The Restaurant Industry: An Entrepreneurial Analysis Mary Brennan FIN 402 December 11, 2002 Executive Summary It was upon learning of a close friend‟s intention of starting up his own restaurant that the author was motivated to research the restaurant industry and write this paper. The author felt that her friend had not thoroughly thought through his prospective investment. In turn, she sensed some sort of obligation to inform him of what exactly was in store for him as a restaurateur, as she perceived him to be overly confident. In researching the restaurant industry, the author tapped into several valuable resources. Such resources included scholarly journals, trade publications, professional associations‟ publications, the Internet, and several databases storing a variety of publications. As a restaurateur, one must be familiar with the industry‟s trade publications and professional associations. Restaurant trade publications provide detailed information about the industry, its segments, and even its sub-segments. Professional associations often offer similar publications and most supply “how-to” advice for the restaurateur who is considering starting up and managing his own business. Historically, restaurants have been owned and operated by sole proprietors or small partnerships. Despite the appearance that large corporate franchises outnumber small restaurants, this simply is not the case; instead, most restaurants are small businesses. Trends that currently dominate the industry also indicate that many opportunities exist for the restaurateur. One such trend is the growth in the industry‟s share of the consumer‟s food dollar. Another trend favoring the industry is the rise in disposable income. While such trends suggest a bright future for the industry, it, nonetheless, has its share of challenges. For example, existing restaurant operators are grappling with recruiting, training, and retaining decent employees. After all, the industry is well-known for its notorious employee turnover rates. Others operators are more concerned with the potential impact that the current recession will have on their bottom lines. For the restaurateur just starting up, the challenges that must be confronted are quite different. The restaurateur must finance the start-up, which can easily run between $250,000 and $500,000. It is not uncommon for these funds to be obtained through the employment of bootstrapping techniques. The restaurateur will also be responsible for making critical decisions that will affect his business, including how to manage inventory and determining which risks to bear and which to transfer through insurance. Decisions of another nature will also have to be made. For example, the restaurateur must identify a way to operate his business successfully without compromising his ethical standards. Some of the common ethical issues that arise in the restaurant industry involve labor practices, misrepresentation of food quality, invasion of employees‟ privacy, and conflicts of interests between the restaurateur and the customer‟s well-being. Investigation into the financial attributes that characterize the restaurant industry revealed some key points, as summarized below. The restaurant industry is in fact a cash business. Inventory comprises the next largest portion of a restaurant‟s current assets, second to cash. Restaurants typically have slightly positive, if not negative, net working capital. Much of a restaurant‟s short-term financing needs are fulfilled through trade credit extended by suppliers. Besides this, many restaurateurs depend on short-term loans granted by family, friends, and colleagues. Restaurants are capital-intensive because they require a significant investment into equipment and, if the restaurateur does not opt for a lease, land and a building. Since the lives of these assets are long-term, the financing of these assets are likewise long-term. Loans drawn to finance fixed assets often require a significant amount of the assets‟ value to be pledged as collateral and sometimes stipulate a personal guarantee by the restaurateur. While banks and other traditional sources of external, long-term financing have been reluctant to lend to restaurants because of their high probability of failure, they are more willing to do so (and on more favorable terms) if the loans are guaranteed by the Small Business Administration (SBA). Among the most popular of the SBA‟s lending programs available to restaurants are its 7(a) Guaranty, LowDoc, and 504 Certified Development Company (CDC) loan programs. Restaurants can easily spend just as much on COGS (cost of food and beverages) as they do on payroll. Restaurants typically achieve slim profit margins. Table of Contents The Restaurant Industry: An Introduction ...................................................................................... 1 Major Professional Associations..................................................................................................... 1 Major Trade Publications ................................................................................................................ 2 Trends ............................................................................................................................................. 3 Getting Started ................................................................................................................................ 4 Typical Business Structure ............................................................................................................. 5 Restaurant Failures.......................................................................................................................... 5 Ethical Issues .................................................................................................................................. 7 Risk Management ......................................................................................................................... 10 Inventory Management ................................................................................................................. 11 Financial Analysis ......................................................................................................................... 11 Common Exit Strategies ............................................................................................................... 15 Conclusions ................................................................................................................................... 16 Appendix A ................................................................................................................................... 17 Appendix B ................................................................................................................................... 18 Appendix C ................................................................................................................................... 19 Appendix D ................................................................................................................................... 26 Works Cited .................................................................................................................................. 29 The Restaurant Industry: An Introduction The restaurant industry is one in which many entrepreneurial opportunities exist. At first glance, the restaurant industry may appear to be comprised mostly of large corporations and their franchisees. However, the truth be told, most restaurants are independently owned and are classified as small businesses. Statistics have shown that as disposable income increases, as it has over the years, consumers will spend more on food and will allocate more of their food dollar on food away from home. For this reason, demand for food away from home has increased and, in turn, the industry has caught the eye of some entrepreneurs. Perhaps the more important reason that entrepreneurial opportunities exist within the industry is because there is so much innovation out there that has yet to be exploited by restaurateurs. Major Professional Associations When starting up any type of business, it is important to be aware of what professional associations exist. These professional associations often provide information and services that prove to be invaluable to the entrepreneur or any business person for that matter. Some of the most widely recognized restaurant associations and a brief description of their purposes are found below. Additionally, Appendix A lists these associations‟ website addresses. National Restaurant Association (NRA) The NRA‟s “mission is to represent, educate