Skip navigation
Restaurant entrepreneurs: Evaluate potential partners carefully

Restaurant entrepreneurs: Evaluate potential partners carefully

Steve Rockwell is managing director of Restaurant Investment Banking at Janney Montgomery Scott and has 30 years of experience in the restaurant industry. He can be reached at [email protected]. This article does not necessarily reflect the opinions of the editors or management of Nation’s Restaurant News.

Janney Montgomery Scott managing director Steve Rockwell

Consider the following hypothetical story:

You are an entrepreneur who has a vision for developing a restaurant brand with very strong appeal to Millennials. You and a partner open your first location and sales significantly exceed expectations. Cash flow is tremendous, enabling the second location to be built with minimal debt. Sales at the second location exceed expectations again, with cash flow following suit. The process repeats itself a few more times, requiring some investment in infrastructure that is cobbled together from internal cash flow and leveraging your own resources.

The financial community begins to take note of the sales, and investors and advisors meet with you to have a jump on helping you raise outside capital, although you are still too small for outside institutional capital. You continue to grow rapidly, and one or two knowledgeable individuals invest, join the board and become business advisors. They were added in good faith and for the right reason — they have built relevant companies and should provide wisdom as you continue to grow rapidly — but before you have been able to develop a strong personal relationship and truly understand each other’s culture and values.

The consistent success of the new units has resulted in annualized cash flow sufficient to attract a meaningful outside investment. The growth opportunity has crystalized and the competitive environment has heated up. The time is right to raise more substantial outside capital to fund both additional infrastructure and unit growth.

There is no shortage of interest from outside investors. But because you have limited time, you reach out to only a small number of potential investors for proposals. In order to save the fee a financial advisor would charge, you manage the financing on your own. One investor group is pursued, largely because it has offered the most attractive terms — your primary focus. Softer issues such as the investor’s values and goals for the chain beyond just providing a return on its investment are either ignored or glossed over.

The investment is made and the investor is given a seat on the board. You now have the capital to open more units and the financial strength to test a different market strategy to determine the true potential of the brand. Sales at these new locations, while still acceptable by most measures and relative to the investment, trail those of the earlier units. You believe that the slower initial sales are largely the result of a lack of brand awareness, although you recognize that some elements of the brand may need to be modified to appeal to the typical consumer in these different markets. However, your outside investors and board members have a heightened level of concern and begin to place pressure on you to narrow your expansion criteria to consist of only those locations that will produce similar sales levels to the initial restaurants. The conflict escalates between you and the board and, unfortunately (perhaps an understatement), you lose operating control of the brand that you played a significant role in developing.

This scenario, or a version of it, is not unusual. While there is no guarantee that it would have been avoided, there are a couple of steps that the above entrepreneur could have taken to minimize the chances of the occurrence of the unfortunate outcome.

Three mistakes to avoid

(Continued from page 1)

Most importantly, any outside advisor or investor should be engaged only after a thorough vetting of his or her actual experience, operating philosophy and personality fit. This is not to say that one should surround oneself with advisors who think the same way, but rather that their experience, style and operating philosophy should be compatible with those of the entrepreneur and the brand. For example, someone who has built a large-box brand may not be the right fit for a fledgling small-box brand, and visa versa. My experience is that many executives who have built large restaurants have a bias to increase the size of a restaurant prototype in a quest to increase sales, whereas it may be more profitable and less risky for a small-box operator to address high demand through greater market penetration while remaining very disciplined on the unit investment.

An institutional investor should also be vetted carefully, focusing on the knowledge of the industry and the value, besides the capital, that they can bring. The non-financial capital is often more important than the money. Finding that right partner at a lower valuation can often be much more valuable in the long run than choosing the investor based on valuation alone.

What is the most important quality you look for in an investor? Join the conversation in the comments below.

Finally, raising institutional money without an advisor can be a mistake for three reasons. First, company management does not have the time to broadly market the company, so it will be exposed to a limited number of potential investors. That reduces the chances of finding the optimal investor, one that can provide additional value beside money. Second, it is less likely that there will be multiple bidders for the company; without an auction, the valuation may be affected. Third, the advisor often will know the potential institutional investor and can provide the operator with insight on the cultural compatibility of the two.

Taking the time to find partners that share the culture and values of an entrepreneurial company takes time and may cost a little more in the short term. In the long term, however, that extra time and expense could create more value and a smoother path for the entrepreneur.

TAGS: News
Hide comments

Comments

  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
Publish