Source: The Small Business Loans Administration
4) Merchant Cash Advance
A merchant cash advance is where a percentage of an eligible restaurant’s future sales (typically credit card sales) are purchased in exchange for an up-front lump sum.
Unlike a loan where a payment is due to the lender each month, a merchant cash advance takes a more automated payback approach: The majority of third parties will deduct payments through a daily ACH (Automated Clearing House) deduction from a bank account.
While most loans will present the cost of capital as an interest rate or APR, the cost of a merchant cash advance is typically presented as a factor,
A merchant cash advance is great for businesses that accept credit or debit card purchases. If you’re running a cashless restaurant, this may be a good option for you.
5) Business Line of Credit
A business line of credit works similarly to a credit card: An approved business owner is extended an open line of credit from a brick-and-mortar bank or an alternative lender. As with credit cards, there is typically a spending limit, which must be repaid either monthly or annually before a merchant can draw down additional credit. This option is beneficial for two big reasons:
It gives business owners working capital when they need it and the flexibility to decide how much they need
It helps business owners improve their credit score
Of all the restaurant financing options on this list, crowdfunding is both the youngest and the most trendy.
Crowdfunding is a business financing option where new business owners pitch their business idea or product idea to the public in exchange for a benefit – like an invite to the soft opening, a free meal, or a guaranteed reservation once a month – once it has launched. Popular sites for crowdfunding include:
Kickstarter specifically has a full section devoted to restaurants seeking crowdfunding. Restaurateurs looking for the funding to open their first location or the capital to move into the consumer packaged goods space by bottling up their famous house-made hot sauce or jam might want to explore crowdfunding.
Crowdfunding has a lot of benefits, such as the ability to reach a broad investor base and streamline the fundraising process. Things to consider are regulations around the amount of money an issuer can raise using crowdfunding and the disclosure requirements for certain information about the business and the fundraising effort.
7) Asking Friends or Family Members
Ah, the ol’ reliable. Asking for funds from friends and family is a tried and true way to gain business funding without the red tape application and approval process.
Asking friends or family for a loan requires no credit check, no business plan, no W-2s or work history, just trust. That being said, you will want to heavily weigh out bringing your personal life into your professional life, as well as any conflicts of interest that may arise through business decisions you make that may not align with your lender’s outlook on life. Make sure the investment is well documented and you pick the partner that works for you and your business.
Along with the above seven restaurant financing options, there are three additional options – commercial real estate loans, equipment financing, and purchase order financing – that could be viable options if you have a project in mind where the specifics ladder up with how these sorts of funding must be used.
8) A Commercial Real Estate Loan
As real estate costs continue to rise, it’s getting harder to be able to afford rent on brick and mortar restaurants in an attractive location. If you’re an existing restaurant expanding by incorporating a new location or you’re a new restaurant looking to purchase your restaurant location outright, decide whether it’s worth applying for a commercial real estate loan to help you shoulder the costs.
9) Equipment Financing
Whether a valuable piece of equipment broke or you’re looking to upgrade, equipment financing is a great option to get capital for restaurant equipment related projects. Here’s how it works: An equipment financing lender either sells you the piece of equipment you need or gives you the funds to buy it, and then you pay them back in monthly increments (plus interest). Some equipment financing companies will also let you take out a loan against your paid-off equipment to fund small projects within your restaurant, known as a sale leaseback. Sale leasebacks tend to have very low interest rates and attractive repayment terms compared to other sources of funding.
10) Purchase Order Financing
Looking to expand into new revenue streams, introduce your brand to new audiences, and grow profits? If you’re a restaurant with a signature product – like a hot sauce, bbq sauce, jam, or seasoning – that guests adore, testing sales in grocery stores and other brick and mortar retail locations as a consumer packaged good (CPG) could be a viable revenue option for you.
Purchase order financing gives restaurants that have already taken orders but need additional capital to fulfill them the funds they need, so it can be a good fit for brands looking to expand into the catering or consumer packaged goods space who may need help scaling to meet demand.
Now that you’ve got a better idea of the business financing options available to new and existing restaurant owners and how they work, your next question is likely about how to choose which restaurant financing option is right for you.
How to compare and evaluate restaurant financing options
You’ve done some planning to outline how you would use capital, researched popular business financing options, and now you’re wondering how to compare the opportunities available to you. The main characteristics business owners want to consider when comparing business financing options are:
Lender or Partner
We’ve added a few additional details to consider, like:
Reputation of the lender
Fixed rate payments vs. variable rate payments
Whether you need to put up collateral
Daily or monthly payment schedules
How quickly you can get the capital, once approved
1 . Consider how quickly you can get your capital
Before you choose to go with one restaurant financing option over another, consider how long it
will take until the capital is available to be put toward the project you have in mind. Ask your potential lender (or other third party financing provider) what information they need, eligibility criteria, and an anticipated timeline that you can expect to hear back, but also ask yourself: Can you wait for the capital with a longer term build out, or do you need to replace a broken oven today?