and promote the rapidly growing industry that is comprised of 858,000 restaurant and foodservice outlets employing 11.6 million people” (NRA “About Us”). Moreover, the association has 52,000 member companies that represent more than 254,000 restaurant establishments (NRA “About Us”). It is also a member of the International Hotel and Restaurant Association. National Restaurant Association Educational Foundation (NRAEF) The NRAEF is the educational arm of the NRA. It is responsible for “helping the industry attract, support, guide, train and teach people” that represent the future of the industry (NRAEF “President‟s Message”). State Restaurant Associations State Restaurant Associations serve the same purposes as the NRA at the more local level. The Nebraska Restaurant Association, for example, “acts as the principal advocate for Nebraska‟s Hospitality Industry and promotes the qualities of strength, unity and excellence in and of its membership” (Nebraska Restaurant Association “About the NRA”). American Culinary Federation (ACF) The ACF “is a professional, not-for-profit association for chefs and cooks” that has set out “to promote the professional image of American chefs worldwide through education among culinarians at all levels, from apprentices to the most accomplished certified master chefs” (ACF “About the ACF”). International Association of Culinary Professionals (IACP) The IACP is a not-for-profit association with 4,000 members from 35 different countries (IACP “What is the IACP?”). Its mission is to serve “as a resource and support system for food professionals worldwide” and “to help its member achieve career success ethically, responsibly and professionally” (IACP “What is the IACP?”). Brennan 2 National Bar & Restaurant Association (NBRA) The NBRA‟s “mission is to provide discounts, services and networking opportunities enabling restaurant, bar and hospitality professionals to increase revenues and profits through innovative promotions, marketing and management” (NBRA “Benefits of NBRA”). American Institute of Wine and Food (AIWF) The AIWF is an organization “dedicated to understanding and celebrating the pleasures, benefits and traditions of the table” (AIWF “About the AIWF”). It has 30 chapters in the U.S. and more than 7,000 members who are restaurateurs, food industry professionals, food educators, nutritionists, chefs, wine professionals and dedicated food and wine enthusiasts (AIWF “About the AIWF”). International Hotel & Restaurant Association (IH&RA) “The IH&RA is a global network of independent and chain operators, national associations, hospitality suppliers and educational centers in the hotel and restaurant industry” (IH&RA “About the IH&RA”). Major Trade Publications It is equally important for entrepreneurs to read some of the major trade publications relevant to their industry. Below, some of the major restaurant publications are listed and described. Appendix B provides the website addresses for those trade publications that are available on-line. Restaurants USA. This on-line magazine is published monthly by the NRA and provides comprehensive coverage of the foodservice industry. Restaurant Economic Trends. This is a monthly newsletter published by the NRA and provides updates “on industry and economic issues such as food prices, wages, sales and the overall health of the U.S. economy” (NRA “Restaurant Economic Trends”). Nation’s Restaurant News. This is a weekly on-line publication that covers an array of topics, namely trends, tips and upcoming events. Restaurant Hospitality. This is a monthly publication “for chefs and other commercial foodservice professionals” that is aimed in keeping them “informed of industry trends and happenings and helps them run their operations more profitably. Topics regularly include new food and equipment products and trends, menu and recipe ideas, industry news, new technology, food safety, emerging new concepts, consumer attitudes and trends, labor and training, and profiles of successful operations” (Restaurant Hospitality “Subscription Information”). Restaurants & Institutions. This is a monthly publication that provides food trends, business analyses, exclusive research and a broad industry perspective. Cornell Hotel & Restaurant Administration Quarterly. This publication “publishes articles that help hospitality managers work smarter and do their jobs better” (Cornell University “Cornell Hotel & Restaurant Administration Quarterly”). Food Review. This is a publication that tracks the “trends in the agricultural and restaurant sectors of the U.S. economy” and is published by the Economic Research Service (NRS), a division of the U.S. Department of Agriculture (NRA “Resources”). Brennan 3 Legal Monitor. This NRA publication provides “a monthly sampling of recent court decisions and administrative rulings that could affect the restaurant industry” (NRA “Legal Monitor”). Trends Sales. The NRA expects total industry sales “to reach a record $407.8 billion in 2002, an increase of 3.9%,” or 1.4% after adjusting for inflation, from 2001 (“2002…Overview”). If this sales projection is accurate, restaurant sales will equal roughly 4% of U.S. GDP and will average $1.1 billion daily (NRA “2002…Overview”). Nebraska restaurant sales, in particular, are expected to grow 3.6% in 2002 (NRA “2002…Outlook”). Interestingly, in 2000, the Midwest outpaced all other regions with expenditures of $2,322 per household or $929 per capita (Ebbin). Spending. Household Income. In 2000, households with an average pre-tax income of $70,000 or more, which represented 19% of the population, accounted for the largest portion (36%) of total spending on food away from home (Ebbin). Figure 1 in Appendix C shows the breakdown of spending on food away from home by household income for 2000. Age. Today, spending on food away from home represents 46.1% of the consumer‟s food dollar (NRA “2002…Overview”). In 2000, households headed by persons under the age of 25 spent 48.8% of their food dollar on food away from home, which was more than any other age group (Ebbin). However, households headed by persons age 45 to 54 spent $2,638 per household on food away from home, the most of any other group (Ebbin). Even still, households headed by persons age 55 to 64 spent the most ($999) per capita on food away from home in the same year (Ebbin). The logic backing up these statistics is that people aged “35 to 54 are in the prime of their earning potential and their higher income result in higher spending on food away from home” (Ebbin). The same is true of the 35 to 44 age group but because they are also in their prime child-raising years, their per capita restaurant spending is diluted by a higher average household size (Ebbin). Household Size. In 2000, one-person households had the highest restaurant spending per capita “($1,348) and allocated the largest share of the food dollar on food away from home (47.7%)” (Ebbin). Nonetheless, these households spent less than the nation‟s average while households comprised of two or more persons spent a total of $2,454 per household on food away from home (Ebbin). Household Composition. Households comprised of a husband, wife and children spent 35% above the national average on food away from home (Ebbin). However, households with just a husband and wife “posted the highest per-capita spending on food away from home” (Ebbin). Moreover, statistics indicate that in households with children, as the children get older, restaurant spending increases significantly (Ebbin). Number of Wage Earners. Spending statistics show that “both household income and total spending on food away from home rise with the number of wage earners in a household” (Ebbin). Brennan 4 Occupation. “Persons employed in managerial and professional occupations posted the highest total and per-capita spending on food away from home” and “allocated the highest proportion of their total food dollar to food away from home” in 2000 (Ebbin). Challenges. Table 1 in Appendix C summarizes what operators identified as being the biggest challenges for 2002. Clearly, quick service operators and low-end full service operators expected difficulties in recruiting and retaining employees1. The industry is already characterized by incredibly high employee turnover. For example, the employee turnover rate is 84% for full-service restaurants with an average check size of $15-$25 and 96% for fast-food chains (Standard & Poor‟s 8). On the other hand, full service operators with larger average check sizes seemed to be more concerned with the economic slowdown. Getting Started It is not enough to have a good idea and match it with an opportunity in order to be an entrepreneur, or at least a successful