Financing your second location – Restaurant loan underwriting
A few months ago, I got a call from a friend that works as a lender at a community bank in a nearby city. We had worked together at a previous bank, and he likes to pick my brain when it comes to underwriting problems. This time, he was trying to get an SBA loan approved for a restaurant. The restaurant was going to be a carbon copy of the successful “sports theme” restaurant that the borrower currently owns. The borrower had twenty years of experience in the restaurant business, and had owned his restaurant for more than ten years.
For those unfamiliar with “sports theme” restaurants, the concept is simple and effective. Lots of big screen TVs, sports memorabilia décor, fast food, chicken wings, and lots of beer pretty much sums it up. You cater to a male audience, and hope that your local sport teams do well enough so that you are packed with hungry people on game days. Lets just say that our area has been blessed with popular sport teams, so that has not been a problem.
My lender friend told me that he was having trouble making the deal work, and asked for help so immediately I got into question asking mode. I think it is always good to get the parameters of the request down by asking pertinent questions, because a lot of commercial lending is customizing a financing solution for particular needs. The following summarizes the question and answers:
First question of course was, What are you financing?
My friend proceeds to tell me about this great opportunity that his borrower had found. A new restaurant closed after six months of being opened because of conflicts between the partners, but the location was great in a pedestrian friendly street, with lots of shops and other restaurants around to attract potential customers. The failed restaurant being sold was an “ethnic food concept”, that proved to be not as popular as the seller thought. The deal at its core was an asset purchase that included; the rights of the remaining 10-year lease, business equipment and the leasehold improvement made to that restaurant. On top of that, the borrower needed money for remodeling, and new equipment. The cost was estimated at about $500,000.
Now that I knew what was being financed, I asked what kind of loan he was looking to get approved?
The proposed loan facility was an SBA 7a loan in the amount of $400,000. The loan would have a 75% guaranteed by the United States Small Business Administration (SBA) The loan was structured with a 7 year term with interest rate based on WSJ P+2.75% on a floating basis for the life of the loan and adjusted on a quarterly basis. The loan was interest only for 6 months to allow the applicant sufficient time for the completion of the leasehold improvements, followed by 78 installments of principal plus interest.
The plan sounded good to me, the borrower was obviously coming in with a nice chunk of the money, so there was equity there. We had an experienced operator. The structure made sense with an appropriate maturity and amortization. It looked as a good idea, so I asked the follow up question.
So what is the problem?
Apparently the credit at my friend’s bank did not like the deal because it relied solely on projections, and they were not comfortable with the projections being met even with the fact that the borrower was successful in his original location.
The credit people in the other bank were right. Lending based on projections is a dangerous game. Even with the benefit of a government guarantee on 75% of the outstanding, you are taking a big gamble when you base your repayment on a company without a history of performance. One way to mitigate this is looking at the financials of the owner. If the owner has a lot of liquidity, it is easy to point to the liquidity and say that the wherewithal to make the bank whole is present. In this case, the owner had enough money saved up to contribute $100,000 to the new restaurant, but not much more other than the value of his existing restaurant, and his house. While a lot of lenders like to go after the house to secure loans, I know that mortgaging the house is a touchy subject with borrowers and their spouses, which is why I try to look at other ways to improve loan structure.
Please take into consideration that commercial lending is more of an art than a science. This particular loan could have been presented a hundred different ways, but once he told me that the existing restaurant was not a part of the deal, but that it was making money and the borrower would more than likely not object to making it part of the deal, I knew I had the answer.