Restaurant Startup Loans: What You Need to Know
Few people can finance a restaurant out of pocket, but new restaurants are opening all the time, so where does that money come from? Some particularly gutsy restaurateurs sell everything they have and use personal funds to get their restaurant up and running. Others seek out business partners to invest. A third option to obtain funding is through restaurant loans, which can be an excellent option to start your restaurant. If you want to open a casual diner or a swanky black-tie restaurant, read below to explore restaurant loan options and what to consider in the process.
Restaurant Startup Costs Breakdown
Asking a bank to invest a large sum of money in you is daunting, so the more information you're armed with, the better off you'll be. Before you try to convince a lender to go forward with your proposal, be sure to have some numbers in mind so you know how much you need. Your total funding (personal funds and loans) will need to cover the following costs:
- Loan guarantee fee– Percent of the loan amount guaranteed to be paid to the lender if the recipient is unable to fully repay the loan.
- Loan repayment plus interest – Money paid at a regular percent rate for the use of the loan; interest rates are typically negotiated between the lender and the loan recipient.
- Commercial lease – Cost per month to rent the space in which you plan to open your restaurant.
- Restaurant insurance – Coverage that protects your restaurant from losses that may occur during the normal course of business, including property damage, accidents and injuries, crime, and workers’ compensation.
- License Fees – Specific licenses and fees will vary depending on your location, but common restaurant licenses include Food Service Establishment Permits, liquor licenses, and general business licenses.
- Staff wages and benefits – Mandatory wages for tipped employees differ throughout the United States. Non-tipped employees must be paid at least the state minimum wage, but their wages are then at your discretion as the restaurant owner.
- Renovations – Your space may just need a new coat of paint, or it may need to be completely outfitted with proper gas, water, and electrical lines.
- Kitchen equipment–Make kitchen equipment one of the first items negotiated in your loan meeting to ensure the costs are covered, just in case you are not approved for the amount you originally planned. The cost of your new commercial kitchen varies based on the size of your kitchen and restaurant.
- Beginning stock and inventory – Create a sample menu and estimate the cost of food inventory for your restaurant. In addition to food stock, your inventory will also include dishes, flatware, serving utensils, furniture, and linens.
- Working capital – In the beginning, you must have some money to cover operating costs while your restaurant has more expenses than income. Working capital is the amount of money it takes to keep the restaurant running on a daily basis. Ideally, you will budget 6 – 12 months of operating costs to tide you over until the restaurant becomes profitable.
- Marketing capital – Much advertising for a new restaurant happens by word of mouth. If you choose, however, to fund a marketing campaign to get the word out, be sure to account for those costs in your total loan request.
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Types of Restaurant Loans
There are many factors to consider when choosing the best type of restaurant loan, including interest rates, down payments, and collateral requirements. To help you find the right loan for your restaurant startup, check out some of the most popular ones below.
1. Traditional Commercial Loan
If you want to apply for a loan directly through a bank, you must have a high credit score. If you go this route, you must also be able to wait up to six months or more for approval. However, if you are approved for a bank loan, you’ll receive lower interest rates (between 6-8%) which result in lower monthly payments.
You can also decide whether you want to apply for a short- or long-term loan, but long-term loans aren’t usually ideal for start-ups because there are many unknown factors when you’re first starting out. Another potential downside to term loans is that they require collateral, such as your home, vehicle, or business assets.
Finally, consider where you are getting your loan from. Big banks may have inflexible rules about lending. On the other hand, a smaller lender that knows your local market might be more willing to create an accommodating relationship with you.Pros of Traditional Commercial Loans:
- Lower rates
- Potential access to higher amounts of capital
Cons of Traditional Commercial Loans:
- Must have a high credit score
- Must be able to wait up to 6 months
- Must provide the bank with collateral
Applying for a Traditional Commercial Loan
- Choose which bank you want to work with. Talk to representatives from several banks, and don't be afraid to go with a smaller, local bank. They are often better for businesses that are just starting out.
- Prove your personal and/or business credit to the bank.
- Show the bank your business plan. This is important to lenders, who need to know exactly what you plan to spend the money on. They will also need to see your expected cash flow over the next 1-3 years, so they can determine whether or not you'll be able to pay the loan back.
- Wait to see if you're approved. If you aren't approved by one bank, try several more. It helps to work with banks that you're already a member of, because sometimes they’ll give you better deals for your loyalty.
2. Business Line of Credit
A line of credit is like a credit card. You can get approved for a specific maximum credit amount, but only pay for what you have used. So if you get approved for $100,000 line of credit and only use $20,000 in the first month for renovations, then your monthly payment is based on the amount you have drawn - $20,000. Also, like a credit card, a line of credit is revolving. As you pay the balance down, you have more credit to draw on for future expenses.