entrepreneur. To begin with, the restaurateur must be able to finance the start-up. As it is the case when starting up any kind of business, a certain amount of capital investment is required. The cost of financing a start-up restaurant varies widely, as demonstrated in Exhibit A in Appendix C. However, the CEO of the Texas Restaurant Association says that “as a general rule, restaurant startup costs range from $250,000 to $500,000” (Colley). If the restaurateur is able to finance the startup, it is critical that he or she be able to manage the business. According to a career-oriented website, a restaurant manager must possess certain skills, abilities and knowledge, as summarized below, in order to be successful (Wharekai). Restaurant managers must have the following skills and abilities: o Leadership o Decision-making o Planning o Marketing o People o Team management o Communication o Computing/Accounting (especially if they‟re running their own business) o Works well with others o Works well under pressure o Ability to accept criticism o Calmness in emergency situations Restaurant managers must have knowledge of the following areas: o Food and bar management o Licensing laws o Health and safety regulations 1 As a manager at McDonald‟s, I can attest to this. As sales have stagnated, the management team has had to cut employees‟ hours and freeze merit increases. As a result, employees have come to feel underappreciated and many have submitted their notice of resignation. Brennan 5 o Competitors‟ price and services o Wholesalers‟ products and prices o Business, marketing and market trends Restaurant mangers must possess the following personal qualities: o Friendliness o Patience o Helpfulness o Tactfulness o Adaptability o Motivational o Restaurant managers must meet some physical requirements: o Fit o Healthy o Stamina (for long hours standing) o Neat and tidy appearance Typical Business Structure “Despite a trend toward consolidation, the U.S. restaurant industry remains highly fragmented. Eating and drinking places in America are mostly small businesses; historically, about more than half are sole proprietorships or partnerships, according to the National Restaurant Association” (Standard & Poor‟s 6). In fact, “one out of three eating-and-drinking place firms are sole proprietorships or partnerships” and “more than seven out of 10 eating-and-drinking places had less than 20 employees in 1999” (NRA “2002…Factbook”). While there is no one clear reason why restaurateurs have chosen to operate their businesses as small proprietorships or partnerships, a comparative analysis of the different types of legal structures provides some insight. The table presented in Appendix D makes the pros and cons of each type of legal structure more visible. Undoubtedly, the greatest benefit that proprietorship and partnership forms offer to the restaurateur is simplicity. Proprietorships and partnerships are easy to form, avoid many of the legal formalities to which other legal structures are subjected and allow the owner(s) to retain a significant amount of, if not complete, control of the business. Restaurant Failures Consider this: “53% of all entrepreneurial startups across all industries fail within five years” (Crandall, Vozikiz, Sparks 33). Unfortunately, this statistic is accurate and representative of failure rates in the restaurant industry. Researchers at Cornell University and Michigan State University conducted a study of restaurants in three markets over a period of ten years. The results of their study are summarized in the table below (Farkas 60). Time Period Failure Rate After 1st Year 27% After 3rd Year 50% After 5th Year 60% Entire 10-Year Span 70% Brennan 6 Additionally, according to BizMiner, restaurant start-ups pose higher than average risk to the entrepreneur than any other start-up and have higher failure rates than the collective restaurant industry and small businesses within the industry. The table below presents BizMiner‟s findings. Firms Tracked Survival Failure Risk Index from 1/98 – 1/01 Rate Rate where 1.0 = Average Industry 487,661 70.10% 29.90% 0.96 Small Business 262,078 71.92% 28.08% 0.90 Start-Ups 27,914 54.17% 45.83% 1.47 While all these statistics may be discouraging for some entrepreneurs, it is somewhat comforting to know that “81.4% of small business failures result from forces within the owners/managers‟ control” (McQuaig C7). That is, owners and mangers can be proactive in avoiding the pitfalls that lead to a small business‟ demise. The table below presents one study‟s findings on small business failures (McQuaig C7). Reason for Failure % of Business Failures Poor management of financial activities 32.1% Lack of management competence or experience 14.6% Inflation or economic conditions 12.4% Poor books or records 12.3% Sales/marketing problems 10.7% Staffing problems 9.0% Union problems 6.2% Failure to use external advice 2.7% Moreover, Mike DeLuca, a writer for Restaurant Hospitality, says that there are “Seven Deadly Sins” that lead to restaurant failure that are within management‟s control and are summarized as follows (14). Perhaps abstaining from such “sins” would aid the restaurateur in achieving success. 1. Sloth. Management neglects the restaurant‟s “appearance, hygiene, and daily management needs.” 2. Envy. Instead of taking any action whatsoever to counter a competitor‟s efforts, management sits back and stews over jealousy. 3. Greed. Management prices “items unreasonably and charges even for items that are expected to be free, such as ice water.” 4. Pride. Management declines the advice of others because it possesses the know-it-all attitude. 5. Lust. Management becomes involved with co-workers or hires workers on the basis of attraction and the relationship distracts management from what it should be concerned about—running the business. 6. Gluttony. Managers are slobs. 7. Anger. Managers have quick tempers. Brennan 7 Ethical Issues Labor. Employee Stealing. The practice of stealing employees from competitors is well known by the restaurant industry. In fact, one restaurateur had some chefs walk “right into his kitchens and offer his cooks more money,” adding that employees “will jump ship just to make a quarter more an hour, even though they receive regular raises” (qtd. Walkup 138). When labor markets are tight, it is very difficult for restaurants to retain employees and attract new ones. Moreover, “finding and keeping wait staff is even more troublesome than retaining kitchen workers” (qtd. Walkup 138). He adds that Hispanic kitchen workers are easier to retain than Americans because they are more loyal and do not “have a problem doing the same job every day” (qtd. Walkup 138). Discrimination. If it is the case that Hispanics have proven to be better kitchen workers, a potential ethical issue may be racial discrimination. Are restaurateurs partial to certain racial groups? “The 2000 U.S. Census revealed a significant increase in the number of minorities in the United States, especially the Hispanic community” (LaGreca). Even though “Hispanics accounted for only 10% of all employed civilians in 1999”, they “accounted for 16% of eating- and-drinking-place employees” (LaGreca). Most worked as “miscellaneous food-preparation workers” while slightly fewer worked as cooks (LaGreca). Gender discrimination, too, may exist in the foodservice industry. “According to a 1995 report published by the Glass Ceiling Commission, the U.S. labor force remains gender- and race-segregated, with white men filling most top management positions in corporations” (Hedden). While 43% of women hold “executive, administrative and managerial positions, they account for less than 3-5% of top executive positions” (Hedden). Clearly, the glass ceiling has yet to be shattered. Pay inequities still exist too. According to the Women‟s Bureau, in 1994, “women working full-time and year- round averaged 72 cents for each dollar that men earned” (Hedden). In fact, the typical foodservice industry manager is male (54%) and white (84%) (LaGreca). Teenagers. “Employees in food-preparation and foodservice occupations tend to be younger than those employed in other occupations” (LaGreca). “In 1999, teenagers accounted for 27% of all food-preparation and foodservice occupations and 28% of eating-and-drinking-place positions” (LaGreca). Many states are considering imposing further restrictions on the hours that teenagers can work (Pulley B1). Much of the legislation is driven by the fact that working teenagers‟ tend to compromise their health and schoolwork (Pulley B1). Since the restaurant industry is one that employs many of these teenagers, it will no doubt be affected by such legislation. The businesses that