With industry observers questioning whether the Dow’s 300-plus-point plunge in late July has punctured the leveraged-buyout bubble and put the kibosh on debt financing, operators in need of funds—especially those at smaller companies—already are seeking alternatives away from the volatile credit markets.
While observers agree that private equity will continue to play a role in the restaurant industry, smaller operators in need of capital to expand are relying on cash, lease arrangements and innovative loans to insulate themselves from the market’s current uncertainty.
“The pendulum really had swung too far,” Cheryl Carner, a managing director at CapitalSource Inc., a commercial lending, investment and asset management business focused on the middle market, said in reference to the dizzying size of recent debt-financed deals. “The level of inexpensive debt was really not sustainable in the long term.”
One repercussion of the current environment: On July 25, the Chrysler Group announced that it couldn’t garner the necessary $12 billion in debt financing to fund a buyout by Cerberus Capital Management. Similarly, restaurant deals may slow and deal price tags could fall as the cost of financing increases and leverage levels pull back.
“There is a significant degree of uncertainty right now,” Carner said, adding that the middle-market deal rate has slowed from the high last year as private-equity funds or other investors in the restaurant space are waiting it out to see whether this is a temporary event or a long-term change in the debt market.
Operators point out, however, that private-equity funding is not the only game in town when a restaurant concern is looking for capital to expand—and many say they prefer to avoid the volatile debt market.
Tavistock Restaurants LLC, a full-service restaurant company in Emeryville, Calif., purchased in late July the 19-unit Freebirds World Burrito fast-casual chain in an all-cash transaction. While the company would not disclose terms, officials did say they liked to fund growth through cash so that future decisions are not made based on market dynamics.
“This is a tough enough business without owing a bunch of money to a bunch of people,” said Bryan Lockwood, president and operating partner of Tavistock.
Lockwood said it sounds simplistic, but relying on cash is an ideal way to “maintain immunity” from unpredictable market events. The company has not ruled out the use of debt to help fund growth at Freebirds, although it already has funded the chain with two years of embedded capital for growth.
Tavistock Restaurants is a subsidiary of the private investment company Tavistock Group. It operates six California Cafe restaurants, six Napa Valley Grilles, two Alcatraz Brewing Co. units, and single locations of Blackhawk Grille in Danville, Calif., Cafe del Rey in Marina del Rey, Calif., and Horizons in Sausalito, Calif.
Old-fashioned tools, such as equipment leasing, are among the growth instruments currently working for Cheeseburger Charley’s, a seven-unit chain in Nashville, Tenn., that has just started to franchise.
Along with its bank, investors and landlords, Cheeseburger Charley’s is using equipment leasing to reduce the needed capital for the construction of new units, both corporate and franchised, said the company’s founder, Chuck Watkins.
Equipment leasing is “a good way to control costs,” Watkins said. “It helps you manage costs, budget the cost of equipment…so when you are four or five years down the road and you are deciding that you need to remodel, as far as equipment is concerned you don’t need to budget because it’s built in [to your profit-and-loss statement.]”
Although a lease could hold higher rates than a typical bank loan, it is a much easier process to execute, especially should the credit markets continue to deteriorate, Watkins said.
At Majors Sports Cafe, a 15-unit upscale sports grill-and-bar chain, the company is building new units with the help of a lender that loans capital based on—and receives payment through—future credit card revenues. It is not a cash-advance company, but a lender that targets the middle market with loans that typically range from $150,000 to $3 million.
“I didn’t want to have to go through a lot with our bankers,” said Bob Carlson, owner and chief executive of Eden Prairie, Minn.-based Majors. “That requires pulling down your pants and going through every item on your statement.”
Majors took a $500,000 credit line, which is about half the necessary capital for a new unit. The other half will come from cash flow, Carlson said.
“We are using it for growth capital, and it’s pretty painless and seamless,” he said.
The company plans to use the credit card futures company, which typically charges an interest rate of 1 percent per month of the term, for future growth. Restaurant operators can repay the loan through automatic daily payments of between 3 percent and 15 percent of credit card sales, depending on the terms of the loan.
