you have reason to know (not believe) your food is significantly better than the competition’s food – it tastes better, is more authentic, whatever – then you may be able to grab your share of the market. Just be careful thinking it’s easy to open and take a piece of the pie. It isn’t always. The nature of competitive, free markets in a capitalist society is that there is usually more supply coming into the market than demand – that’s how that works. I made this mistake in the mortgage business in Houston in the early 2000s. I started a mortgage brokerage with a partner and we assumed it would be easy to take our share of a busy market. Without something unique to offer, it was tough sledding for a long time. We eventually created an innovative mortgage product and rode it to a sale of the company, although I learned my lesson about assuming I was naturally entitled to some share of the market. I wasn’t. You aren’t.
And, do not think your competitive advantage will be from lower cost or better management. Those things are tough to rely upon. We’ll talk about costs in a minute, but simply undercutting the restaurant next door on price is not a good strategy – you will just wind up taking less money home at the end of the day. And, margins aren’t high in the restaurant industry, so cutting your prices too much may mean there is no profit left in the end.
Whatever you do, be clear about your concept. We live in a niche world. In any major city, Austin included, people are looking for specialty offerings – the best of the best in a certain niche. They are naturally skeptical of the Chinese restaurant that also doubles as a pizza parlor. The owners may believe they can do both well and they know not everyone wants Chinese food all the time, so they look to diversify their offerings. But, that’s a very tough thing to pull off in a large market. Eagle Lake, perhaps. Austin? Not going to happen.
How Much Money is There in the Restaurant Business?
Tao Asian Bistro in Las Vegas grosses close to $50 million per year. They likely have a profit margin in the range of 10% (the actual profit margins aren’t disclosed). That’s some serious cash! To see the top 100 grossing independent restaurants in the United States, visit http://www.restaurantbusinessonline.com/special-reports/top-100-independents.
Back to reality, though, you should be aiming for $250+ in sales per square foot for a full-service restaurant and $300+ for a limited-service (where diners order and pay before they sit down) restaurant.
There are some great answers to this question at https://www.quora.com/How-much-money-does-a-successful-high-end-restaurant-make.
Keep in mind that the numbers you’ll be looking at consider only the profit and loss from ongoing operations. If you borrow money to launch your restaurant, you will need to factor in paying back the debt plus interest. The high leverage (cost of debt) is a reason many otherwise-solid restaurant ventures don’t survive. They are competing with existing restaurants that have no debt on their books – that’s a serious cost advantage.
The Cost to Open a Restaurant in Austin
Below I lay out a realistic budget for launching a high-end restaurant in the Austin market. This is just an idea of startup costs. Your costs may vary significantly. I’ve heard the renovations at Jeffrey’s in Clarksville cost over $3 million – way more than I estimate below for initial design and buildout. These numbers assume you lease your space, which you should do initially. If you are fortunate enough to launch a restaurant that becomes a mainstay in the market, you can buy the building later. Until then, you don’t want to be tied down in a certain location for longer than the typical five years on a commercial lease term.
Although very rough estimates, these numbers will get you started thinking about the amount of capital you’ll need to launch a high-end restaurant in Austin. These numbers assume a second generation space (i.e., that the space was previously occupied by a restaurant, otherwise your buildout costs will be higher) and 5,000 square feet of space.
Space buildout and improvements – $325,000
Interior design and finishes – $225,000
Bar and kitchen equipment – $125,000
Point of sale system – $40,000
Phone and security system, office equipment – $15,000
Signage and exterior – $10,000
Opening inventory – $40,000
Professional fees (lawyer, engineer, architect) – $100,000
Marketing – $35,000
Working capital (operating expenses) – $150,000
TOTAL: $1,065,000
Key Metrics in the Restaurant Business
To be successful in the bar and restaurant business, you have to know your numbers. Here’s a rough breakdown of where major expense categories generally fall as a percentage of sales (revenue):
- 30% on food costs
- 32% on labor
- 12% on operating expenses (uniforms, menus, utensils, other supplies)
- 10% on rent
- 5% general and administrative expenses
- 3% on marketing
- 3% on utilities
TOTAL: 95%
Assuming these averages, the profit margin (earnings) would be 5%. Like the startup costs above, actual profit margins will vary widely from restaurant to restaurant, although 5% is about right. According to Forbes, “Average industry net profit margins have steadily increased from a low of 0.4% in 2008, hitting 5.1% in 2013, according to Sageworks’ financial statement analysis of privately held restaurants (NAICS 7225).”
One of the tough things about the restaurant and bar industry is that there is a lot of cash moving through the system. Employee theft is a big issue. It can come in the form of outright stealing from the register. It also shows up when bartenders give away free drinks to juice their own tips. Regulars expect an occasional “one on the house,” although some bartenders give away one freebie for every one at cost, hoping the patron will tip generously in return. While not theft exactly, employee negligence or apathy can lead to runaways costs – pouring extra stiff drinks, too many mistakes, forgetting to ring up drinks – these can kill a bar, offsetting the money you make on food. Meanwhile, poorly cooked dinners or waitstaff forgetting to put orders in and having to discount them to make it up to the diners drains costs. If you watch Restaurant Impossible or Bar Rescue, you’ll quickly see that a recurring tactic is to tighten up the controls to stop wasting food and beverage and to catch theft.