will be affected in particular are those that are family-run. For example, one Italian eatery in New York is run by a couple and their eight children (Pulley B1). The Labor Department has already found in its investigations “evidence of teenagers working illegally long hours” and “operating dangerous equipment” (Pulley 1B). With even tighter restrictions on child labor laws, one can only imagine how well small restaurants will comply. I suspect that some restaurateurs will engage in under-the-table practices with their teenage employees as to avoid seeking out new, and probably more expensive, labor. Brennan 8 Former Welfare Recipients. Besides rejecting applicants on the basis of race or gender, the restaurant industry is notorious for rejecting former welfare recipients. The restaurant industry has been reluctant to hire former welfare recipients despite the National Restaurant Association‟s and its state partners‟ endorsements and the potential tax credit of up to $6,000 per welfare recipient hired (Prewitt and Allen 5). One restaurateur commented that the biggest problems with hiring welfare recipients are “assimilating people who have not worked for a long time,” “logistical problems like transportation,” and their “ignorance of protocol, suspicion of authority and lack of enthusiasm” (Prewitt and Allen 5). Another “operator said that the only thing people have to do is pass the „huff‟ test…If they can huff on a mirror and make it foggy, then they are hired” (qtd. Prewitt and Allen 6). Apparently, there are mixed feelings regarding the hiring of former welfare recipients. Even still, former welfare recipients are not exactly looking to be employed by the restaurant industry either. In fact, an employee of America Works2 indicates that most of the people he helps “want an office job with a window, pushing papers” (Prewitt and Allen 6). Many people are stricken with “the misconceptions that restaurant positions are menial, low-paying and arduous” and overlook the fact that “there are other things that” such positions “could lead to if they stick with it” (Prewitt and Allen 6). Cutting Corners. It is not unlikely that some restaurateurs comprise the quality or safety of their products to widen their margins. In fact, the chef/owner of one Italian restaurant articulated the actions of one of his “sleazebag” competitors as follows: he has “been promoting free antipasto to bring people in—though I know damn well he‟s cutting down the quality of the entrees to pay for it. And of course once he‟s got them, it‟s all about building up the check. I mean, I pity the customer in that place who knows nothing about wine” (Stein “Honesty” R35). He also “went on a jag recently about successful restaurateurs who get away with serving cuisine just this side of edible:” "It's incredible, they provide enough atmosphere -- nice decor, expensive linens, fresh flowers -- and no one seems to notice the entrees are third-rate" (Stein “Bottom-line”). Security Measures. “Dishonest employees are responsible for theft of goods, bogus workers‟compensation claims, embezzlement, credit-card fraud and a host of other crimes against their employers” (Featsent). “Security experts suggest that operators use measures such as inexpensive background checks and security cameras to protect themselves” (Featsent). However, restaurant owners must be careful in instituting such security measures. The National Restaurant Association, for example, “cautions that background checks put restaurants at risk of possible discrimination in hiring, depending on the questions asked” (Featsent). “The Equal Employment Opportunity Commission is sensitive to questions about an applicant‟s prior conviction record, since convictions may be more prevalent among minority groups than nonminorities” (Featsent). Moreover, if cameras are to be installed, they should be set up in “areas where there is not a reasonable expectation of privacy, as there is in such areas as restrooms, and inform employees of the cameras” (Featsent). Otherwise, employers may hinder their employees‟ right to privacy. 2 America Works is a not-for-profit organization “that specializes in landing jobs for people on public assistance” (Prewitt and Allen 6). Brennan 9 Additionally, restaurateurs should be aware that installing surveillance cameras may send the signal to employees that they do not trust them. This, in and of itself, can actually instigate problems where none had previously existed. Customer Well-Being. The restaurant industry has recently been under attack for contributing to the United States‟ growing obesity epidemic. “Government surveys show that at least 55% of the nation‟s 97 million adults are overweight or obese and at growing risk of developing illnesses such as coronary heart disease, stroke, high blood pressure, high cholesterol and diabetes” (Sullivan R6). Considering that “at least one-third of our calories are now eaten outside the home, up from 18% in the late 1970s,” it is little wonder why people have come to blame foodservice providers for Americans‟ chunkiness (Sullivan R6). Additionally, the Agriculture Department reports that “fat currently accounts for 31.5% of total calories in foods eaten at home” and 38% for meals served in restaurants (Sullivan R6). Reportedly, “restaurant owners use fattier meads and add fat in the form of butter and sauces to make food taste better” (qtd. Sullivan R6). Moreover, portions are getting larger as “the American idea of „getting your money‟s worth‟” has prevailed (qtd. Sullivan R6). Interestingly, according to a recent Gallup poll, “Americans‟ favorite meal is steak, salad, and baked potato followed by a slice of pie for dessert” (Sullivan R6). So, it is curious to know how restaurateurs are dealing with these facts. Are they making efforts to serve healthier meals in smaller portions? Or, are they more concerned with making a buck by whatever means necessary? Despite the notoriety that some lawsuits made by obese Americans against foodservice providers have gained, one survey reveals who people really hold accountable for obesity. The findings of the survey, which involved 1,000 respondents, are summarized in the table below (Branch B1). Who is Responsible for Obesity? Percentage of Respondents Individuals themselves 57% Food Manufacturers 5% Restaurants 2% Other Causes 36% While it appears that consumers at large really do not blame restaurants for the rise of obesity among Americans, some individuals do. For example, Caesar Barber filed a lawsuit against McDonald‟s, Wendy‟s, Burger King, and Kentucky Fried Chicken alleging that these fast-food chains caused his obesity (Associated Press). At the time of the filing, he was 5‟9” and 272 pounds (Associated Press). He claims that “he ate fast food for decades, believing that it was good for him until his doctor cautioned him otherwise” (Associated Press). His lawyer stated “that restaurants should list ingredients on their menus!” (Associated Press). For the record, the restaurants named in Mr. Barber‟s suit “have provided nutritional information of their meals for many years” (Associated Press). It would be ethical for restaurateurs to offer menu items that contribute to their customers‟ well- being. However, the customer will make the ultimate decision as to what he/she will and will not eat. So, the restaurateur might reason that if consumers will eat such-and-such, he might as Brennan 10 well offer it because if he doesn‟t, a competitor will. Then again, not only are there ethical implications involved in making such a decision, but legal ones as well. A restaurateur who does not offer strictly healthy foods bears the risk of getting sued in the future by sue-happy Americans. Is that a risk he is willing to be burdened with? The answer to that will depend entirely on the restaurateur and his risk tolerance. Speaking of risk, the restaurateur must employ some risk management in his operation of a business, as will be discussed next. Risk Management The restaurateur must consider three factors when considering insurance. First, he must determine the probability or likelihood of a loss occurring. Second, he needs to quantify the size of the loss. Third, he must assess whether or not his business could absorb the loss. The losses that are outside of normal business operations should not be insured. Such losses would include the breaking of glassware and the like. According to the Entrepreneur Magazine Group, the following list includes the types of insurance coverage most commonly considered by the restaurateur as well as a brief description of the coverage (qtd. Illinois Chamber of Commerce and Community Affairs and Illinois Institute for Rural Affairs 17). Take note that