Many or all of the companies featured provide compensation to LendEDU. These commissions are how we maintain our free service for consumers. Compensation, along with hours of in-depth editorial research, determines where & how companies appear on our site.
Many people dream of owning a restaurant, but far fewer actually put their money where their mouth is, lease a space, design a menu, and open the doors on their own space. Whether you’re thinking about opening up your own pizza joint or you’ve been running a fine dining restaurant for decades, you might need to borrow money at some point to help expand, remodel, or open your business.
If you’re considering a loan, you might be wondering if it’s the best idea for your business. The good news is that the restaurant industry is growing. In 2017, annual sales at restaurants were expected to top $799 billion in the US with more than 1 million restaurant locations.
It’s not surprising that things are going so well. Consumers are spending more on restaurants and food. In 1955, families spent just 25% of their food budget on restaurants whereas nowadays they spend around 42%. Total food purchases currently amount to 12.5% of household income.
Despite these promising numbers, around 30% of restaurants fail in the first year after opening and about 80% of businesses fail by their fifth year.
This is partly because a lot of restaurant businesses are undercapitalized. There are a lot of sunk costs in running a restaurant including buying equipment, paying staff, buying supplies, advertising, and paying your lease. If you don’t have enough working capital to handle cash flow issues or slow periods, you might have to shut the doors prematurely because you can’t pay the bills. That’s where a small business loan could have a big impact – both in preventing that from happening and in saving the day if it does.
What is a Small Business Loan?
A small business loan is an installment loan that you take out from a bank or other lender in order to finance costs related to your business. That loan is then amortized over a set period known as a term length. These loans can have fixed or variable interest rates and can also have different fees associated with them like pre-payment fees or origination fees. You can get them from a brick and mortar bank of from an online lender.
Some small business loans are backed by the Small Business Association (SBA) and so often offer lower interest rates – but because of this they have more rigorous qualifying conditions and rules and fewer business owners are able to get approved for these types of loans.
What Are Unsecured vs. Secured Business Loans?
A secured business loan is one in which you have to offer up collateral in order to receive the loan while an unsecured loan is a business loan without any kind of collateral attached to it. It can be very difficult to get a small business loan if you’re an entrepreneur.
Given the high failure rate of restaurants, it is even more difficult to get a loan if you’re in the restaurant business. For that reason, banks often require some sort of security in order to be willing to lend you money. With a secured loan, you’re also more likely to be able to borrow a larger amount and to get a lower interest rate. This is because there is less risk for the bank or lender.
Depending on your business and the state of your business credit, you might have to personally guarantee your loan with your own credit and assets or you might be able to solely use your business credit and assets to secure your loan.
Why Might a Restaurant Need a Small Business Loan?
There are almost as many reasons why a restaurant might need a small business loan as there are restaurants. Every business is unique and has unique needs, but there are some common reasons why you might need a restaurant loan.
The first reason why you might need a small business loan is because you’re opening up your restaurant and need the money to pay for equipment or as working capital. If your business is more established, you might need a small business loan to pay for new equipment or to cover a slow season in the restaurant business.
You might also want to get a small business loan if you want to expand, build your credit, or if you realize that your business is undercapitalized.
Potential of Using a Restaurant Loan
There are a number of potential benefits when it comes to using a small business loan. When you are first starting your restaurant, you might consider taking on investors. However, if you get a small business loan, you could potentially maintain a greater ownership share of your business since you won’t have to give up equity it in order to get the money you need to start your business.
Another benefit of getting a small business loan is that you will be starting to build your business credit. Building your business credit is critical because if you ever need to borrow money in the future, it will be more difficult if you have a low business credit score. Not only will you likely have to personally co-sign a loan, but you also won’t be able to borrow as much and you could end up paying more in interest.
If you think you might want to open a second location and will need to borrow money to do so, borrowing a small amount and paying it back could help prove you’re a good credit risk. If your business has good credit, you might be able to borrow money in the future without personally co-signing the loan.
Another benefit of getting a restaurant loan is that you can deduct the interest on your loan as a business expense on your taxes. That’s something you can’t do if you take on equity investors.
Disadvantages of Using a Small Business Loan
When it comes to financing your restaurant, you have to be careful that you don’t borrow too much or agree to repayment terms that make it difficult for you to repay the loan. Since revenue in the food industry can vary by season, make sure that you’ll be able to always make your payments. For this reason, a business line of credit might be a better choice since it would allow you more flexibility in your repayment.
Some small business loans can also have very high interest rates and that could mean that you’ll end up paying much more in interest over the life of your loan than if you financed your loan with a home equity line of credit or personal loan. If you’re worried about interest rates, you might want to get a fixed interest rate loan rather than a variable one which could increase over the life of your loan.
Another downside of borrowing money to finance your business is that it could lead you further into financial trouble if your restaurant is already struggling. Given that you will likely lead to personally guarantee the loan, taking out a small business loan for your restaurant could greatly affect your restaurant.
What’s Right for You?
Whether or not you should get a small business loan for your restaurant will depend on your business and personal financial situations. You might want to put off an expansion or big purchaseuntil you can afford to pay for it in cash or you might decide to take on investors rather than getting a loan. If you’re not sure what’s right for your business, sit down with a business advisor and get their advice on the best option for you.
Author: Jeff Gitlen