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The #1 Business I Would Never Own
And the four reasons behind it
Buying a business is honestly a great feeling but also an incredibly scary one. Obviously, there are people more passionate about certain areas of business than others and that’s what could make them great owner/operators.
However, there’s one business that in theory I would love to own but I know I never will. Not because of market dynamics but purely by choice.
The #1 business I would never own is 🥁🥁🥁…….restaurants.
Don’t get me wrong I love going out to eat and trying new foods and cuisines from different parts of the world. It’s a great feeling. But just because it’s a great feeling doesn’t mean that it makes sense.
I mean, the stats for starting a restaurant are pretty terrible. The failure rate is at 60% in the first year. And 80% of restaurants don’t make it past year 4.
Additionally, most businesses typically sell at a multiple to cash flow between around 2-4x, excluding software/internet companies.
Restaurants, however, don’t always fit that bill. Giving some examples below, some trade below even 2x cash flow and even worse, 1x cash flow.
This is not a “good deal” because of the multiple but because the businesses come with an incredible number of risks which I’ll explain below.
In general, and I tell this to everyone, you need to figure out the answer to one very important question when you’re looking to buy a business.
That question is, how am I going to or how could I get fucked by this deal?
One way or another, you’re going to get fucked and you need to understand where the weak points are so that you can determine if they’re worth handling.
In restaurants, they’re everywhere. Let me explain first by working backward before I get granular.
Groupthink here, what makes a restaurant successful? I can categorize it into a few buckets that are NOT mutually exclusive.
Consistently great tasting food.
Consistently great service.
Pricing fit for location.
Cleanliness and ambiance.
That’s obviously not all of them but those 5 round out almost everything that it takes to make a restaurant successful.
But here’s the problem with those. They’re all attached to things that I feel are just too difficult for me to want to take the plunge and own a restaurant. Many of these reasons can also be translated into other lines of business so don’t think this is just an isolated list.
I’ve listed them below in no particular order.
Competition is always hard in the food space. It relies heavily on consumer tastes, trends, and cravings that fluctuate on a daily basis. To make matters worse, in a given area there are only so many people that can actually come into your restaurant. Scaling is a problem.
It is just simple logic: a new restaurant in your neighborhood is not giving birth to 100 new customers. It is simply taking away 100 customers from the restaurant next door. But when you have 10 new restaurants fighting for that same 100 customers, you can imagine just how difficult it can get to stay in business!
I don’t want to be at the mercy of consumers’ tastes for the day when it comes to making a food decision nor do I want to be attached to discretionary spending as well.
#2 Food Costs
Food cost weighs heavily on operating expenses and you’re really not in control of much when it comes to that. Food cost generally makes up around 28% to 35% of a restaurant’s ongoing expenses. The cost can also differ based on what type of menu items you plan to serve. For example, a steakhouse may run up to 40% in food costs, while an Italian restaurant may run closer to 28%.
Food costs are volatile. A bad weather event like a hurricane or other natural disaster can quickly throw everything into flux. You’re also at the mercy of trends driving up demand and, therefore, costs. If avocados, for example, become a hot item on the market, you are vulnerable to supply-and-demand issues, which may drive up food costs.
Vendor relationships are also crucial to keeping food costs low so if you’re not the type that’s good at negotiating, this can really bite you in the ass. And finally, food waste. A difficult balance exists between not having enough of an item and having too much. One study found that 58% of restaurants struggle to manage their inventory properly and end up ordering too much food, resulting in wasting money and food.
Something that as an owner, I wouldn’t want to deal with and actually would feel bad about personally. Spoilage and waste just suck.
Simply, hourly employees are tough to manage for a whole list of reasons. Labor makes up a large slice of operating costs and includes hourly wages, vacation pay, sick days, employee benefits, payroll tax, and more.
Restaurants attempt to keep labor costs at around 25% to 30%. Quick-service restaurants are at the lower end of the range, while casual dining is at the upper end.
But aside from the payroll, you still have to deal with the employees themselves. Calling out sick, not showing up, abruptly quitting, pissing off your customers. For the cooks, if your menu is dependent on skilled labor then you’re kinda up shits creek if they leave or decide not to put passion behind their creations.
We talk about being a strong athlete, and use athletic terms because you have to have the mindset and the physical energy. It's physically demanding. You have to be on your feet and mentally engaged to make the guest happy.
It's the hardest job in the world.
We have 30 people on staff tonight. 30 different personalities. Everyone either had a good day, an okay day, or a sh*tty day. We're about to open up the doors and say hello to 200-250 people all in the same boat. It's show business every day. It's playoffs that never end. It never ends. It's the Super Bowl every day.
This applies to most smaller businesses but you don’t want to be at the whim of your employees if you can’t do the job yourself. I.e. if you can’t get back there and cook, perhaps having that employee leverage over you might not be the best especially when you have bills to pay.
The headaches and drama with managing different staff levels just aren’t worth the squeeze to me.
#4 Quality Control
This one is easy in practice but tying it back to your employees, it can be one that can go south quickly. This means keeping the restaurant clean with no dust, trash, or anything that’s not supposed to be there from being there.
The quality of service is important as well. Greeting customers quickly and with a happy personality and that they’re seated and attended to. Something that does matter to many because if people have a bad experience, more often than not they won’t say anything to you and just not come back.
The last portion is with food quality. All food needs to go out perfectly every time or you have the waste that I talked about above or you have angry customers that could leave bad reviews.
Not being mostly in control of all these aspects of quality is tough and something that I know would irk me unless I’m there 100% of the time.
Running a restaurant is hard and I have incredible respect for those who end up taking that plunge. There are just too many factors that can make or break a concept that ironically we all need in order to survive.
There’s a fun fact about the restaurants in NYC. It’s said that you can eat at a different restaurant for every meal for the rest of your life and never come full circle. That’s because so many open and close that it’s impossible to complete that task.
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Until next time,
Paul Cerro | Cedar Grove Capital
Personal Twitter: @paulcerro