The restaurant industry is set to end 2020 with more distressed businesses than it had during the Great Recession, according to an AlixPartners report. As of October, 50% of limited-service restaurants and 63% of full-service restaurants were distressed. Comparatively, at the end of the recession, 33% of LSRs and 17% of FSRs were at risk of not meaning their financial obligations.
"The industry has really taken a beating," Edward Webb, advisory partner at BPM, said. BPM specializes in accounting, taxes and financing. "[For] independents, particularly the smaller independents, it's really been catastrophic."
Traffic in urban centers has largely disappeared, putting businesses that rely on heavy foot traffic in a difficult situation, Webb said.
Now, with PPP loans all but dried up, a new round of COVID-19 restaurant restrictions and little hope of federal aid until January, restaurant owners and operators face a grim outlook. Many will have to consider whether to close their operations for good.
Restaurant Dive spoke with Webb about what restaurant owners need to know when they consider their next steps — whether that means closing down a business, declaring bankruptcy or seeking a sale.
Editor's note: This interview has been edited for clarity and brevity.
INDUSTRY DIVE: What would you tell an owner who might be considering a sale, bankruptcy or winding down operations?
EDWARD WEBB: There are a couple of pretty important steps that they need to go through. One is to make sure they have good, accurate financial information. If they haven't had a good bookkeeping function, or they haven't been able to use an outside accountant, then they need to make sure that their books are cleaned up. There is the immediate cash flow analysis. They need to understand where their cash is, what the demands are short- and medium-term, and then try to ascertain what their sources of cash are. And once that's done, and they've been able to determine how much time is realistically available to them, then they can look at their business model.
They need to ask, "Is the business model that they had previously been operating under effective now?" Assuming that it's not, and it's been negatively impacted by the pandemic, then will it return? Or is there some type of modification to the model that will enable them to become profitable again? And if the answer to that is no, then it really becomes an exercise of what the business owner is looking at. There's an end point to the business and the owner needs to understand how best to enter into that end point. Is it a simple wind down of operations? If there are a lot of creditors out there, if there are leases that are onerous, then that may require bankruptcy. It's driven by the owner's business decision. So they assess the cash, they look at the model, they determine what that next step is and then they figure out what we would call a harvest strategy.
What have been some of the common paths that business owners have been taking as their end strategies?
In situations where the owners can simply wind down, maybe they have a lease that they can get out of, or it's a lease without onerous terms and they're not personally guaranteeing it. If they're able to do that and liquidate their assets, utilize those funds, pay off whatever creditors they have, and basically walk away, that is far and away the easiest, quickest and cheapest path. They will likely need some type of accountant or business professional, and then they'll want a lawyer as well just to make sure that there's no backdoor that somebody can come in and cause problems.
If there are significant liabilities attached, and they really believe they have to protect themselves in bankruptcy, that becomes an expensive and time-consuming process. They can expect it to be a 12- to 18-month process. It's unlikely fees will be less than a quarter of a million dollars and oftentimes more. You really only do bankruptcy in a situation where the personal effect of those liabilities is dramatic. So it's a clearly less-desirable choice.
One thing we haven't seen much of lately — and I would expect that to change in 2021 — is business combinations. In those situations where there's a healthy restaurateur, who sees an opportunity to either expand their operations or protect themselves in some way, maybe they can get a really advantageous deal. We haven't seen many of those primarily because everyone's afraid to move. Everybody's cautious. I would expect that will ease.
In terms of business combinations, what would an owner need to do to make sure they are getting a good deal and finding the right buyer?
If they have been dealing with an external accountant or some type of business manager, who they really like and they trust, that is really valuable. Ultimately, when you're going to bring two businesses together, there has to be the ability to kind of find that common language and bring the financial side of the businesses together effectively. Once a business owner has gotten their act together financially, and they know where they are, and they have a pretty good sense of where they're going, they can turn to a brokerage that can help restaurateurs find other restaurants or investors and assist them to sell the business. It can be expensive and sometimes you need to be pretty careful about the choices that you make with those folks.
Once you have that data, and it's solid, then you have the flexibility to approach the market. When the time comes to actually put the businesses together, you really do need a financial professional. That can be very difficult for a business owner to do because they have a day job of running the business. There are also potential tax implications, licensing and regulations that need to be looked out for, and so they're better served by making sure they got a pro.
What happens if an owner doesn't have the help of a financial professional for a business combination?
One outcome is there's no deal. The acquiring entity just couldn't figure out how to consume the other because they did not have accurate data and they weren't able to comfortably assume those operations. Then another scenario is the entity without good data can sometimes be taken advantage of and they will not be able to strike a good deal. The seller will find themselves in circumstances where the buyers will say, "Hey, we'll still take it off your hands, but we're gonna pay you less because we don't have this information now." That's pretty typical.
What should owners do to make sure the process goes smoothly?
If you have a case where there is a letter of intent, or some type of intent has been indicated, the buyer is going in to perform due diligence. At that moment, if the seller is fully prepared, if they have pulled their financial information together, they have cleaned up their inventory, they have identified their legal contracts, they are able to prove that they're current on taxes, they have their employee records in place, if all of those things are in order, then it obviously makes it a whole lot easier for the buyer coming in. And the buyers are typically going to be a little bit more sophisticated, because they're the buyers. Since they are able to afford it, they will have professionals of their own.
For example, we will do buy-side diligence on behalf of our clients. And when we go into circumstances where the seller is sophisticated and prepared for what's coming, then buy-side diligence can be very quick and relatively painless. Due diligence is never fun, but when a buyer comes in, and they encounter a seller who is ill-prepared to sell, the control of the negotiations subtly shifts to the buyer.
If the buyer and the seller are prepared, they come together and diligence is complete and everybody's satisfied. The nature of the restaurant business is very short cycles. So those tend to be very clean transactions. The issues are more readily identified, and once resolved, they are put to bed.
What do you anticipate we will see with business combinations going forward?
I believe there is going to be continued pressure, primarily by baby boomers who are reaching retirement age, for them to get out. And so they'll keep pushing on that. And if there are easy transitions that can be made with family members, friends, neighbors, anybody, they'll do those deals. I think that there probably, unfortunately, is going to be an increase in the number of distressed situations, in which there are trailing liabilities owners cannot get away from as the impact on real estate is felt more. The commercial real estate business has suffered maybe more than anything. But the banks aren't pushing it right now. They're not calling loans. They're not getting aggressive. When the banks have to begin doing that, then I think there'll be a trickle down effect, which may lead to increased distressed situations.
