Reduce the Risk
of Opening a New Restaurant
For anyone evaluating the
feasibility of opening a new restaurant, whether it’s your first
or your hundred and first, there’s one key financial factor that
points to success or failure in this business probably more than
any other. It’s referred to as the sales to investment ratio. That
is, how many dollars of annual sales can you reasonably expect a
proposed restaurant to generate for every dollar of invested
capital it will take to take to open it.
The sales to investment ratio is
calculated by taking the projected annual sales of a proposed
restaurant and dividing it by the total projected startup
investment required to open the restaurant and get it operational.
you go into a new venture expecting to do
$1,000,000 a year in sales and instead do
$600,000, chances are you’re DONE, out of
business, with little or no chance of turning it
|-- Jim Laube
As the sales of a new restaurant
increase relative to its startup investment, so too increase it’s
chances for profit and financial success. It’s no secret that the
chain restaurants with the highest sales to investment ratios are
consistently among the industry’s most successful profit
Two Main Restaurant Structures
There are essentially two ways to
structure a new restaurant venture in terms securing the capital
assets required for operation. The most widely used method is to
obtain the use of a building space by leasing a facility from an
unrelated third party. The other option is to directly, or
indirectly through an affiliate, purchase the land and develop the
physical structure or buy the land with a building already in
First, we’ll examine a leasehold
scenario. When deciding on the feasibility of a restaurant venture
that will be operated in a leased facility, start by calculating
the total projected startup investment. This would include the
cost of the leasehold improvements, furniture, fixtures and
equipment, utility deposits, soft costs like architectural,
design, legal and accounting and startup costs including opening
labor, training and inventory. It’s also good to include a 10% to
15% contingency for change orders, cost overruns and a working
capital reserve for operating losses for the first 3 to 6 months
after opening. Here’s a summary of the major cost categories
usually included in the startup investment in a leasehold
For purposes of calculating the
sales to investment ratio include the cost of “all” the assets
regardless of how they will be financed.
The next step is to estimate the
annual sales volume of the proposed restaurant. A logical way to
do this is to begin with the days of the week the restaurant will
be open and estimate the table turns or number of customers you
expect to serve during each meal period. One of the best ways to
do this is to spend time during several meal periods on different
days of the week in existing restaurants in the market area of the
proposed restaurant. Find out what meal periods and days are the
busiest, which days and shifts have the longest wait times and
when it’s slow. Also, find out when the slowest and busiest times
of the year are.
To save time and get loads of
valuable information, make a point of introducing yourself to the
managers in these local restaurants. Use some tact and diplomacy
and they will probably tell you everything you want to know.
I’ve often had managers, and even owners, tell me in vivid detail
about their sales volume, when they’re busy, slow and how they’re
doing this year compared to last. I’m constantly amazed about
what other operators, even potential competitors, will tell you
when you’re face to face and just ask them questions about their
Below is an example of a
worksheet I’ve used frequently to make a more systematic and
logical estimate of the sales volume in a proposed restaurant.
Yes, this does take some time and it’s only as good as the
assumptions you make, but, going through this type of detailed,
fact finding exercise now can save you loads of heartache and
despair down the road.
Estimate the number of customer you expect to serve at each meal
period in a typical week.
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Restaurant Startup & Feasability Spreadsheets
Again, it's important to find out
how many customers similar restaurants in your market area are
serving during these meal periods while taking into consideration
seating capacity as well. Taking the time to do this will
dramatically enhance your understanding of the local market and
improve the quality of your sales projection, which is a
“critical” component of your prospects for success.
Enter the customer counts for each
meal period along with an estimate of the check average. This will
help you determine an estimated sales volume for a typical week as
in the worksheet below:
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Startup & Feasability Spreadsheets
To get an annual sales amount you
can multiply this number by 52 weeks or you can go one step
further and do a weekly sales projection for a week during the
peak sales season, another for the slow season and a third for a
moderate or middle of the road week. Then estimate the number of
weeks for each of the three periods (peak, slow & moderate) and do
the math to arrive at an annual projection.
In the restaurant business,
success or failure hinges almost entirely on one number “SALES”.
If you go into a new venture expecting to do $1,000,000 a year in
sales and instead do $600,000, chances are you’re DONE, out of
business, with little or no chance of turning it around. Take the
time to run the numbers BEFORE you commit to a specific location.
Make sure you can justify just how you’re going to get to that
$1,000,000, or whatever, a year in terms of customers, check
averages and average weekly sales.
From my experience, this
approach works 100 times better than just pulling a sales estimate
out of the air. Not only will this method impress your banker
and potential investors but, most importantly, it will give you a
much better basis to evaluate whether or not you should move
forward on a particular location or not. Making a bad decision at
this stage of the opening process often leads to a business
venture fraught with red ink and failure. Don’t pull the trigger
on a location until not just your gut, but also “the numbers,”
point favorably to a good chance of profit and success.
With a reasoned and systematic
estimate of the annual sales volume and startup investment you can
use the sales to investment ratio give you the benefit of some
reliable restaurant industry benchmarks and rules of thumb.
Based on being privy to over 100
startup ventures over the past 10 years, my sense is that a sales
to investment ratio of 1.25 to 1 is too low and I would advise
against moving forward on this particular location given the
amount of investment required and the projected annual sales
My rationale is this: Say, the
development of this restaurant went forward and the startup costs
came in at exactly $800,000 and the restaurant actually generated
sales at the rate of $1,000,000 per year. Even if the operator did
better than most restaurants, and netted a bottom-line net income
of 10% or $100,000 a year, at that rate it would take at least “8
years” to recoup the $800,000 investment (actually longer if we
considered income taxes). To me, that’s too long to have your
startup capital at risk in any restaurant venture. The goal should
be to recoup all the initial investment in half that time or four
years, at most.