This is different from a term loan, in which interest begins accumulating immediately after the loan is disbursed. Because this is such a flexible way to borrow money, banks have higher lending standards. As a result, interest tends to be higher, and you might not be able to borrow a sum as large as you need.
Pros of Business Lines of Credit:
- Interest only accumulates as you borrow the money
- You can continue to use the credit line as you pay it down, so you always have access to business capital
Cons of Business Lines of Credit:
- Higher lending standards
- Can't usually borrow as much money compared to other loan types
Applying for a Business Line of Credit
- Like with a term loan, you’ll start by choosing which bank you want to work with.
- Prove your personal and/or business credit to the bank.
- Show the bank your business plan and expected cash flow over the next 1-3 years.
- Wait to see if you're approved. Once you’re approved, you can draw from the line of credit as needed.
3. Small Business Loan
Most regional and national banks offer small business loan options. The majority of banks offer their small business loans through a partnership with the U.S. Small Business Administration (SBA).
What Is the SBA?
The SBA is a government agency tasked with supporting and protecting the interests of small businesses and business owners. The SBA works with banks and other lenders to help small business startups obtain funding while ensuring the lenders don’t take on too much risk.
The SBA offers several funding programs for small businesses, but their Guaranteed Loan Programs are most pertinent to restaurants. Through these programs, the SBA sets guidelines for loans, which the SBA’s lending partners then give out. SBA guidelines include guaranteed repayment of loans, which eliminates risk for the lender and makes loans more attainable for small business owners.
Individuals with borderline credit (650+) have a better chance of getting approved with a small business loan. Additionally, small business loans have low interest rates, and they allow applicants to cover less than the 20% down payment. However, they usually require collateral.
Pros of Small Business Loans:
- Lower interest rates
- You can be approved with borderline credit
Cons of Small Business Loans:
- Requires collateral
- May take longer to be approved
Applying for a Small Business Loan
- Apply for an SBA loan through a participating lender.
- Complete the specified forms detailing your personal financial background, which will prove your ability to pay the loan back. You will need to submit all of the following:
- Personal information for any other partners who are involved in your restaurant
- Your original business license (not a copy)
- Any past personal or business loan applications
- Your personal and business income tax returns
- Resumes for you and any business partner(s)
- A copy of your business lease
- A copy of your business plan with an explanation for why you need an SBA loan
- The SBA will process your application and determine if you’re a good candidate for the loan. It usually takes between 30-60 days to hear back.
- If you are approved, you will be contacted and your funds will be disbursed.
Small Business Loans for Restaurants: The 7(a) Loan
The SBA’s most common type of loan, 7(a) loans can be granted in a maximum amount of $350,000 and are repaid with monthly payments of principal and interest. Loans may be granted for real estate purchase and renovations, equipment purchase and maintenance, and working capital.
Loans for real estate must be repaid in a maximum of 25 years; equipment loans in 10 years; and working capital loans in 7 years. According to the SBA, to qualify for a 7(a) loan, your restaurant must:
- Be a for-profit venture
- Be small, according to SBA Standards
- Be located in the United States
- Have reasonable invested equity
- Use alternative financial resources (including personal assets) before seeking financial assistance
- Demonstrate a need for loaned funds
- Use the loaned funds for sound business purposes
- Not be delinquent on any existing debt obligations to the U.S. government
What You Need to Apply for a Restaurant Loan
When applying for any startup loan, first be sure to have a detailed business plan in place. In addition, you will likely need the following documents:
- Loan application– Consider including a table of contents so your banker can easily access all of your documents
- Personal background and financial statement – This includes a Statement of Personal History and a Personal Financial Statement
- Profit and Loss Statement– Must be current within 90 days of your application and include supplementary schedules from the last three fiscal years
- Projected Financial Statements – A detailed, one-year projection of income and finances, along with a written explanation of how you plan to achieve that projection
- Ownership and affiliation documents – A list of names and addresses of any companies you own, partially own, or hold a controlling interest in, including any affiliations you may have with stock ownership, franchises, or business mergers
- Business certificate/license – Must be your original certificate or license for doing business
- Loan application history – Record of any past loans you have applied for
- Income tax returns – Be sure to include signed personal and business federal income tax returns for the previous 3 years
- Resume – Include a personal resume for each business partner involved
- Business overview – Brief outline of your restaurant and why you need a loan
Depending on the amount of funding you need, the type of restaurant you wish to open, and your current funding ability, you can decide which loan is fit for your business. With diligent preparation and a promising restaurant concept, you can secure funding for your eatery.