while all these different types of insurance coverage are listed individually, insurers often offer policies or packages that provide for comprehensive coverage. For example, the typical Business Owner‟s Policy provides coverage for both property and general liability. “Fire and general property insurance—covering fire losses, vandalism, hail, and wind damage” “Plate-glass insurance—covering window damage” “Consequential-loss insurance—covering loss of earnings or extra expenses when business is suspended due to fire or other catastrophe” “Burglary insurance—covering forced entry and theft of merchandise and cash” “Fidelity bonding—covering theft by an employee” “Fraud insurance—covering counterfeit money, bad checks, and larceny as well as stolen credit cards” “Public-liability insurance—covering injury to the public such as a customer or pedestrian falling on property” “Product-liability insurance—covering injury to customers arising from the use of the goods purchased through the business” “Worker‟s compensation insurance—covering injury to employees at work” “Life insurance—covering the life of the owner(s) or key employee(s)” “Business-interruption insurance” “Malpractice insurance—covering the owner against claims from customers who suffer damages as a result of services performed” “Errors and omissions insurance—covering the store against claims from customers who suffer injury or loss because of errors made, or things that should have been done but were not done” Brennan 11 Inventory Management As inventory is a critical aspect of the restaurant business, possibly more so than in most other retail industries, it is vital for the restaurateur to be prepared to cope with the various issues that arise. While there is a plethora of inventory issues which the restaurateur must consider, be aware that only a few are briefly discussed here. Likely the most obvious inventory issue that the restaurateur must deal with involves perishable goods. Ineffective management that results in a lower-than-optimal turning of perishable goods can result in large losses for a restaurant. That is, if perishable goods are not used, they spoil and must be accounted for as waste. On the alternative end, if not enough inventory is ordered, the restaurant will not be able to serve customers with the entrees they desire. In turn, many restaurants take a two-prong approach to inventory control. First, many restaurants are equipped with computer systems that feed point- of-transaction data into a program that itemizes the approximate amount of each ingredient used to prepare the meals purchased by customers. These amounts are then deducted from the starting inventory. Management, in turn, can approximate how much and which inventories need to be replenished. However, a physical inventory should also be taken. Hence, the second prong. The physical inventory almost always reveals that not all diminished inventories have been accurately captured by the computer system. This is likely caused by some combination of three things: employee theft, waste, and larger- or smaller-than-expected portions of ingredients used in the preparation of meals. The use of both specialized computer systems and physical inventories can aid restaurant managers in effectively managing inventory levels3. Financial Analysis The Financial Statements. The Balance Sheet. Exhibit B in Appendix C shows the compilation of balance sheet data from 689 eating-and- drinking establishments in year 2000. Note that cash accounts for 12.8%, or the majority, of current assets, confirming that the restaurant industry is in fact a cash business. “Because virtually all sales in the restaurant industry are transacted in cash or equivalents like credit cards, many restaurant companies operate with a negative working capital” (Standard & Poor‟s 17). Naturally, inventory makes up the next largest portion of current assets. Overall, however, these establishments‟ assets are largely made up of fixed assets. Eating-and-drinking places are required to invest into a lot of capital like property and equipment. By looking at the claims- side, it becomes evident that these establishments tend to be heavily leveraged. It appears that the largest component of current liabilities is accounts payable, which arise from trade credit extended by suppliers. Gift certificates sold, too, are recorded as payables. The long-term debt can be attributed to the financing of big-ticket items like equipment, buildings, and leasehold improvements. Exhibit C in Appendix C provides balance sheet data for the restaurant industry in greater detail. 3 For example, at McDonald‟s the computer system keeps a perpetual inventory that is trued up by a physical inventory that is conducted at month-end. Brennan 12 The Income Statement. Exhibit D in Appendix C shows a high-level perspective of the restaurant industry‟s income statement. Note that restaurants spent almost equal amounts on the cost of goods sold (cost of food and beverages) and employee compensation. Exhibit E paints a similar picture, but breaks down the various cost items into more detail. Moreover, it shows a pre-tax profit that is considerably larger than that indicated in Exhibit D. Clearly, the restaurant industry is one in which margins are slim and, in turn, is highly dependent upon volume. Ratios. Exhibits F and G in Appendix C show the restaurant industry‟s key financial ratios. While these ratios reflect the norms for the industry, it is not practical to expect a start-up restaurant to achieve the same ratios. Nonetheless, the restaurateur can aspire to achieve such ratios over time as his business develops and are fairly useful in the benchmarking process. Short-term Financing. As shown in Exhibit B in Appendix C, it is not unusual for a restaurant to have negative working capital. While Exhibit C implies positive working capital, current assets just barely exceed current liabilities. As such, it is curious to know how restaurateurs are able to cover their current liabilities. In turn, the focus here is on short-term financing. “An estimated 80% of the fastest growing companies have been financed solely by founders using personal savings, credit cards, second mortgages, customer advances, extended terms from vendors, and other creative bootstrap techniques” (qtd. Illinois Chamber of Commerce and Community Affairs and Illinois Institute for Rural Affairs 14). This certainly holds true in the restaurant industry. The reason many restaurateurs have come to depend on bootstrap financing is because many investors, namely banks, have come to perceive investments in the restaurant industry as highly risky. As previously mentioned, the success rates for restaurants, in particular start-ups, are poor. As such, it is very difficult for restaurateurs to receive funds through traditional sources. In turn, it is not uncommon for restaurateurs to take out short-term loans from family, friends, and colleagues in lieu of bank financing. While it is not common for banks to draw loans for start-up restaurants, some do. Such loans, however, typically have extremely short maturities. Consequently, many restaurateurs turn to the Small Business Administration for assistance. With an SBA guarantee, most banks are less reluctant to lend to start-up restaurants and offer more reasonable terms. For example, through its 7(a) Guaranty Loan Program, the SBA can help restaurateurs finance working capital. The maximum loan maturity for working capital is generally seven years (SBA “Financing…7a”). For small loans, deemed to be $150,000 or less by the SBA, the SBA can guarantee up to 85% of the loan and will charge a guaranty fee equal to 1% of the portion guaranteed (SBA “Financing…7a”). Additionally, the loan is subject to a 0.5% servicing fee, “which is applied to the outstanding balance of the SBA‟s guaranteed portion of the loan” (SBA “Financing…7a”). “Interest rates are negotiated between the borrower and the lender but are subject to SBA maximums, which are pegged to the Prime Rate” (SBA “Financing…7a”). The table below summarizes the maximum interest rates that can be charged by loan amount for fixed interest rate loans with maturities of less than 7 years (SBA “Financing…7a). “Variable rate loans can be pegged to either the lowest prime rate or the SBA option peg rate”, “which is a weighted Brennan 13 average of rates the federal government pays for loans with maturities similar to the average SBA loan” (SBA “Financing…7a”). Loan Amount Maximum Interest Rate $25,000 or less Prime + 4.25% $25,000 - $50,000 Prime + 3.25% $50,000 or more Prime + 2.25% Besides the 7(a) Guaranty Loan Program, the SBA also offers a LowDoc Loan Program that can aid the restaurateur