Should You Buy a Restaurant Instead of Starting One?
Whatever business you’re getting into, including the restaurant business, you have an initial decision to make – build vs. buy? Should you start a new restaurant or buy an existing one? Buying and selling businesses is known as M&A, or mergers and acquisitions. Among the reasons to buy an existing restaurant is mitigated risk, assuming you buy a successful restaurant. If a restaurant already has a well-known local following and you don’t make radical changes to the décor, menu, chef or other personnel, you can have an expectation of continuing to make money. Opening a new restaurant carries much more risk – the market may not like what you put out. Or, your chef may have an off night or two when key food critics show up. It can be a fine line between success and failure. You need a great concept, near flawless execution and a little luck.
There’s also buildout risk if you build a new restaurant rather than buy an existing restaurant. Construction projects often go way over budget from both a time and cost standpoint. If you start a restaurant, carefully choose your general contractor – someone who knows the local market and has built out restaurants like yours before. And, be sure your architects and engineers involve your GC early and often. Your architect may draw up amazing details and features, but your GC will know what those features cost and be able to help you think about the value of every detail and feature in the broader context of your budget. No matter what, build in plenty of contingency for time and cost.
One of the downsides of buying a successful restaurant is cost. You can expect to pay 3-5 times seller discretionary earnings, which is a measure of earnings that’s adjusted to account for expenses the current seller runs through the business that aren’t necessary expenses for a new owner. For example, the current owner may pay herself a salary out of the business without working much in the business. If you bought the restaurant, you can eliminate that expense, so it’s added back to the bottom line. 3 to 5 times seller discretionary earnings is nearly certain to be considerably more money than the hard cost of the assets of the business. When you buy a successful business through merger or acquisition, you pay for the benefit of the operations, not just the cost of the assets. In other words, you can start from scratch for less money. Does that make starting from ground zero the right move for you? That’s the first decision you need to make.
Considerations When Purchasing a Restaurant
An alternative to starting a new restaurant or bar venture from scratch is to buy an existing establishment. When you buy the new business, you purchase the assets of the existing bar or restaurant, and it may or may not include the name and current employees. Buying may be quicker, provide access to an ideal location and give you an established clientele from the start. The name recognition may be another benefit, but only if the place has a stellar reputation. Before investing in an existing bar or restaurant, you need to conduct thorough due diligence to see whether it’s a good idea to buy and to understand why the current owner is selling. Owners may sell because the bar or restaurant is not doing well financially, or the owners are exhausted and just want out. There are several potential risks to look out for when buying. As part of the investigation, you need to get the financials, research the property ownership, search for outstanding liens (e.g., judgments, loans, tax liens), and evaluate the location and reputation. For more information about how to avoid taking on liabilities of an existing business when you buy it, read How to Avoid Seller Liabilities When Buying a Business.
As part of due diligence (this is the term in mergers and acquisitions for looking under the hood to confirm the information the seller of a business provides and to flesh out any problems), the potential buyer will receive and should verify tax returns and bank statements, not just profit and loss statements (especially if the P&Ls are unaudited – they’re easy to massage in the seller’s favor). You should look at food and beverage sales, labor costs, supply costs, and maintenance and operating costs. To see if a potential acquisition is a good investment, the entrepreneur should analyze the profitability of a bar or restaurant through standard financial metrics.
Depending on the size of the establishment, looking at a seller’s EBITDA (earnings before interest, tax, depreciation, and amortization) or discretionary earnings (EBITDA, plus owner’s compensation) is a reliable metric to compare across potential targets. For smaller businesses, it can be tough to separate out what the owner gets versus the earnings of the company, so the owner’s compensation and other is added back in (hence the terms, seller’s discretionary earnings). Understanding a seller’s discretionary earnings or EBITDA helps you predict and understand your potential return on investment. The metrics are a good gauge on a company financial strength, excluding the debt load. Buying a financially successful company comes at a premium. Buying an existing business comes at a premium. As discussed, for a successful food or drink place, you’ll pay a multiple of sales, not just the asset value. If a business isn’t financially successful, that doesn’t mean it isn’t worth buying. New management may be the solution to turning the place around, although tread cautiously. You want to be 100% sure it’s poor management and not a bad location, bad concept or some other issue that is insurmountable. And, keep in mind that convincing locals to try a restaurant that doesn’t have a great reputation can be tough. You have to communicate to them that management has changed and, even then, some won’t think it’s worth the risk vs. going somewhere they know is a great restaurant.
