Restaurant Letter of Intent

restaurant-buildout-letter-of-intent

Reviewing Sections of the restaurant letter of intent (LOI)

Communicate Each Point Clearly

Let’s take a look at a sample letter of intent from one of my deals, so we can understand what’s in it. It’s important to educate yourself and knowing the details of your LOI will help you to weed out the attorneys that may not know the basic terms we use in the restaurant industry. This was a deal I had to walk away from because the numbers were ridiculous and the rent was about $12k a month. We’ll talk more about budgets and what are good numbers later on. I’ve also listed other terms that I’ve seen in the past that may not be in this LOI.

Most LOI will be written the same way and there are definitely items that can and must be negotiated before the first draft of your lease. Location: Make sure your location is clearly stated. If there is a unit or location number, make sure it’s listed in the LOI. I can’t tell you how many times this was “mistakenly” changed. I’m sure it’s an honest mistake, but just double check it.

Size Matters

Yes, size does matter! Don’t accept anything smaller or bigger than your needs or budget can fit. If the space is too small it can hurt your business especially with seating, if it’s too big it can hurt your bottom line adding to your rent.

Permitted Use

Make sure you have exclusivity on the products you’re selling especially in a mall. I’ve seen coffee shops literally open yards away from each other. You want to be the only game in town. Also, you don’t want to start selling an item only to have the landlord state another tenant has exclusivity. Make sure it’s clear what you’re selling.

Letter of Intent Terms

If you’re opening in a shopping center make sure to get 10 years on your lease with an option for 5 more years. Also, make sure you have a way out of the lease if you’re opening in a mall or shopping center. You never know how things are going to go. The economy might fall apart or the shopping center’s main road is going to be repaired and access to your location is nearly impossible or the anchor store the mall promised would open decides not to and now there is no traffic coming to your location. These are things you need to consider, so make sure there is an out. Make sure there is an option on a 10 year lease; for example, tell the landlord you want a 5 year lease with an option for another 5 years. If you’re not doing well within a few years of opening, then you always have an opportunity to leave before the next 5 years begin. With a good attorney broker you may be able to pull out in less than 5 years with a very small penalty. We’ll discuss this more when we get into the “Good Guy Clause”.

Minimum Rent

Don’t go for anything that is going to be more than 10%-15% of your gross sales, the smaller your rent the bigger your bottom line. In this deal the “BASE” rent is $120k a year, this means I need to sell $1.2 million dollars of food a year. I’m a small to medium size restaurant, and my CPA projected about $600k in gross sales for this location. This was based on the traffic, the economy, the uniqueness of my food, and location. My rent “ALL IN” should be $60k half of what was being offered in this deal. That is $5,000 a month. This means, I should be selling a minimum of $50k a month in gross food sales.

CAM

Common area maintenance charges. Although it’s not mentioned in this “LOI”, it is a very common practice and this is the amount that will add to your base rent. CAM charges are additional rent, payable on a per-square-foot basis, based on the tenant’s share of the rentable area. CAM charges can add a significant load to the base monthly rent expense. I’ve seen deals where the CAM was set anywhere from $3.50 to $35.00. Let’s do the math on the LOI above to see the ridiculous numbers they offered us at this location. In this case, they wanted $25.00 per square foot per month for premises consisting of 144 square feet in addition to the $120,000 base rent, $2,000 for real estate taxes, and another $2,000 a year for their marketing fund, during the term of the lease. It was a sucker’s deal and I had to walk away. Interesting enough, they would call me a few months later to accept my offer, but that ship had already sailed I was on to the next deal.

TIP: Try to have your attorney/broker negotiate an annual cap on increases such as 100 percent of the amount of the previous year’s CAM charges.

Percentage Rent and Breakpoint

This will vary for each location. Some ask and some don’t. The trick is to make sure that the break-point is unobtainable; for example, I know I’m going to sell max at my location $600k, so I’m going to make the break-point after $700k. Don’t over inflate the number because the landlord will expect a higher rent. It’s hard to negotiate your rent when your break-point is too high. The idea is that the landlord will get 10% of every dollar over $700k in addition to their rent!

Trash Removal

Not a big deal and it’s usually very low and you want this if you’re in a mall. If you’re in a shopping center they will add it to the CAM (Common Area Maintenance).

Real Estate Taxes: You got to pay it! Let your financial advisor look into it to make sure it’s fair.

Marketing Funds

Don’t pay for it! You’re paying enough in rent; in fact, all the tenants are paying rent and some are paying this marketing fund too. You must advertise your own restaurant outside of the mall or shopping malls advertisement.