finance working capital. This program offers loans limited to $150,000 and a guaranty of up to 85% (SBA “Financing…LowDoc”). The guaranty fee is 2% of the guaranteed portion and interest rates follow the 7(a) loan program‟s structure (SBA “Financing…LowDoc”). Applying for this type of loan over a 7(a), for example, requires significantly less paperwork and the SBA will respond within 36 hours of receiving a complete application (SBA “Financing…LowDoc”). To secure this type of loan, the restaurateur “must pledge available business and personally owned assets” in addition to personally guaranteeing the loan (SBA “Financing…LowDoc”). The maturity of the loan is determined by the business‟ “ability to repay” and “the use of the loan proceeds,” but is “generally 5 to 10 years” (SBA “Financing…LowDoc”). Outside of the restaurateur‟s own contribution, the most common source of short-term financing for restaurants comes from their suppliers in the form of trade credit. For example, “inventory, financed from normal trade credit, turns rapidly in the restaurant business. This is also one reason why its debt levels are relatively low compared with other industries, especially those that must support high levels of slow-moving inventory, such as retailers” (Standard & Poor‟s 17). Moreover, “suppliers often give trade credit terms for inventory ranging from 30 to 60 days, which means that total inventory can turn over as many as 12 times before the first check is sent to the supplier. Likewise, accrued expenses, such as salaries, taxes, and royalty fees, can also be 6 to 12 times greater than inventory levels. For a typical restaurant operator with accruals and payables up to 24 times the size of inventory, working capital tends to be negative. It is not uncommon to see restaurant operators with current ratios of 0.4:1” (Volk 46). Additionally, “some commercial finance companies…may provide capital because they are asset-based and focus on a restaurant‟s worth instead of profits. Such finance may include working capital or even finance equipment purchases and other accounts payable necessities ranging from glassware to cutting boards” (Letwin 48). Long-term Financing. While short-term financing is important, long-term financing is more critical to the restaurant industry. The principal fact that supports this is the tendency for financiers to match the term of a loan to the life of the assets for which funds will be used. Since restaurants are heavily invested in long-term, fixed assets, the bulk of their financing will also be long-term. Despite their love/hate relationship with the restaurant industry, “banks are the single largest suppliers of credit” to the industry (Volk 45). Most banks that finance restaurants‟ long-term Brennan 14 assets usually require collateral, usually 50% to 80% of the total value of the underlying assets, or personal guarantees (Gasper, ed. 157). As previously mentioned, a restaurateur who has been rejected for a traditional commercial bank loan may apply for assistance from the SBA. As aforementioned, one of the more popular loan programs among restaurateurs offered by the SBA is its 7(a) Loan Guaranty Program. While “the maximum SBA guarantee to a bank is limited to $750,000, SBA loan sizes can vary widely from $5,000 to $2 million” (Hedden). In fact, in 1995, “the SBA guaranteed in excess of 6,000 foodservice loans worth more than $940 million,” with an average loan size of $152,000 (Hedden). It is also the most popular program for start-up businesses, including franchises (Hedden). Note, however, that just because a loan is guaranteed by the SBA, the lending bank does not drop collateral and personal guarantee requirements (Hedden). What a SBA guaranteed loan does allow for is more money to be lent by the bank, longer terms and approval to less-mature businesses that would otherwise be rejected (Hedden). SBA guaranteed loans‟ maturities are often determined by the useful life of the assets financed and are subject to a maximum of 25 years for real estate and equipment (SBA “Financing…7a”). The guaranty fee4 charged to the borrower is 3% for loans of $150,000 up to and including $700,000 and 3.5% for loans greater than $700,000 (SBA “Financing…7a”). These loans are also subject to the same servicing fee previously mentioned. The SBA also has determined maximum interest rates that can be charged for these loans that mature in 7 years or longer. The table below summarizes the maximum interest rates that can be charged by loan amount for fixed interest rate loans with maturities of 7 years or longer (SBA “Financing…7a). Borrowers may also opt for a variable rate loan as aforementioned. Loan Amount Maximum Interest Rate $25,000 or less Prime + 4.75% $25,000 - $50,000 Prime + 3.75% $50,000 or more Prime + 2.75% Aside from its 7(a) program, the SBA also offers a 504 Certified Development Company (CDC) Loan Program. “This program provides long-term, fixed-rate financing for major fixed assets, such as purchasing land or buildings, renovating existing facilities, or purchasing long-term machinery and equipment. The 504 program cannot be used for working capital or inventory, consolidating or repaying debt, or refinancing” (Panitz). Some specialty finance companies are also willing to fund long-term restaurant assets, especially equipment. They also offer lease financing that tends to be capitalized rather than operating leases as well as real estate financing (Volk 47). Other companies provide sale-leaseback financing specifically for the restaurant industry (Volk 47). Irrespective of the external source of funds, borrowers are expected to put a certain amount of equity into their business. For example, the Vice President of the National Restaurant brokers in Atlanta, Patrick Silvia, indicates that borrowers must put “a minimum of 10-20% cash” into any deal in addition to “some kind of personal recourse” (Brooks 28). Mr. Bob Min, second Vice President of Small Business Banking at First National Bank of Omaha and professor of Small 4 Note that the guaranty fee percentage is applied to the outstanding portion of the loan that is guaranteed by the SBA, just as it is in the case of shorter-term, smaller SBA-guaranteed loans. Brennan 15 Business Management at Creighton University, indicates that when he considers lending to small businesses, he likes to see at least 20% of strings-free cash upfront from the owner(s). In turn, restaurateurs must be able to make a good-sized monetary contribution to the business before he can seek out external sources of capital. Common Exit Strategies Unfortunately, the most common exit strategy for restaurateurs is bankruptcy. As reiterated throughout this paper, the prospects of success in the restaurant industry are not bright. As such, many restaurateurs find themselves unable to service their large debts and determine that their only way out is to seek bankruptcy protection. This tendency reinforces banks‟ reluctance to lend to restaurants at all, let alone on unfavorable terms. For example, consider the table below, which summarizes the cumulative defaults of the restaurant industry by segment (Brooks 29). Restaurant Industry Segment Cumulative Defaults Quick service 41% Convenience & Gas 27% Other 19% Casual Dining 7% Independents 4% Other 2% When a restaurant proves to be successful, however, the restaurateur may want to expand. To finance such expansion, the restaurateur‟s financing options grow. For example, the restaurateur may possibly attract business angels or venture capitalists to make capital investments into his business. However, as some restaurateurs have come to dub such investors as “vulture capitalists,” a private placement or public offering might be a more attractive option (Belman). One restaurant analyst states that there are only two strong reasons for a restaurant company to go public: to raise capital or for liquidity reasons (Belman). In the early 1990s, restaurant IPOs surged and included such companies as Boston Chicken, Schlotzsky‟s, Lone Star, and Outback Steakhouse (Belman). However, “the weak performance of restaurant stocks in 1994 and 1995 curtailed recent IPO activity in the industry” (qtd. Belman). Even still, it is often the case that business angels or venture capitalists are necessary to finance the preparation of either a private placement or public offering and, in turn, are virtually unavoidable. One restaurateur, on the other hand, discussed his experience putting together his own stock offering (Belman). “He spent three years researching a little-known program called the Securities Corporate Offering Registration (SCOR), which is designed to help small companies raise capital through small, public securities