Restaurants, bars and bakeries offer extraordinary opportunities for investors, but many perils make investments risky for entrepreneurs or investors who don’t research the concepts, markets and demographic trends of the areas where restaurants operate. Americans spend 48 percent of their food budgets eating in restaurants or ordering take-out foods, and hospitality businesses include upscale, quick-service and middle-scale establishments. Each type of hospitality business attracts different kinds of customers.
Due Diligence for Restaurant Investments
The restaurant business isn’t a cakewalk but a hard-edged investment. Aspiring chefs, bartenders and bakers often concentrate on plying their craft without any business savvy or commitment to costing strategies and marketing. According to a National Restaurant Association and Cornell study, 60 percent of restaurants, bars and bakeries fail within three years. Investing in a single restaurant successfully requires a marketing study, branding research and a detailed business plan. Investors can always choose restaurant ETFs that spread risk among multiple hospitality businesses instead of risking their capital on one facility.
Checklist for Investors
Unsuccessful restaurants and food-and-drink businesses almost never return significant capital, so investors shouldn’t risk more money than they can safely lose. Even buying a successful business requires a feasibility study because changing demographics, mobile marketing, zoning changes, bankruptcies and relocations, and evolving attitudes about food affect business prospects. Considerations of investors should include, but not be limited by, the following factors:
| Topic | Research | Action |
|---|---|---|
| Business Structure | Research the pros and cons of sole proprietorships, partnerships and corporations. | Hospitality businesses choose their business structure based on tax advantages, legal liabilities and control issues. Genuine corporations involve ceding independence, but limited liability corporations protect personal assets while allowing owners to control every aspect of the facility. |
| Concept | Concept involves decor, infrastructure, targeted customers and location. | Choose a restaurant that has a concept that resonates well with the typical customer’s educational background, income and ethnicity. |
| Competitive Environment | Research the restaurants in the area, and study population figures from the Census Bureau. | A greater selection of restaurants splits the pot and reduces gross sales even when more people live in the area. Restaurants in urban areas with 1,000 people per restaurant earn less than restaurants with only 400–500 people in suburban environments. Assess investments by considering these factors. |
| Neighborhood Demographic Profile | Incomes, ethnic backgrounds and education levels of residents and workers in the area determine the best bets for type of cuisine and menu prices. Get information from Dun & Bradstreet. | Rural areas have difficulty attracting upscale clients unless the cuisine and ambience attract tourists and diners from long distances. Upscale areas might enjoy fast-food trucks or respected national chains, but neighborhood burger restaurants face an uphill struggle. Avoid investments that seem unlikely to generate solid backing from typical residents in the area. |
| Future Developments | Check with city planning commissions, local governments and state agencies to assess future developments that might impact a restaurant in positive or negative ways. | Develop healthy skepticism for changes in traffic, disruptive long-term construction and untested zoning change proposals. Don’t assume that new developments will automatically boost sales. |
| Population Trends | Find out how the neighborhood has changed in the past few decades to understand trends. | A fast food restaurant in a gentrifying neighborhood could prove risky, but an upscale restaurant committed to sustainability makes a better bet. Rapidly changing neighborhoods prove risky for any type of restaurant unless costs are low enough to recoup investments quickly. |
| Financial Considerations | Assess restaurants for costs, gross profits, food costs, equipment condition and costs for repairs, redecorating and putting a new style of management in place. | Avoid investments where repair and decorating costs seem prohibitive. Be wary of restaurants that have high food costs and an aging customer base. Plan to operate without significant profits for a year or two if major changes must be made. |
Culinary Investment Tips and Pitfalls to Avoid
People expect great food and service as a given, so restaurants need other creative selling points to bring home the bacon. Every restaurant owner thinks that his or her food is great, but a successful hook gives people a reason to dine that competitors don’t offer. A unique selling point might be 1950s nostalgia, customer accommodation for special diets, fast service of upscale food or ethnic and fusion cuisines. Consider the following warnings before investing in a bar, bakery or restaurant:
- Avoid restaurants with long menus and too many exotic, expensive foods. Even upscale restaurants use the same ingredients in multiple dishes to lower food costs and speed preparation.
- Marketing plans and rewards programs help to sell hospitality services in the digital age, so plan marketing strategy at the same time as vetting a restaurant investment.
- Analyze food costs carefully by determining wholesale costs, waste, portion sizes and labor costs.
- Find out why a successful restaurateur wants to sell a thriving business or impress an investor because there is usually tarnish on the silver.
- Long-standing employee salaries and benefits could make an otherwise attractive investment risky because owners are stuck with things as they are or the uncertain costs of hiring and training new staff.
Restaurant investments are primarily for people who love the industry but understand the risks. Commit to studying each opportunity in a rational, organized way.