Merchant Association

Don’t pay it. It’s the mall’s expense not yours’.

Personal Guaranty

It’s not on this LOI because my attorney fights hard not to get me to personally guarantee anything! Don’t get me wrong, we don’t’ always win this fight, but my guaranty at most would be 1 or 2 years. When I first started on my own with no help or advisors, I was signing it for 5 or more years (Learning Pains!). If you, as a tenant, take title to the lease as a corporate entity, which is often the case for liability, tax or other reasons, you should expect the landlord to insist that each significant owner of the underlying entity sign the lease as a guarantor, ensuring that it will not be left with an “empty shell” as the only thing to chase if the tenant fails to meet its lease obligations.

Condition of Space

The landlord will want you to take it as is. The only time I would take an as is location is when it’s a lipstick job. Meaning, all I must do is paint it and dress it up and I’m good to open; unfortunately, I haven’t found many of these lipstick operations. Typically, I will ask for development money since I don’t own the real estate why am I going to build out and fix a restaurant that I may not have for more than 5 or 10 years? As soon as I’m gone, the landlord has a developed location for the next guy and that guy might just get the lipstick location I leave behind.

Development Money or Tenant Allowance

Development money can come in two forms. I ask that the landlord give me anywhere from 25% to 30% of my cost to build out the location at the end when I open and all releases from my general contractor are submitted and cleared by all sub-contractors. We will spend time in later chapters on general contractors, sub-contractors, how to protect yourself, and not get stuck with liens on your property. The other way to get development money is to have the landlord build out 25% – 30% of your store. I highly recommend you go with the first option. It gets messy when the landlord’s general contractor and your general contractor should make that transition, so you GC can finish out the build-out. The other issue is that your landlords GC may not really understand your vision and the outcome may not be what you expected.

Extension Terms

Extension terms, often referred to as option or renewal terms should be negotiated upfront. Many leases include an initial five-year term and two successive five-year extension terms. Knowing that you’ll be able to keep the space (at your option) for up to 15 years is money you need in the bank before expending the capital necessary to open the business. Normally, rent and CAM terms for the renewal terms are negotiated upfront, as well, but sometimes they state vaguely that they will be “90 percent of the market rate for comparable buildings in the same geographic area.” Nailing down specific terms up front is a better idea unless you expect rents to drop.

Free Rent During Build Out

The last two items on the LOI above may vary. When it comes to opening a kiosk, inline store, or shopping center location make sure you ask for 9 months of free rent during the build-out phase. Our restaurant typically when done by a very competent GC will only take 3 months, I got stuck once with a store that took 11 months to build out because the county kept screwing us and I wound up paying 5 months of rent and no store. I was fortunate to have other stores running and operating, imagine that being my only store. I would have been out of business quickly! Chances are you won’t get 9 months, but you may get 6 months. If you open in 3 months, that will make a heck of a difference those 3 months you’re open with no rent to pay.

Security Deposit

I’ve been able to get away with one month’s rent and it’s usually used for my first month’s rent. That’s not every deal, but my Attorney/Broker is highly skilled in getting incredible deals.I think it’s very clear that you need a very good real estate attorney that can double as your broker to negotiate the LOI, familiar with the restaurant industry, and has done these deals before to insure you get the best deal possible. Every LOI is different and there may have been some terms I missed, so make sure you seek out the advice of your attorney before getting into any deals. As I mentioned before, a good real estate attorney that’s been in the game for a long time will also be able to broker. After the deal is brokered, and an LOI is issued, your attorney already familiar with the deal now can review the lease to make sure everything is in order and the items in the LOI match the lease.

Personal Guaranties and Good Guy Clause

As we read earlier, Landlords will often ask for a personal guaranty from a business owner and may refuse to rent the space without one. This is a large risk for small restaurant owners especially when the company provides the sole source of income. If the restaurant cannot make enough money to meet its expenses, it is unlikely that the restaurant owner will be able to make the rent payments. Thus, the only escape may be to file for personal bankruptcy protection; however, some landlords will include a “good guy clause” in the lease. If a business needs to terminate a lease early, the landlord will not enforce the personal guaranty as long as the business has vacated the premises and has paid all rent up to the date of termination.

This clause can allow the business owner a “way out,” and may dodge having to declare personal bankruptcy. Be sure to read the good guy clauses carefully, as some will only allow you to get out of the personal guaranty if your company is going out of business. Transfer/termination: Assigning the lease is an important clause to have in your lease agreement. You may want to resell and make a big profit on your very successful store or maybe you want to move; in any case, you will need to be able to transfer your lease. Make sure you have the right to assign the lease, sublet all or part of the premises or give notice that you are terminating the lease without breaching your contract. Your landlord won’t be happy about this, so make sure it’s clear and upfront.