sale” (Belman). So, “between the hot sauce and the sugar packets,” he put out “table tents offering $1 million worth of class A common stock to finance a second restaurant” and “to make the stock more attractive,” he “offered dividends in kind to any investor” (Belman). That is, he offered a 4% discount on a customer‟s check if he/she bought $500 worth of shares and an 8% discount if he/she bought $1,000 worth (qtd. Belman). Additionally, “shareholders got preferential seating, their name on the front door, [and] all those little ego things that go along with owning part of a restaurant” (qtd. Belman). Initially, the restaurateur had almost 1,000 people ask for prospectuses, but he only ended up Brennan 16 raising $50,000 (Belman). The biggest drawback of a SCOR is the absence of a secondary market and some investors require some liquidity (Belman). Moreover, as a result of the SEC‟s relaxation of regulations that restricted companies from selling stock directly customers, the practice has grown. For example, Bob Evans Farms was one of the first restaurants to offer the option (Belman). In the first year that the option was offered, 9,000 to 10,000 people bought the company‟s stock through the plan (Belman). McDonald‟s, too, has a similar direct stock purchase program called McDirect Shares (Belman). While “no more than 80 companies currently offer a no-fee direct stock-purchase plan,” the number is expected to grow (qtd. Belman). Conclusions While an array of topics has been addressed here, this discussion has merely scraped the surface of what a restaurateur needs to know in order to start-up and manage a successful restaurant. It would be in the best interests of the restaurateur to obtain additional, detailed information from the trade publications and professional associations tied to the industry, as indicated at the onset of this paper. While starting up a restaurant can be costly, typically ranging from $250,000 to $500,000, certain trends that prevail in the industry indicate that many opportunities exist for the restaurateur. The restaurateur, however, can expect some challenges, like recruiting, training and retaining employees, offsetting the effects of current economic slowdown, obtaining reasonably- termed external financing, and beating the odds of the high failure rates that characterize the industry. The restaurateur will also be called upon to make critical decisions that have ethical implications, manage the risk structure of his business, and establish effective inventory controls. Financial analysis of the industry has revealed that it is a cash business that is highly dependent on trade credit from suppliers as well as bootstrapping for short-term financing. Additionally, it is a capital-intensive business that requires large dollar investments in property, building and equipment, for which debt financing is needed. Since a restaurant has mostly fixed assets, as aforementioned, the bulk of its debt is long-term. While banks and other traditional sources of financing are weary about lending to restaurants because of their marked failure rates, they nonetheless provide financing to restaurants under the condition that loans are secured with a large percentage of the underlying assets, the restaurateurs personally guarantee the loans and, often times, are guaranteed by the Small Business Administration. If the restaurateur is successful in his entrepreneurial venture, he may seek to expand his operations. To finance such expansion, he can consider investments from business angels or venture capitalists, or can raise capital through a private placement or public offering. Unfortunately, the majority of restaurateurs are unsuccessful and accumulate so much debt that it becomes unserviceable, forcing the business to exit via bankruptcy. Brennan 17 Appendix A Professional Restaurant Associations’ Website Addresses National Restaurant Association (NRA) www.restaurant.org National Restaurant Association Educational Foundation (NRAEF) www.nraef.org State Restaurant Associations www.restaurant.org/states/index.cfm Nebraska Restaurant Association www.nebraska-dining.org American Culinary Federation (ACF) www.acfchefs.org International Association of Culinary Professionals (IACP) www.iacp.com National Bar & Restaurant Association www.bar-restaurant.com American Institute of Wine and Food (AIWF) www.aiwf.org/france/index.asp?chapter=124 International Hotel & Restaurant Association (IH&RA) www.ih-ra.com Links to Specialty Organizations & Associations www.restaurant.org/business/resources_associations.cfm http://restaurantresults.com/associations/001.htm Brennan 18 Appendix B On-line Trade Publications’ Website Addresses Restaurants USA www.restaurant.org/rusa/magIssue.cfm?CFID=2699987&CFTOKEN=93327187 Nation’s Restaurant News www.nrn.com Restaurant Hospitality www.foodservicesearch.com/RestaurantHospitality/index.cfm Restaurants & Institutions www.rimag.com Cornell Hotel & Restaurant Administration Quarterly www.hotelschool.cornell.edu/publications.hraq Food Review www.ers.usda.gov/publications/foodreview/Archives/ Legal Monitor www.restaurant.org/legal/lm/index.cfm Links to Specialty Publications www.restaurant.org/business/resources_magazines.cfm Brennan 19 Appendix C Supporting Materials Figure 1 Total Spending on Food Away from Home by Household Income Before Taxes, 2000 Less than $5,000 2% Pre-Tax Income Bracket $5,000 - $9,999 3% $10,000 - $14,999 4% $15,000 - $19,999 4% $20,000 - $29,999 11% $30,000 - $39,999 11% $40,000 - $49,999 11% $50,000 - $69,999 18% $70,000 + 36% 0% 10% 20% 30% 40% % of Total Spending on Food Away from Food Source: Ebbin, Robert. “Midwest Tops in Restaurant Spending.” Restaurants USA. July 11, 2002. Available: http://www.restaurant.org/rusa/magArticle.cfm?ArticleID=797. Last Accessed: October 7, 2002. Brennan 20 Table 1 Top Challenges Expected by Operators in 2002 Top Challenges Quick Full Service Operators Service Average Check Size Operators <$8 $8-$14 $15-$24 $25+ The Economy/Recession 12% 16% 21% 27% 36% Maintaining Volume of Business 14% 16% 17% 16% 22% Recruiting and Retaining Employees 33% 23% 14% 13% 14% Competition 5% 11% 9% 11% 9% Higher Cost of Doing Business 3% 11% 13% 8% 2% Other 33% 23% 26% 25% 17% Source: National Restaurant Association. “2002 Restaurant Industry Forecast: Overview.” Available: http://www.restaurant.org/research/forecast_overview.cfm. Last Accessed: October 7, 2002. Exhibit A Restaurant Start-up Costs Item Rent Low High Initial Inventory $ 4,250 $ 102,000 Equipment/Fixtures 10,648 76,395 Leasehold Improvements 55,749 138,511 Licenses/Tax Deposits 16,700 31,250 Phone/Utilities Deposits 150 300 Owner/Manager 50 350 Employees 4,200 5,000 Grand Opening Advertising 7,600 77,500 Legal Services 1,800 16,169 Accounting 672 300 Insurance - 1,500 Miscellaneous 1,794 5,100 Total Costs 300 500 $ 103,913 $ 454,875 Suggested Operating Capital $ 47,782 $ 477,468 Source: Illinois Chamber of Commerce and Community Affairs and Illinois Institute for Rural Affairs. “Restaurant Start-up Profile.” p. 10. Available: http://www.illinoisbiz.biz/pdf/bus_pdf/restaurantprofile.pdf. Last Accessed: November 21, 2002. Brennan 21 Exhibit B SIC 58 Eating & Drinking Places Year 2000 689 Establishments Common-Size Balance Sheet Cash $167,790 12.8% Accounts Receivable 64,232 4.9 Notes Receivable 9,176 0.7 Inventory 87,827 6.7 Other Current Assets 78,652 6.0 Total Current Assets 407,677 31.1 Fixed Assets 713,106 54.4 Other Non-Current Assets 190,074 14.5 Total Assets 1,310,857 100.0 Accounts Payable 142,883 10.9 Bank Loans 5,243 0.4 Notes Payable 78,651 6.0 Other Current Liabilities 291,012 22.2 Total Current Liabilities 517,789 39.5 Other Long-Term Debt 437,825 33.4 Deferred Credits 2,622 0.2 Net Worth 352,621 26.9 Total Liabilities & Net Worth 1,310,857 100.0 Net Sales 3,562,111 100.0 Gross Profit 2,055,338 57.7 Net Profit After Tax 117,550 3.3 Working Capital (110,112) --- Source: Industry and Financial Consulting Services. “SIC 58 Eating & Drinking Places.” Industry Norms & Key Business Ratios. Desktop Ed. 2000-2001. New Jersey: Dun and Bradstreet, 2001, p. 146. Brennan 22 Exhibit C Balance Sheet Data for Eating and Drinking Places--SIC No. 5812S Average Dollars As Percent of Total Assets Assets Cash and Equivalents 31,377 9.50% A/R--Trade 5,651 1.70% Inventory 20,343 6.20% All Other Current 30,243 9.20% Total Current 87,614 26.60% Fixed Assets (net) 214,214 65.10% Joint Ventures and Investment 1,505 0.50% Intangibles (net) 9,050 2.70% All Other Non-Current 16,832 5.10% Total Assets 329,215 100.00% Liablilities Notes Payable--Short Term 18,938 5.80% Current Matured Long Term Debt 14,832 4.50% A/P--Trade 24,329 7.40% Income Taxes Payable 1,508 0.50% All Other Current 21,638 