Financing equipment can be a difficult process, especially when you have to get the money elsewhere. Rob Johnson reports.
Capital equipment is a bigger problem for restaurants than it is for many industries. Like many industries, it’s fundamental to your business. Like many industries, it costs a motza. But unlike many industries, it’s extraordinarily difficult to determine a return on investment for it. You can’t really skimp on it, but whether you’re starting a new restaurant or refurbishing an existing business, the amount of capital you have to hand is vital, and lots of it is going to be tied up in buying stuff.
“The quality of the machinery you use has an impact,” says Michael Gelb, managing director of Melbourne’s Good Taste Company. “Especially in the kitchen, which is the nerve centre of the operation. It’s not always best to go for the cheapest options available,” he says. But how do you pay for it?
It was the question faced by Alex Herbert and Howard Gardner when they recently opened Bird Cow Fish in Crown Street, Surry Hills. Any reasonable person would say Herbert and Gardner were not a risky proposition: they’ve been in the restaurant business for 20 years, having worked in celebrated spots like Berowra Waters Inn, Sailors Thai, Chris Manfield’s Paramount and Longrain. The restaurant had a previous incarnation, under the same name, as a much-loved Balmain bistro. And they found getting bank finance to lease equipment extremely difficult.
“Basically, we’ve mortgaged our home and used that to secure a loan for the business,” says Herbert.
“We couldn’t get leasing finance, despite being in the business for 20 years and running three restaurants, because we were considered too much of a risk. We didn’t have current operating figures, so we couldn’t get a lease. I looked at the banking options and other people offering leasing finance, and compared taking out a loan or taking out a lease, and it came down to six of one, half-a-dozen of the other. But on top of that, leasing would have been complicated.”
According to Warren Williams of Finrent, who specialises in organising finance for the hospitality industry, such a scenario is pretty common. “Most people are familiar with the idea of securing finance with the family home or, if they have the freehold for the restaurant, with equity in that,” he says. “That’s how most bankers would want to finance you. As a rule, banks are happy to lend money when there are bricks and mortar involved.”
And he’s sympathetic with those bankers who are presented with cash flow projections with little basis in reality. “Our funders appreciate well presented cash flow projections, but at the same time they treat them with a grain of salt,” he explains. “I’m yet to see a bad cash flow projection. More important are the assumptions behind those projections. If they’re based on ‘x’ number of covers, on these costs, on this number of staff and so on, then they’re treated with more relevance. More and more people are backing up their cash flow projections in that way, but many aren’t. It’s a cost they don’t want to incur—the cost of figuring it out with their accountant—but they will benefit from doing so.”
Gelb agrees that some restaurants just don’t get the whole cash flow process right. “A pitfall a lot of restaurants face is the cash flow and having a good forecast in place. That’s a big trap for a lot of them—they don’t plan ahead.”
But hocking the family home isn’t the only option available—in fact, if you don’t own property it isn’t an option at all. The nature of what you’re doing, says Gelb, means the starting point is looking at what equipment you need based on the type of business you have, and your expected output. “So looking at needs might involve deciding on a six burner grill or a four burner—evaluating what the needs are based on the kind of business it is. Once that’s in place it’s going out and seeing what’s around.”
From there, he says, investigating leasing options can save an enormous amount of money. “I was just talking to a client who was telling me about the cost of chairs,” he says. “At around $200 each, that’s a huge cost for a restaurant to bear.”
Williams says a lot of people get knocked back because they’re either a start-up or they’re not property owners. “Interestingly, I tend to deal with the same banks they’re talking to,” he adds, “but I deal with the finance head offices of them. To certain degrees, those funders are happy to look at lease finance for equipment.
“The initial benefit for the restaurateur is that you don’t have to spend cash on something that isn’t income generating right away. So it makes sense to pay that off over the term of the lease and have those payments aligned to your income stream. That way it doesn’t affect your cash flow immediately.”
Repayment terms on a lease can be structured in a way that minimises the impact on cash flow. If you’re leasing your premises, Finrent will structure the term to suit the renewal of the lease on the premises. There’s a range of leasing options available, all of which have potential tax benefits. They include traditional lease finance and commercial hire-purchase, which many people may already be familiar with, as well as rental and chattel mortgages. “Each venue is going to have its own way of treating tax, so some options are going to be more suitable depending on how they account for things, the turnover of the establishment, and whether they can claim GST back up-front or over the term of the lease,” says Williams.
He says all the options cost around the same up-front, although commercial hire purchase and traditional leases are a little cheaper. But it’s not a simple case of the cheapest option is the best, he points out. “The tax department has depreciation guidelines for kitchen equipment,” he explains. “According to them, after five years most kitchen equipment is still worth a significant amount of money, where in reality it’s not. With lease finance you’re facing up to a 50 per cent residual at the end of the term—whilst that keeps your monthly repayments down, you can end up saddled with a large debt on outdated equipment that isn’t really worth that much.”
If, in a worst-case scenario, everything doesn’t go to plan, there’s another trap for the unwary. As a general rule with restaurant fit-out, says Williams, “a funder is unlikely to refinance because of the depreciating value of the equipment. They know that, despite the tax department’s valuation, from experience it’s unlikely that the equipment will be worth much when it’s that old.”
There are potential traps with rental, too. If you’re taking this option, there are sometimes tricky clauses in master rental agreements demanding interim payments, extension clauses and return conditions which can add significantly to the amount you’re paying out. Your only protection, says Gelb, is to be careful. “I’ve heard of those kind of things but you have to do the same thing you’d do with any kind of financing,” he says. “Check out the supplier thoroughly. It’s often good to deal with bigger brands or well-known names.”
Over at Finrent, Williams says he’s finding the most popular option nowadays is the chattel mortgage, despite its higher up-front costs. “It costs a little more up-front, but generally you can claim back the GST as a lump sum on your first BAS return.” The five-year term with no balloon is most common.
He also points out that, whichever form of financing you eventually choose, don’t assume that finance only applies to capital equipment. “A lot of restaurants aren’t aware of what can be funded,” he says. “We work with project managers and designers on total fit-out maximising what can be leased, which includes floor coverings, lighting, point of sales (POS), telephony and IT, and much more.”
The only thing Herbert of Bird Cow Fish ended up leasing was the POS system. “I asked a couple of people about what POS systems we should have then talked to a couple of suppliers and negotiated a price,” she says. “I got the names of some people who could provide leasing finance, and the numbers were difficult, but not impossible. We eventually went with the ones who came back with the best payment terms. Restaurants always go over budget, so negotiating that effectively gave us $25,000 capital in reserve.”
Which is capital-in-reserve any restaurant would be happy to have.