Restaurant Loan Story – Part II

The Restaurant Loan Story continues

In order to get the loan approved, we needed to convince the credit officer that this was a good loan, relying on projections needed to be mitigated. We also needed to show that even in the face of missing projections, our loan was going to be able to be repaid. When my friend told me that the owner would be amenable to allowing the existing restaurant to guarantee the loan to the new restaurant, the deal became much easier to underwrite.

The goal here was to be able to use the cash flow of the existing restaurant to support the debt service of the new loan. Having the existing restaurant as a guarantor, would insure that they were considered legally liable for the debt. In my opinion, the only way that another entity’s cash flow can be counted is to get them to be a party of the loan, this means making the other entity a co-borrower or at least a guarantor.

In this case, I thought making the existing restaurant a guarantor was good enough. We had the owner as a guarantor anyway so pretty much all of the assets were within our reach.

The first step was to figure out how the old restaurant looked as far as revenues, cost structure, and profitability. We also needed to review the projections for the new location with the same critical eye, and see how both of them looked together. So I came up with a small spreadsheet to show this:

 

In Thousands of US$

Original

New

Combined

Sales

$2,000

$1,800

$3,800

Cost of Goods Sold

$1,000

$900

$1,900

Gross Profit

$1,000

$900

$1,900

Depreciation

$50

$50

$100

Interest Expense

$48

$30

$78

Other Operating Expenses

$662

$604

$1,266

Total Operating Expenses

$760

$684

$1,444

Net Income (Profit)

$240

$216

$456

Looking at the numbers side to side was easy to see where the owner got the assumptions about the new location. He assumed that the cost structure for the new place was going to be similar to his existing location, and that as far as popularity the new location would be close to his established restaurant.

By adding the original location as a guarantor, I was half way through the process of mitigating the concerns of the credit officer at my friend’s bank. I could see that the existing location was profitable, but profit does not pay loans. I needed to know what the cash flow for the existing restaurant was, and I needed to know what the cash flow for the new restaurant was going to be. In order to do that, I needed to apply traditional cash flow calculations to the income statements. To do that I needed to find out if there was any debt on the original restaurant. My friend informed me that the borrower had two loans (SBA 504) on the original restaurant, and he provided me with the monthly payments. With that information, as well as the historical income statement for 2010 as well as the 2012 projection for the new location, I was able to do a combined debt service.

 

In Thousands of US$ Combined
Net Income

$456

Depreciation

$100

Interest Expense

$78

Cash Available to Service Debt

$634

Existing 504 loan 1st Mtg. P&I

$37

Existing SBA 504 loan P&I

$28

Proposed Facility P&I (7.5%)

$78

Total Debt Service

$143

DSCR

4.43X

Cash After Debt Service

$491

So far I have made half of my argument for the loan by moving away from relying solely on projections for the proposed loan. I have improved the structure by tying an existing business with a long track record to the loan repayment, and proved ample repayment capability by showing a DSCR (Debt Service Coverage Ratio) of 4.43X. And it is important to note that the coverage was assuming a 7.5% rate, which is higher than the current effective rate.

However, I was only half way there because the concern about projections not materializing was still there. I was still relying on the new restaurant to provide almost half of my cash flow to repay the combined debt service. I needed to do a sensible downside scenario.

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