6.60% Total Current 81,245 24.70% Long Term Debt 162,679 49.40% Deferred Taxes 2,585 0.80% All Other Non-Current 9,793 3.00% Net Worth 72,913 22.10% Total Liablilities and Net Worth 329,215 100.00% Source: Illinois Chamber of Commerce and Community Affairs and Illinois Institute for Rural Affairs. “Restaurant Start-up Profile.” p. 39. Available: http://www.illinoisbiz.biz/pdf/bus_pdf/restaurantprofile.pdf. Last Accessed: November 21, 2002. Exhibit D The Restaurant Industry Dollar Full Service Limited Service Where It Came From Sales 100% 100% Where It Went Cost of Food Sold $ 0.27 $ 0.32 Cost of Beverages Sold $ 0.07 $ 0.03 Salaries and Wages $ 0.31 $ 0.29 Employee Benefits $ 0.04 $ 0.02 Restaurant Occupancy Costs $ 0.06 $ 0.06 Other $ 0.19 $ 0.23 Pre-Tax Income $ 0.06 $ 0.05 Source: National Restaurant Association. “Operating Ratios: The Restaurant Industry Dollar.” Available: http://www.restaurant.org/resesarch/op_ratios.cfm. Last Accessed: November 25, 2002. Brennan 23 Exhibit E Income Data for Eating and Drinking Places--SIC No. 5812S As Percent of Average Dollars Total Sales Sales/Revenue 855,908 100.00% Variable Disbursements COGS 311,139 36.40% Advertising 21,474 2.50% Bad Debts 122 0.00% Car/Delivery 2,057 0.20% Commissions 863 0.10% Freight 48 0.00% Taxes/Licenses 14,395 1.70% Travel and Entertainment 3,346 0.40% Total Variable Disbursements 353,445 41.30% Contribution 502,463 58.70% Fixed Disbursements Bank Services Charges 1,220 0.10% Amortization of Intangibles 4,657 0.50% Depreciation/Depletion 24,829 2.90% Dues and Publications 445 0.10% Employee Benefit Program 4,661 0.50% Insurance 12,444 1.50% Laundry and Cleaning 3,757 0.40% Leased Equipment 2,618 0.30% Legal/Professional 5,519 0.60% Office Expenses 1,895 0.20% Outside Labor 2,075 0.20% Pension/P.S./Payroll Taxes 20,295 2.40% Rent 36,971 4.30% Repairs and Maitenance 14,234 1.70% Supplies, Operating 12,005 1.40% Utilities 29,710 3.50% Salaries--Officers 32,400 3.80% Payroll 206,050 24.10% Interest 13,696 1.60% Miscellaneous Expenses/Income 59,602 7.00% Total Fixed Disbursements 489,082 57.10% Pretax Profit 13,381 1.60% Dollar Sales Breakeven 833,113 Source: Illinois Chamber of Commerce and Community Affairs and Illinois Institute for Rural Affairs. “Restaurant Start-up Profile.” p. 41. Available: http://www.illinoisbiz.biz/pdf/bus_pdf/restaurantprofile.pdf. Last Accessed: November 21, 2002. Brennan 24 Exhibit F SIC 58 Eating & Drinking Places Year 2000 689 Establishments Ratios Upper Quotient Median Lower Quotient Solvency Quick Ratio (times) 1.1 0.5 0.2 Current Ratio (times) 2.0 1.0 0.5 Current Liabilities to Net Worth (%) 24.5 50.2 117.8 Current Liabilities to Inventory (%) 274.9 669.9 999.9 Total Liabilities to Net Worth (%) 44.1 112.3 291.4 Fixed Assets to Net Worth (%) 63.3 116.6 205.3 Efficiency Collection Period (days) 0.7 2.9 11.0 Sales to Inventory (times) 113.4 81.6 42.5 Assets to Sales (%) 22.5 36.8 62.5 Sales to Net Working Capital (times) 41.8 18.5 9.4 Accounts Payable to Sales (%) 1.9 3.1 4.8 Profitability Return on Sales (%) 6.5 2.6 0.3 Return on Assets (%) 18.0 5.9 0.5 Return on Net Worth (%) 51.4 15.7 4.0 Source: Industry and Financial Consulting Services. “SIC 58 Eating & Drinking Places.” Industry Norms & Key Business Ratios. Desktop Ed. 2000-2001. New Jersey: Dun and Bradstreet, 2001, p. 146. Brennan 25 Exhibit G Ratios for Eating and Drinking Places--SIC No. 5812S Median Liquidity Ratios Current Ratio 1.1 Quick Ratio 0.5 Sales/Receivables 151.5 Days' Receivables 2.4 Cost of Sales/Inventory 15.3 Days' Inventory 23.9 Cost of Sales/Payables 12.8 Days' Payables 28.5 Sales/Working Capital 134.4 Days' Working Capital 2.7 Coverage Ratios Earnings Before Interest and Taxes/Interest 2.0 Cash Flow/Current Maturity Long Term Debt 2.9 Leverage Ratios Fixed Assets/Tangible Net Worth 3.4 Total Liabilities/Tangible Net Worth 4.0 Operating Ratios Percent Profit Before Taxes/Tangible Net Worth 21.0 Percent Profit Before Taxes/Total Assets 4.1 Sales/Net Fixed Assets 4.0 Sales/Total Assets 2.6 Source: Illinois Chamber of Commerce and Community Affairs and Illinois Institute for Rural Affairs. “Restaurant Start-up Profile.” p. 40. Available: http://www.illinoisbiz.biz/pdf/bus_pdf/restaurantprofile.pdf. Last Accessed: November 21, 2002. Brennan 26 Appendix D Comparison of Legal Structures Sole General Limited Partnership LLC S-Corp C-Corp Proprietorship Partnership Creation No legal Informal or Must be permitted Must be Must be Must be formalities. formal by state law. Must permitted by permitted by permitted by agreement file a certificate of state law. Must state law. Must state law. Must between 2 or limited partnership. file Articles of file Articles of file Articles of more people. Requires an Organization Incorporation. Organization agreement between Must file form 2 or more people 2553 w/ IRS. (must have a least one limited partner and one general partner). Profits and Owner entitled Determined by General partners Determined by Shareholders Shareholders not Losses to all. agreement. In share by agreement. Operating entitled to entitled to use absence of an Limited partners Agreement. proportionate corporate losses. agreement, share profits by share of losses partners share agreement and but limited to the profits and share losses only up extent of the losses equally. to their capital shareholder‟s contribution. basis in the corporation. Brennan 27 Liability Unlimited. Unlimited. General partners Liable up to the Shareholders Shareholders have unlimited. amount of their liable up to the liable up to the Limited partners are investment in the amount of their amount of their liable up to the company. investment in the investment in the amount of their Members and company. company. investment in the managers have Shareholders Shareholders company. NO personal have NO have NO liability. personal personal liability. Must liability. file form 2553 with IRS. Capital & Capital belongs Contributions Set by agreement Set by Issuance of Issuance of Financing to sole set by (may be cash, agreement (may stocks; personal equity securities proprietor and agreement property or be cash, property loans, bank (stocks); all loans are (may be cash, services); personal or services); loans. issuance of debt obtained on the property or loans, bank loans. personal loans, securities creditworthiness services); bank loans. (bonds); of owner. personal loans, personal loans, bank loans. bank loans. Duration Ends when By agreement; General partners: by By Articles of May be May be owner dies or can be agreement and by Organization (set perpetual. perpetual. retires. dissolved by: withdrawal, death date, set 1. action of a or insanity of dissolution partner (e.g. general partner. dates). In some withdrawal) Limited partners‟ states, duration 2. operation of death or withdrawal may now be law (e.g. death does not end the perpetual. or bankruptcy) partnership unless 3. court decree he/she is the only limited partner. Brennan 28 Transfer of Asset may be Partnership Partnership interest Members must Ownership Ownership Ownership sold in entirety interest (with (with full rights) consent to interests are interests are of in part, but full rights) may only be transfer freely freely either result in a may only be transferred upon ownership transferable but transferable. new entity. transferred consent of all interests. must keep in Subject to upon consent partners. Subject to mind IRS restrictions in of all partners. Partnership interest restriction in the requirements for Articles of of limited partner Articles of retaining S-Corp Incorporation can be freely Organization and status. Subject and Bylaws. transferable but Operating to restrictions in usually is restricted. Agreement. Articles of Incorporation and Bylaws. Management and Vested in Each partner Mgmt is centralized Mgmt may be Mgmt is vested Mgmt is vested Control proprietor. has a right of in the general vested in the in the board of in the board of mgmt which partner. Limited members or the directors and in directors and in can be waived partners may not managers. corporate corporate or limited by participate in mgmt officers. officers. agreement of and risk loss of the partners. liability protection if they do. Taxation Business An An informational An informational An informational The corporation doesn‟t file or informational tax return must be tax return must tax return must must file a return pay taxes. tax return filed, but the entity be filed, but the be filed, but the and must pay must be filed, itself does not pay entity itself does entity itself does taxes on but the entity taxes. not pay taxes. not pay taxes. corporate itself does not income. 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