In purchasing a bar or restaurant, you need to know who owns the space. Most businesses lease space, rather than own. As a buyer you need to know whether the current landlord will assign the space to you or enter into a new lease agreement. Most commercial leases have prohibitions on assignment and getting a landlord to agree to assign a commercial lease can be challenging. This is a legal issue that may crop up after a sale closes if proper due diligence isn’t done. Be sure to handle this issue upfront.
Future entrepreneurs need to know whether the establishment’s equipment is truly owned by the business, or if there is a creditor that has a lien on the leased equipment. The Secretary of State’s website lists any liens filed on the equipment, the seller’s entity or the owners themselves. If the equipment is leased, then the new buyer will have to get an assignment of that lease as well.
Understanding why the current owner is selling is the key before pulling the trigger to buy. If undercapitalization is not the reason, is it the location? Is it in a busy area, with plenty of foot traffic? Is there enough parking? Or is the reputation bad? The BBB serves as a trustworthy resource for potential buyers to see reviews and customer disputes. These are three big reasons restaurants struggle – undercapitalization, location and reputation. You can overcome undercapitalization, possibly move the location, but reputation is a tough issue to get past.
What about Permitting Requirements?
As a part of any new business, an owner must ensure their venture complies with all licensing and regulation requirements. Many licenses and permits take several weeks, even months to be approved.
When opening or buying a bar or restaurant in Austin, an entrepreneur may need some of the following:
- Certificate of Occupancy (City of Austin)
- General Assembly Permit (Austin Fire Department)
- Permit to Operate a Food Enterprise (City of Austin)
- Sales and Use Tax Permit (State of Texas)
- Licenses to sell/serve alcohol – provided through the Texas Alcoholic Beverage Commission (TABC)
- Zoning Verification/Approval (City of Austin)
The State of Texas does not require a general business license, but regulatory agencies may have licensing and permitting requirements based on the type of business. To ensure all permitting requirements are met, you should contact the local county and/or city government, such as Travis County, to determine if there are any additional requirements.
In additional to the business permits, employees have special requirements. To obtain a Retail Food Establishment Permit at least one employee must be a Certified Food Manager, acquired by passing an exam approved by the Texas Department of State Health Services.
Some of these permits and licenses may be transferred when buying an existing establishment. Understanding the transfer process is something with which a good M&A lawyer will help.
Here are some licensing/permitting resources:
- https://www.tabc.state.tx.us/licensing/license_and_permit_description.asp
- https://austintexas.gov/sites/default/files/files/Health/Environmental/startingfoodbus_2-6-14.pdf
Other Considerations When Getting into the Restaurant Business
I talked earlier about the weight of debt on the financials of any business. Instead of borrowing money, you can take on investors and give them equity. Whenever you raise capital from investors, you must comply with securities laws. An experienced corporate attorney can help you navigate these issues and how to structure the deal. The articles below were written primarily for technology startups, although most of the information applies to raising money for restaurants, as well –
https://cenkuslaw.com/2016/10/raising-capital-startups-seed-series-a-funding/
https://cenkuslaw.com/2016/11/startup-funding-rounds-series-b-c/
Having partners to share the workload and to commiserate on down days (these exist in any new venture – trust me!) is invaluable. For a few of my thoughts about structuring business partnerships, check out these articles –
https://cenkuslaw.com/2016/12/5050-business-partnerships-good-bad-idea/
Read Most Important Reason to Create a Business Contract
Once you open, you will need to deal with ongoing operational and legal issues, including managing employees. Here is a great guide for Texas employers – Employers Guide to General Employment Law
For general information and support for your Austin venture, check out the resources here – [link to Resources for Small Business Owners and Startups in Austin on the new resources page]
How does a Business Attorney Help?
While lawyers won’t usually help with the restaurant concept and menu, a business lawyer can help you navigate the path from individual to proud bar or restaurant owner. You should think of an experienced corporate attorney as the quarterback of your legal team.
As a corporate attorney, I help entrepreneurs structure their founder relationships, raise capital (securities law), purchase existing restaurants or other businesses (mergers and acquisitions law) and handle a wide variety of other transaction and contract-related issues. I do this in Austin, Houston, Dallas and, depending on the type of venture (for example, restaurants are local ventures with significant local licensing and zoning considerations, although technology companies are not), other areas of Texas and the United States.
If you want a trusted advisor to jumpstart your new venture, please get in touch. I am happy to discuss your plans for the business. As your business attorney, I can help you accomplish your goal of opening a bar or restaurant, and hopefully, put it on the map in your local market.
Author: Brett Cenkus
Brett Cenkus is a business attorney with 18+ years experience based in Austin, Texas. He has worked with a variety of businesses and has clients throughout Texas as well as many technology clients throughout the United States. Brett is a Harvard Law graduate with a sharply seasoned mind and an entrepreneurial heart. As a founder of 6 companies himself, he is especially passionate about helping startups succeed. In 2016 Brett was named the winner in the Individual category for RecognizeGood’s Ethics in Business & Community Award. He offers businesses solutions that are in sync with their culture, goals and values. You can learn more about Brett by visiting the About page on this website.