Obtaining credit has always been difficult for operators in the hospitality industry, a sector where as many as three in five businesses close or change ownership within the first three years of operation, according to a recent study by Ohio State University Professor H.G. Parsa. Normally, getting as far as a loan closing meant having a letter of credit from a reputable bank that said the borrower had assets to cover the amount of the loan being sought. And more often than not, it required the owner to have experience as an owner or manager in the hospitality field, plus a real estate component that could be liquidated in the event of foreclosure.
In these sobering economic times, however, more and more operators find themselves without the financial wherewithal they once counted on to grow, prosper or simply operate, thanks to banks and other lenders not lending or requiring operators to have a lot more skin in the game. Today, that aforementioned degree of financial vetting — letter of credit and assurance of experience — might seem to many like the good old days.
The Buck Stops Here
Just ask Mike Kermode, a stockbroker and commercial mortgage consultant at Maximum Financial Inc. in Dillon, Colo., whose firm helps hospitality owners and entrepreneurs put together business plans and negotiate today’s much tighter credit and financial markets. “I don’t know of any lenders who are touching bars and nightclubs and lounges without an SBA guarantee,” Kermode says, referring to the Small Business Administration’s backing of loans to entrepreneurs (more on that to come).
Typically, Kermode says, banks now require a credit score of at least 660 by the loan applicant, in addition to other credit prerequisites such as a good cash flow and at least two years of experience in the food-and-beverage trade as an owner or manager.
For start-up businesses, the borrower should expect to put down 30 percent with a 70 percent max loan-to-value ratio, he explains, adding, “A strong business plan is necessary on start-ups, along with a strong résumé.”
With traditional business lending all but cut off by bankers unwilling to put their money on the street for anything less than a completely solid deal, the new financial reality for the retail channel portends some significant changes ahead.
Since the beginning of 2009, hospitality lending specialists at San Mateo, Calif.’s Advance Restaurant Finance (ARF) have charted a major shift in the nature of new credit applications by bar, club and restaurant entrepreneurs seeking to remodel or expand their collective businesses.
“We are still lending,” says Kelly Payne, vice president of marketing at ARF. “But we are seeing a lot more delinquent mortgage payments and late business rent payments. And those two things for us are disqualifiers.”
On the affirmative side, however, Payne adds that those qualified borrowers who might normally have gone to their local banks for loans are instead coming to ARF. The company makes up to $1 million in financing available to hospitality ventures that have solid cash flows and have been in business for at least 30 days.
“All together, we are seeing about the same number of applications as we did prior to the credit crunch. The difference now is that we are seeing a certain segment of the bar, club and restaurant industry that we never saw before.”
Payne says geography also is a factor in determining whether a would-be borrower is accepted or turned down for financing in today’s tighter credit market.
Specifically, he says, applicants in regions where the housing market is in significant decline have a much steeper curve to climb now in getting an unsecured ARF line of credit. “In places such as Nevada, parts of California and in Florida, we are more careful with lending because a lot of an applicant’s equity may be tied up in their home. It is a barometer of the economic state of the region.”
Conversely, Payne adds, other areas of the country are fairing much better. “Texas is very strong. New York is good, and in California, Los Angeles is pretty solid.”
Despite an undeniable mindset among many banking institutions to avoid higher-risk ventures in making lending decisions, veteran operator Thom Greco, the owner of Sky Bar, Oyster Restaurant & Bar and The Mines nightclub concepts in Wilkes-Barre, Pa., says owners and operators still have options for securing the funds they need without getting burned and/or loan sharked.
Having utilized a range of financing alternatives to build a Greco Holdings Co. operation that now employs 100 people and enjoys a net worth of approximately $50 million, Greco says one piece of good news to emerge from the current tight money situation is that government at all levels is stepping in to fill the financial void.
“Whether it’s the federal government through the Small Business Administration or an individual state agency, loans and grants to venture businessmen are part of everyone’s game plan to turn the economy around,” he says.
For those with a sound business plan and the requisite “skin” to entice a banker in the form of assets and/or venture capital, preferably raised among the borrower’s family and friends, Greco says the first step to getting an SBA loan is to get turned down by a traditional bank or other private lender. “Generally, the SBA does not pick up until a bank turns you down. And that is not hard in this business.”
A University of Scranton (Pa.) graduate who propelled his career in hospitality with further studies at the Wharton School of the University of Pennsylvania and the Culinary Institute of America in Hyde Park, N.Y., Greco says the borrower eventually ends up back at the banks again because of the SBA’s policy of working with approved banks to aggressively put money into the hands of those who, in turn, use it to create new businesses, jobs and additional tax revenue. “They will lend you the money now because the federal government will guarantee 60 to 70 percent of the deal.”
Even for prospective borrowers who may qualify for financing without government backing, Greco says going after financing through SBA programs offers some clear advantages for the borrower. “Ultimately, using this program gives you a better cash flow because it is a low-interest loan and it’s amortized over 15 years. Traditional banks might make you pay that back over five years or 10 years because of the life of the equipment or the improvements.”
Many state and local government agencies also are ready sources of financing for hospitality ventures through federal block grant initiatives that allow local officials to oversee investment in their community for job creation, Greco adds. “There is a formula as to how much money they make available based on the number of full-time or temporary jobs you create or preserve.”
Although economists typically lump restaurants, bars and nightclubs into a single category for identification and qualifying purposes, not every hospitality venture and vendor is equal in the eyes of commercial lenders today.
Charlie Greener, CEO of Dallas-based Harborage International, a firm that specializes in the design, construction and operation of major hotels, restaurants chains and nightclubs throughout the United States, says operations with successful track records have a decided advantage when it comes to getting the backing of banks and other commercial lending enterprises. “From an owner-operator standpoint, even in times of good money, hospitality is divided among those looking to open their first location, operators seeking to expand and those who are just trying to stay afloat. Particularly for the operator who is looking to expand, this is a bonanza time. He can get some great breaks on leasing costs and equipment.”
In one recent instance, Greener says a new nightclub owner in Texas was able to buy a $600,000 lighting system for just $50,000. “The landlord had all of the assets of a club locked up and was willing to let equipment go for pennies on the dollar.”
More and more, Greener says, landlords who used to be able to basically lease property on their own terms now are willing to put in some physical assets to sweeten the deal for a tenant. “They are doing things like providing air conditioning, equipment, walls and paint that will improve their property so that if the tenant fails, the asset does not go away. They are desperate for good tenants with good ideas.
“They don’t know you, but if you show them that you have a solid enough idea that you can raise private equity, then you have credibility once you walk in the door.”
Those operators who need capital just to keep the doors open may have the fewest options of all three groups in need of financing. However, Greener says all is not lost in today’s challenging economic climate, even for this segment.
“You have to approach the various parties involved — the landlord, private investors, etc. — with a new business plan. If you can secure additional financing from investors, you can then go to the landlord and say, ‘I’ve raised an additional $100,000, and here is my new business plan. I need some reduction in what I am paying you to lease the space.’”
In this worst-case scenario, Greener says timing is everything. “Don’t wait until it is too late. When you see issues developing, get out ahead of them rather than waiting until they have become so serious that people don’t see that what you are asking them to do will make a significant difference.” NCB