A reasonable rule of thumb when
evaluating leasehold ventures is to expect a minimum sales to
investment ratio of 1.5 to 1. And that’s a minimum. I believe it’s
prudent to set a 2 to 1 or higher sales to investment expectation
in a leasehold case.
Something else to keep in mind in
a leasehold venture is the rental rate on the facility. Even if
the sales to investment ratio looks good, also make sure that the
annual lease payments do not exceed 6% of your expected sales
volume. Some landlords have been know to give generous build-out
allowances (which lowers the startup investment) to entice
restaurant tenants, only to jack up the rent to an excessive
amount. Another rule of thumb: Don’t sign a lease where your
monthly building rent is in excess of 6% of your expected sales
volume. Once rent starts to exceed 6% - 7% of gross sales it
begins to seriously erode your chances of making an adequate
Case in Point: Leasehold
Most, if not all, national chains
use the sales to investment ratio or some variation of it to
evaluate specific sites they’re considering for expansion. Here’s
how a successful national steak chain uses this ratio.
This operator invests around
$1,200,000 to open new restaurants in leased locations. They
expect to do at least $3,600,000 in annual sales which gives them
a very healthy sales to investment expectation of around 3 to 1.
This chain’s entire site
selection philosophy is influenced by the sales to investment
ratio. They often pass on high traffic corners and highly visible
sites because they reason that the added cost of acquiring those
locations won’t result in proportionately higher sales. Instead,
they often seek out class “B” locations in class “A” markets to
obtain lower startup costs and rental rates that will enable them
to maintain their high sales to investment ratio goals. This
mindset has paid off handsomely as they are consistently one of
the most profitable companies in our industry.
Purchase Land & Building
While not as common as leasing a
building or space from a third-party landlord, many restaurants
are operated in facilities where the owner/operator also owns the
land and the building.
In these situations, the startup
investment would include all the development and startup costs
noted in the leasehold situation above except the cost of the land
and building would be substituted for the cost of the leasehold
improvements. Again, forget about financing when calculating the
sales to investment ratio. Include the cost of all the assets
regardless of how they are to be financed.
The annual sales volume would be
projected in the same manner as noted in the leasehold scenario
In ventures where the land and
building are owned by the operator, the sales to investment ratio
can be lower than in a leasehold situation and still make good
economic sense. In fact, the sales to investment ratio can be as
low as 1:1. Personally, I advise my clients to expect a minimum
1.2 to 1 sales to investment ratio in ventures involving the
acquisition of land and building but some might interpret this is
as being a little too conservative.
Acquire Land & Building Example:
Assume we estimated the total
startup investment of a proposed restaurant where the operator
will also control the land and building to be $1,500,000 with a
projected annual sales $2,000,000. This would yield a projected
sales to investment ratio of 1.33 to 1.
Provided, of course, our cost and
sales projections were reasonable, on the basis of sales to
investment, I would conclude that this venture show positive
economic potential and should be considered further.
You may be wondering why the
sales to investment ratio can be lower when the operator owns the
land and building versus leasing a facility. One way to look at
this is to consider the residual value of an operator’s startup
investment six months after a restaurant opens and then fails.
When this happens in a leasehold venture, much of the startup
investment is lost. Even the value of the hard assets, the
equipment and leasehold improvements, are greatly discounted,
worth possibly pennies on the dollar at that point.
On the other hand, when the
operator owns the land and building, a sizable portion of the
value of the assets remain in tact even if the restaurant fails.
Also, even though the debt service on purchasing the land and the
building may be higher than it would be to rent a similar
facility, part of the loan payments are paying down the loan and
building equity in the venture. And at some point the loan will
most likely be paid off. When this happens it’s like running a
restaurant with no rent.
Case in Point: Acquire Land & Building
According to their annual report
a few years ago, Wendy’s International invests about $1.2 million
to buy the land, build a building and open a new Wendy’s
restaurant. At that time the average Wendy’s did around $1.3
million in sales so their sales to investment ratio was around 1.1
I’m reminded of a comment made to
me by an operator several years ago. He had made a mark on his
local restaurant scene by opening several relatively small, low
investment Mexican restaurants which were very popular and quite
successful. He then stepped out and built a large, magnificently
appointed restaurant in a chic part of town. It was obvious he’d
spent loads of money to open this restaurant.
A few months after it opened, I
was in the restaurant with my wife. We waited nearly 30 minutes
for a table. As we were leaving, I noticed the owner and made a
point of congratulating him on another successful restaurant. He
seemed appreciative but pointedly replied, “It’s great to do $3.0
million in sales . . . but it’s not so great to 'have' to do $3.0
million in sales.”
Opening a new restaurant always
entails risk. You can reduce your risk by carefully projecting and
considering the sales to investment ratio of a proposed venture.
Experienced restaurant startup professionals rely on the sales to
investment analysis before they make any expansion decision. Every
newcomer and even experienced restaurateur should too.
is the founder and
RestaurantOwner.com. He has a diverse 25 year career in the
restaurant business as a server, bartender, restaurant manager,
controller and CFO for a regional restaurant chain. Over the past 15
years, he has been an advisor to literally hundreds of independent
restaurants in the U.S. and Canada primarily on issues dealing with
profit enhancement, financial controls and business management.