Sublease/Assignment

An assignment permits you to transfer the remainder of your interest in the lease to another party, whom the landlord accepts as the substitute tenant. Getting your landlord to agree is another issue. Be careful when negotiating this portion of the lease and consider including a provision that allows you as the tenant to get out of future liability by paying an agreed lease termination fee. A sublease permits you to act as a sublandlord and re-lease the premises to a third party. This is unlikely in the restaurant business, yet I’ve seen some strange things in this business. I’ve seen a pizza shop sublease a portion of their space to a coffee shop. It was about 200 sq. ft. and they sold espresso, latte, and other coffee type items.

Extension Terms

Extension terms, often referred to as option or renewal terms should be negotiated upfront. Many leases include an initial five-year term and two successive five-year extension terms. Knowing that you’ll be able to keep the space (at your option) for up to 15 years is money you need in the bank before expending the capital necessary to open the business. Normally, rent and CAM terms for the renewal terms are negotiated upfront, as well, but sometimes they state vaguely that they will be “90 percent of the market rate for comparable buildings in the same geographic area.” Nailing down specific terms up front is a better idea unless you expect rents to drop.

Expansion Rights

If you have any reason to believe that your business will expand and the premises that you have leased will become too small for your purposes, you should consider negotiating for a first right of refusal to lease space adjacent to yours if and when it becomes available. Seek the terms of the newly added space be on terms at least as favorable to you as those you already lease.

Lease Terminations

Sometimes, things just don’t work out. Your business just isn’t making enough money to continue the daily struggle. You could breach your lease, in which case the lease will likely find yourself in a lawsuit or you could take a smarter route and approach your landlord with an explanation of what went wrong and have your attorney/broker offer a fair plan in hopes that the landlord will be willing to terminate your lease or otherwise help you. Doing so gives the landlord a chance to find a new tenant, which may mean less from you in termination fees and other damages the landlord may seek to collect.

Transfers by Landlord

Just because you started out with one landlord and built a very strong relationship doesn’t mean that landlord will be there throughout your entire lease that’s not usually how it works in the world of commercial real estate. At some point, the landlord will find a better opportunity, or someone will offer to overpay the landlord for its interest in the center and the landlord will sell, leaving you with a new landlord. The terms of your lease won’t change, other than perhaps by way of a letter that notifies you of the ownership change and asks you to send your rent to the new property manager.

Advantages and Disadvantages of Owning a Restaurant

restaurant-advantages-and-disadvantages

Do you have what it takes of open a restaurant?

ADVANTAGES

People got to eat! For years upon years, people have been hardwired to grab something to eat when they are hungry. This is a major advantage for any startup restaurant. The only thing you need to consider is the future of your product, and will there be a demand for it in your local geographical area. That’s really it in my opinion. People have to eat and here in the U.S. and around the world is something we all enjoy to do. It’s not like opening a haberdashery. Food is universal, and our very basic senses can lead us there. We’re lucky to live in a country where you can try cuisine from all over the world without having to travel to those parts of the world. When people see a restaurant they know there will be food, but now you have to get them into the door and we’ll discuss marketing later on in this guide.

DISADVANTAGES

Labor I’m sure you’ve noticed that most food businesses need a lot of employees to function properly and smoothly with the majority of those workers being low-paid. That leads to a workforce of unreliable employees with a high turnover rate. Finding and keeping qualified employees is a major challenge for the food industry.

Low margins – The food industry is very price sensitive, more so in the world of fast food chains. This leaves you with a very fine line to walk with cost of goods, labor and making a profit. It’s true that food franchises often see high revenues but the net margins are often overlooked. You are also susceptible to food spoilage and theft along with other issues only found in the food industry. I’ve seen anywhere from 4%-11% depending on rent, food and labor cost. We’ll talk more about his later on when negotiating rents and setting up a clear budget. We will also explore my free restaurant software www.recipe-costing.com that can help you get your costs and your daily breakeven number.

Expensive initial investment – A restaurant will require a substantial investment from you in order to get started. You need to pay for many items up front in order to run the business. Not only do you need to pay for the food and labor, also ovens, grease disposal, venting, furniture, point of sale system, and maintenance among many other expenses.

