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Starting a restaurant? 8 key points

By Mary Crane Maureen Farrell, Forbes
August 09, 2007 13:54 IST
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Being a restaurateur is a sexy idea--until you realise how hard starting a restaurant really is. Soon enough, questions will be flying like grains of sea salt. What permits do you need? What are your start-up costs? Where should you buy your produce? What corporate structure should you choose?

Taken together, the following answers to eight fundamental questions will give budding entrepreneurs a head start on making those first critical steps.

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What corporate structure should I choose?

You have five basic choices: a sole proprietorship, a partnership, a limited liability company or a corporation--either an S corporation or a C corporation. Restaurants--and most small businesses, for that matter--should choose an LLC structure.

Setting up an LLC protects you from personal liability. (If a customer suffers an allergy attack from your food, the lawyers can't go after your house.) Unlike with sole proprietorships and partnerships, only the amount of money you put into an LLC is at risk.

If you plan to open up a chain of restaurants, set up a separate LLC for each location, says Stan Smith, an attorney with Womble, Carlyle, Sandbridge & Rice. That way, in the event of a lawsuit, only an individual restaurant's assets are at risk.

Corporations limit your personal liability too, but LLCs have additional merits. For starters, LLCs are simpler and more flexible. Unlike both types of corporations, LLCs don't require a board of directors, shareholder meetings and other managerial formalities.

Better yet, LLCs allow entrepreneurs to divvy up profits any way they choose, as opposed to shareholders in corporations, who have to carve them up in proportion to their percentage ownership in the company. That's a nice benefit, given the inherent risks of running a restaurant. With an LLC structure, restaurateurs can entice investors or employees with a share of the profits--even if those people didn't pony up their own equity in the beginning.

Another advantage with LLCs: tax-treatment flexibility. An LLC's profits can be taxed as a corporate entity (a C corporation) or as a "pass-through" entity (an S corporation), meaning that the company avoids paying taxes on both corporate profits and the owners' personal income. Most LLCs choose the pass-through option.

What is the biggest external threat to my business?

No, it's not the industrial-strength Applebee's or Ruby Tuesday moving in down the block. (If anything, they help drive traffic to your joint.) The biggest threat is the lack of capable--and affordable--workers.

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For all the talk about the US becoming an overly service-based economy, there still will be plenty of restaurant jobs to fill. While nearly 13 million people now work in the restaurant industry, analysts estimate that restaurateurs will need to add some 2 million jobs over the next decade--even as they cope with minimum-wage hikes and stricter immigration regulations.

In 2005, just 1.9 million people--or 2.5 per cent of all hourly paid workers--made less than $5.15 per hour, according to the US Bureau of Labor Statistics. But 75 per cent of those 1.9 million are employed in service occupations (many in food preparation), and by 2009 their services will run to $7.25 an hour.

As for immigration reform, if hardliners in Congress have their way, it will be harder for foreign-born workers to enter, live and work in the US. Restaurateurs lean on a large number of foreign-born workers--both in-house and indirectly via their suppliers in agriculture. According to the Pew Hispanic Center, nearly a third of the country's estimated 12 million undocumented workers hold jobs in the service industry.

What piece of technology can I not do without?

Tasty fare will only get you so far without timely, accurate service. The latest generation of software-based, point-of-sale systems from Micros Systems and Radiant Systems can help you cater to even the fussiest of customers.

Micros offers two basic point-of-sale systems, depending on the size of your restaurant. On the low end, there's the Micros e7, targeted at smaller eateries grossing under $1 million annually. A middle-of-the-road package runs $7,000 and includes two touch-screen workstations equipped with point-of-sale software that allows servers to enter customer orders that get transmitted to printers in the kitchen. The printers are also included--along with a couple of cash drawers, credit-card processing and about two days' worth of employee training.

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A more upscale package--the Micros 3700, for $12,000--comes with three touch-screen workstations, printers, cash drawers and credit-card processing, as well as nifty software that can track inventory turnover rates, schedule employee shifts and process customer loyalty cards. It even syncs up with accounting software, such as Intuit Quickbooks.

Both systems' workstations run on Microsoft Windows CE .NET platforms. The software is scalable too: More touchscreen stations can be added as the restaurant grows or locations are added.

Micros knows good help is hard to find, which is why it also sells hand-held point-of-sale devices for servers who can't make it from the table to the workstation without forgetting an order. Don't want order printouts catching fire or ending up in the soup? Try a Kitchen Display System, which includes monitors that display orders prioritized according to cooking time. The price is about 15 per cent more than plain old kitchen printers.

What are the three most important performance metrics?

Accounting profits are nice, but for budding restaurateurs, cash flow--which tracks the actual dollars moving in and out the door--is more critical. Cash flow should be monitored monthly--even weekly--rather than quarterly, like net income.

That's because most restaurants are very cash-intensive, forking over money for fresh inventory and tipping out servers and other staff on a daily basis. Good restaurants also constantly tweak their menu choices, and tracking those effects requires constant vigilance.

Another important measure: the percentage of repeat customers. The National Restaurant Association estimates that three-quarters of most restaurants' sales come from repeat customers. The most successful restaurants aim to get at least 60% of their customers to visit their restaurant once a week, says Louie Psallidas, senior vice president of finance for Papa Gino's, a New England pizza chain.

The added payoff: Your marketing budget is only so big, and happy customers are the cheapest way to get the good word out. Regulars are also more likely to offer constructive feedback on the menu and customer service than one-time patrons. Listen and learn.