2. Evaluate the total payback
There are many different types of cost structures that lenders use and there are equally as many factors to consider when determining total cost, including total payback amount, APR, upfront fees, compounding interest or other penalties, and more.
Annual percentage rate (APR) is a calculation that looks at all interest, fees, and the timing of those fees on equal ground. APR is expressed as a percentage and represents the yearly cost of borrowing funds. While APR is important for comparing funding options, it isn’t the end all be all. Another factor used to assess the cost of a loan is the absolute dollars you will pay back for the funding you receive (inclusive of application costs, interest, late fees, origination fees, etc.,). APR doesn't necessarily translate to the total amount repaid for the amount borrowed. Take a look at our two examples below.
Fixed interest rate loan with a 3-year term
For this example, the total payback is $11,616 for the $10,000 borrowed. This corresponds to an APR of 10%.
Compare the example above with the example below. You will see that while the APR is higher for the next example, it has a lower total payback.
This loan has a fixed cost (called a factor rate), 9-month term, no accruing interest:
For this example, the total payback is $11,000 ($10,000 loan + $1,000 fixed cost) for the $10,000 borrowed. This corresponds to an APR of 26%.
Bottom line? By calculating the absolute dollar amount you will pay back and comparing it to your other offers, you can determine which funding option works best for your budget and cash flows. It is important to pay close attention to any additional fees, like late fees, that you may incur with the funding you receive so that you have a full picture of the total cost of borrowing.
3. Compare the Term
The third characteristic you should evaluate when comparing business financing options is the repayment term (if there is one for the financing option you select) as it dictates the size of your regular payments. The repayment term refers to the amount of time you have to pay back the amount of funding you receive.
Here is an example of a loan with a fixed factor rate. We have assumed a loan of $100,000 with differing terms of 9 months, 6 months, and 3 months.
You may notice a significant difference in total cost in favor of the 3 month term, however, the shorter-term source has the highest APR of all of these options. The significantly higher daily payment required by a shorter term results in a higher annual percentage rate. If you can afford the payment great, but not everyone can.
4. Weigh out the benefits of fixed rates vs. variable rates
If approved for a loan, you’re not just going to be paying back the loan amount, rather you will be responsible for paying back the amount borrowed plus interest or a fixed cost. The interest rate or factor rate (fixed cost) may be based on a variety of potential factors like your sales history, how long you’ve been in business, any debt your restaurant has, and more. Interest rates can either be fixed rate – meaning they do not fluctuate during the life of the loan – or variable rate – meaning the interest rate can fluctuate throughout the life of the loan.
When comparing business financing options that have an interest rate, you’ll want to consider whether fixed rate or variable rate interest payments are more affordable.
5. Find out if collateral is required
As defined by Investopedia, collateral is “an asset that a lender accepts as security for a loan. If the borrower defaults on the loan payments, the lender can seize the collateral and resell it to recoup the losses.”
Sometimes, in exchange for a loan of a large sum of money, banks and other lenders will require you offer up a valuable item – like your house, a car, or your business’s brick and mortar location – as collateral that they would then own should you default on your payments. It’s important to note that some lenders will require you to offer up collateral that is the property of the business – like the funds in the business's account, your food truck, or your brick and mortar location (if you own it), while other lenders may require personal assets (your house, your car, your retirement fund) if they require a personal guarantee, which requires you to put your own assets and personal well being on the line if anything goes wrong.
Offering up collateral can be incredibly stressful, knowing that should you default on your payments, you may lose something meaningful and valuable to you, so it’s important to weigh out the benefits and risks before you sign on the dotted line.
6. Consider the reputation of the financial provider
Do you know the financial provider or others who have worked with them in the past? Will they work with you if you miss a payment or run into trouble? How much volume do they do with the capital product you selected? Do they specialize in working with restaurants?
You may want to focus your search on financial providers that take into consideration restaurant industry challenges, as they may be more likely to take seasonality into account when determining your rate, rather than denying your application because of it. They may also be more permissive of low profit margins, which are standard within the restaurant industry (cite average profit margin) but could be a red flag to a brick-and-mortar financial institution.
You may also want to explore lenders that you have an existing relationship with, as they will be more invested in your business’s success and expansion. For example, POS providers, accounting systems (like QuickBooks), and payment processors may be a good choice to partner with for funding, given your existing relationship with them.
When you have your initial meeting with a potential lender, make sure the interview is going both ways: you should be asking just as much about them as they are about you. You need to make sure that this lender is reliable, has a good rapport with other clients, and won’t pull any funny business a few months down the road.
All restaurants started out first as a dream…
Securing capital for an important project can be scary, but by taking the time to do your research and arming yourself with the right tools and resources, you can make a great investment in the future of your restaurant.