There will always be more disadvantages in the restaurant business then there are advantages. I think more so in the food business with thousands opening up a restaurant in the U.S. not to mention all over the world. There are people out there that are great cooks at home, and that’s where they belong at home unless they’re ready to face some of the challenges that are far from cooking and there are many. Building out a restaurant can be fun or a nightmare. Setting up a POS system can be easy or hard. Dealing with the State and County is never easy. These things have nothing to do with cooking; unfortunately, it has to be done to open the doors.

THE FUTURE…

If I only had a crystal ball, to see what the next trends in the food industry will be? Will the economy be on a rise or are there more financial pitfalls keeping customers away from retail and eating out? We just don’t know and that’s one of many things that make it hard in this business. I remember TCBY and ICBY they came about in the early 90’s the yogurt trends. They were opening all over New York and New Jersey, and people couldn’t get enough frozen yogurt. A couple of years later they closed as quickly as they opened. Here were are in 2014 and now we have new players in the yogurt industry. Regardless of the uncertainty of speculating what the future will bring, trying to predict the next big trend coming down the pike is important for anyone in this business. And nowhere is it more important than in the restaurant industry, where operators strive to fulfill customers’ most basic needs and their most fanciful desires. One thing we can agree on is convenience and quality. Customers want great tasting; healthy quality food and they want it fast. They don’t want to be inconvenienced by long waits, and food that’s been sitting on a shelf begging to be bought. They want to feel they’re eating in a safe, and clean, restaurant. Make your customers feel this way and chances are they’ll come back, and repeat customers will make you successful.

DO YOU HAVE WHAT IT TAKES?

You’ll need to ask yourself if you have what it takes to run your own restaurant business before you decide to open one. Running your own restaurant business is different than running any other type of business. There are many things that you need to be able to manage if your restaurant is going to be successful. Some of the things that are specific to the food industry that you’ll need to be aware of include:

  • Managing your restaurant staff
  • Government regulations
  • Taxes
  • Safety concerns
  • Recipe costing
  • Menu cost and pricing
  • Vendor item pricing
  • Ordering food and other inventory supplies.
  • Franchise Fees and Uniformity (If buying into a franchise)

You’ll need a reserve of funding to keep the machine going when you first open because unless you’re opening a McDonalds or Burger King, people are not going to be lined up to get in.

You have to be ready to do it all. You are the emotional leader and without your direction your team will be lost; more importantly, you’ll have to motivate yourself even when things seem grim. Keep up your spirits, so everyone around you will do the same. Don’t be afraid to make decisions, call people out, and run your business. If you won’t, then who will? Make sure you’re ready to put in long hours, be on your feet most of the time, and every detail requires your attention. Make sure you’re organized and you plan out every day, week, and month. The more organized that you are when it comes to scheduling, buying inventory, and taking care of finances the more success you’ll achieve. It will prepare you to tackle unforeseen circumstances, as opposed to, reacting to them when they happen. Surprises will always arrive, but there may be some you’ll respond to better through proper planning.

AVOID THESE MISTAKES

Here are the top ten restaurant mistakes that are vital to your success:

1. Business Plan

We offer a free business plan at our website www.recipe-costing.com/restaurant-business-plan.doc. It’s a real working business plan specifically built for the operation of a restaurant. Use it as a guide and always work with a professional when your build your business plans. Don’t fall into the trap of not taking the time and effort to write a business plan. At a minimum, it will give you an idea of your concept, financial projections, and start-up cost. After writing your business plan, make sure to review it monthly because things will change and you should update your business plan regularly. If you decide to open a second restaurant, your first business plan is like a journal you can revisit to better prepare yourself for your next build out.

2. The Wrong Location

I don’t want to bore you with the cliché location, location, location, but it’s true. I’ve had some awesome locations and a very poor location. It so happens that the poor location was not my first choice. I wanted to be in this very busy shopping center near COSTCO, but the location was already under contract by Nestle. The east end where COSTCO resided was a very busy section of the mall. I took the west end thinking that the traffic would trickle over to my side of the mall. I couldn’t believe that just being on one side of a shopping center could make that big of an impact and it did. We had to market the heck out that location just so the customers that shopped at COSTCO knew we were there. The right location can either make or break your restaurant. You should never take a secondary location just to save rent. High visibility and accessibility are two key points to having a great location.

3. Startup Costs

Knowing your startup costs are important to the success of your opening. This is where you business plan comes into play. Many times owners are undercapitalized because they believe they’re going to get the best deal on used equipment or they plan to cut certain corners to open their store with minimal investment. Underestimating a restaurant’s startup costs can result in bankruptcy. If you run out of money, you’re GC (General Contractor) will stop working and all sub contractors will be pulled off the site. You’re rent doesn’t stop just because your construction has stopped. One of the best ways to get the right start up costs should be done after you get your architect’s plans. The plans will have all the materials and equipment needed to build out your restaurant. Also have your recipes ready and your inventory cost planned out. I created a software tool to help with knowing your cost. Go to www.recipe-costing.com.