Finally, mind your staff turnover. On average, management turnover rates run around 20 per cent annually for table-service restaurants, while hourly workers turn over at roughly a 150 per cent clip. No matter how delicious the food or generous the cocktails, abrasive or flaky servers and bartenders can botch the whole dining experience. Treat the good ones well, and they might stick around.

How much will I need to shell out in start-up costs and ongoing expenses?

After you snare the right permits, decide whether to start from scratch or fix up an existing eatery. Depending on how fancy your new place is, a blank-slate approach will set you back $100,000 to $300,000 for stuff like industrial cooking and ventilation equipment, refrigerators, freezers, tables, bar stools, shelving and counters with stations for cutting, heating and cooling.

Renovating an existing restaurant with a similar concept will cost less, though the rent may be comparatively higher because the value of the previous build-out is already baked in.

Unless you're starting an old-fashioned diner that runs on grease-stained order slips, you'll also need a point-of-sale system to collect money and manage the floor and the kitchen. These systems also will allow you to accept credit cards, but in order to get your money from Visa and American Express, you have to set up an account with a processing middleman such as Heartland Payment Systems. (Commissions run 1.8 to 2.5 per cent of sales.)

And don't forget the little things, like an eye-catching outdoor sign, menus and triplicate china, glass and linen sets for every seat in the house.

As for ongoing expenses, the cost of goods sold (food) will be the main course: 25 to 40 per cent of revenues, depending on the restaurant concept, says Peter Ryan at Restaurant Solutions in Myrtle Beach, S.C. (Pizza joints will be on the low end, steak houses on the high end.) Payroll will gobble an additional 20 to 25 per cent; rent should eat 8 per cent. After marketing, payroll and taxes, if you end up clocking 5 per cent profit margins, pat yourself on the back.

One last move: Even if you don't need it, open a line of credit with a local bank. The track record you establish will come in handy when you're ready to open your next restaurant--and the ones after that.

What permits do I need to open a restaurant?

Depending on the location of the business, you will have to file articles of incorporation or organization. (Approval is quick.) Once established, you'll be able to secure a Federal Tax Identification Number, which registers your business with the federal government so Uncle Sam can take his cut.

The next step: more paperwork. First, your physical space must meet all the local zoning laws governing restaurants. Then, once you install all your equipment, you have to pass muster with the local department of health services or a related restaurant regulation agency. (The governing bureaus vary state to state.)

While these permits run less than $100, you might wait nine months for acceptance. The extensive application and inspection process includes documentation of counter space (regulators don't want raw meat mixing with the lettuce), kitchen equipment and ventilation systems. You may even have to supply a menu.

Most states also require the owner (and perhaps the manager and the chef) to take a one- to two-day course on food safety for around $100. If you make it that far, you then have to schedule an appointment with the local fire inspector.

If you're serving alcohol, you will need a liquor license, of course. (Rules for these licenses vary by municipality.) Liquor licenses sold directly through the local alcohol bureau can cost from a few hundred dollars up to about $10,000.

In some cities like Boston, where the number of licenses is capped, you might pay in the hundreds of thousands of dollars in the secondary market. A local community board may have a say in the proceedings as well. Bottom line: Allow plenty of time to get those permits.

How do I choose suppliers for my restaurant?

Finding food and liquor suppliers is easy; sizing them up is trickier. Price is important, of course, but so are quality and safety.

Depending on your location, you might have up to 20 suppliers of fresh foods (meat, fish, produce and dairy products) to choose from. Some specialize, while others sell the works. There is no rule of thumb for which group to choose, but nearly all are small, local distributors.

To keep costs down, owners of larger restaurants might try pitting fresh-food vendors against one another. Rather than calling each one separately, have vendors fax their prices on a weekly basis, suggests Ron Yudd, a restaurant consultant and former director of food service for the US Senate.

Smaller joints (90 seats or less), on the other hand, might be better off sticking with a smaller, regular pool of suppliers.

When weighing fresh-food vendors, ask to tour their facilities and see their handling practices, says Yudd. Pay special attention to the freshness and packaging of seafood. One bad order of mahi-mahi can filet your reputation.

On the "dry goods" side (everything from pasta to paper products), Sysco and US Food Service dominate the landscape. (These behemoths supply kitchen equipment too.) Here you're buying primarily on price and reliability. The same goes for liquor, but unlike dry goods, booze tends to be sold through small distributors. Try to stock just two weeks' worth of dry goods at any one time. Any more and you're letting money rot on the shelf.

Which big company is the ideal role model?

While there are some 660,000 independent restaurants in the U.S., each with its own menu, strategy and clientele, all have something to learn from Starbucks. What began as a small coffee shop in Seattle's Pike Place Market is now an international mega-brand, with nearly $9 billion in annual revenue and more than 12,000 retail outlets worldwide. And for what? Selling cups of consistent--if richly priced--coffee.

Starbucks takes pains to craft its image--coffee isn't just a wake-up call these days, it's a lifestyle--and even do some good. (The company uses cups made out of recycled paper, for example.) Smaller restaurateurs can send their own do-good message--say, by volunteering food for local events.

Starbucks' domination also hinges on how it treats its employees, who, as in all restaurants, are the real face to customers. For example: Health benefits are available to any Starbucks employee who works at least 20 hours a week and has been with the company for more than 90 days. If you can't stomach that, there are other, more affordable perks, such as offering the chance at a managerial position or even a tasty slice of equity.

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Mary Crane Maureen Farrell, Forbes

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