4. Architecture Plans

  • Get three quotes from general contractors that have experience building out restaurants.
  • Take the equipment list from the architect’s final plan and get three quotes on new equipment from equipment vendors.
  • Get three quotes for your external sign.
  • Get three quotes for your décor work.
  • Finally, make sure you keep your funds in escrow with an attorney that’s work in the restaurant business. Let your attorney pay your vendors during the start-up. Your attorney will make sure the work is done and free of any liens before they pay any of your vendors. The attorney is an added cost, however, you will be elated when you run into the first signs of trouble and you have someone representing you at every turn.

Use the highest of these quotes for your business plan startup costs. You will use the lowest one when you’re ready. In the beginning, it will give you a very good idea of what your initial costs may be and it’s an opportunity to see if all your vendors are all on the same page or are the numbers all over the place. Use the sample business plan to review other costs. When you have the total startup costs take about 15%-20% of your startup cost and add it as your working capital fund. When I setup my accounts, I have an operating account, payroll account, merchant account, and working capital account. If you pay royalties and your franchisor requires an ACH, then create a royalty account to drop your royalties into that account. I know it sounds like a lot of accounts. It works well when tracking your funds and reconciling.

5. Profitable Day One

It’s unlikely you’ll be profitable in the first few months. When we opened our Homestead location, we had incredible sales the first 6 weeks. We call it the honeymoon stage, and with all those sales we were still in the red. The reason for not making a profit had to do a lot with training new employees and lots of mistakes on the line. During this time you may have a lot of marketing going on, a soft opening, coupons, and free giveaways will all take away from your profitability. After the world wind, it will take time for you and your manager to get inventory and labor under control and get a real good feeling for your business.

6. Operations

Before opening, make sure you have your procedures in place and your opening checklists. Utilizing these check lists can help increase your success and will insure your employees know what you expect from them. Before I let any of my cooks on the line, I make sure they take a product knowledge exam that they must score a 90% or better. Knowing what goes into the recipe makes the cook much more confident and the learning curve to prepare the meal decreases tremendously. Our point of sale had a training mode and we had an exam for our employees running our point of sale system. Every job in your restaurant should have a knowledge exam.

7. Know your customers

After doing your research, site survey, and developing your business plan you should have the pulse of your customers. Keep in mind that you are providing your customer a food service they are missing. Your concept should be the first one or the best one, and make sure you’re focused on serving your customers.

8. Keep your menu simple

The data you have collected is telling. If you did the research you know what your customer is missing in the local market and what they want. Now keep the menu simple. Don’t try to be every food to everyone or your food cost and success will slip away quickly. Once you have a concept, you need to define your niche and remain focus in filling that niche. Try to use a single food item like chicken breast in many menu items to reduce your food costs.

9. Opening Day and No Plan

The worst thing you can do on opening day is being unprepared. I recommend doing a soft opening for the first week. Don’t advertise you’re opening until you are absolutely sure you’re ready to go. I’ve been to openings where the restaurant owner opened the doors and was missing key items. The employees were frustrated, the owner was putting out fires, and the customers left with a bad taste in their mouth. The customer’s first impression is the most important and you have to impress them as soon as they walk through your doors if you want them to return. The soft opening will allow you to work out kinks or any foreseen problems.

10. Be an Owner

Your employees rely that you know it all and you are their comfort zone. Be patient and develop a nurturing environment to keep your staff at ease. They are going to make mistakes, don’t crucify them since it will only crush the little self-esteem they have left on doing a good job. Explain their mistake, correct it, and tell them to try again. You’re not one of the employees or their assistant. You’re their emotional and spiritual leader. Lead them and when they make a mistake let them fix it with your guidance. Don’t jump on the line and push them aside. There is a difference between working in your business and working on your business. Your job is to work on the business managing cash flow, reviewing reports, analyzing and strategic planning to grow your business.

What’s next?

In any business there are advantages and disadvantages and contrary to popular belief, restaurant failures are more related to unpreparedness of the operator, lack of understanding, and not having enough cash to weather the first 6 months to a year of slow business. Before going out an opening a restaurant it’s important you educate yourself on the actual business of running a restaurant. You may be a brilliant brain surgeon or rocket scientist, but nothing will prepare you for the daily stress of running a restaurant.