Structure for Success!

Structuring your restaurant ownership is a balance of needs, wants, sweat, and cold hard cash. There is no one right formula, and rarely is the formula the same from restaurant to restaurant. In this month’s Enterprise Insight, we discuss some common options, and how to balance your narrative and numbers. Specifically, we will review entities, equity vs. profit distribution, management fees, and valuations.

Entities
Restaurants are most commonly set up as a Limited Liability Corporation. More importantly, though, is to actually set up two: one for the physical location, and one for the intangibles, such as intellectual property. The purpose of this is to balance the equity and access to the brand that an investor group has. For example, if you publish a cookbook with only one LLC—then your investors, who have equity in that LLC, are entitled to a share of those profits. This leads to our second point, equity and profit distribution.

Equity vs. Profit Distribution
The first thing to determine is the ownership interest of the involved parties and how that differs from the profit distribution. As an LLC, which most foodservices enterprises should be, the business can distribute profits differently than the equity is split. This allows an owner to retain a majority stake but pay out his or her investors with an accelerated distribution.

Accelerated returns are common, but they can handicap the enterprise if the operator is left with nothing to help fuel growth. This is part of the reason why we advise owners take a management fee.

Management Fees
As the creators and operators of a concept, owners should consider pulling a management fee from the top line, especially if the concept is or will be multi-unit. This allows owners to accomplish two things: fund the centralized back-office operations and lower his or her risk by not relying on profits for compensation.

This is particularly important for operators with a pre-existing brand or background in the space. These management fees get directed to the holding corporation that we previously discussed. Think of this as protecting the intellectual property and creating a salary for the developer.  Generally, the more an investor wants in equity and distribution, the more important a management fee is.

Valuation
Determining the mix of management fees, equity, distribution, and ownership locations is always murky. Some operators say the idea is worth 33%, the work is worth 33%, and so their sweat equity is worth two thirds. Some operators base the valuation on a multiplier—usually five to six times—of the third year’s EBITDA, usually the year the restaurant hits its stride.

Ultimately, we advise that operators ask two questions: what must prove true, and what happens when? The right formula is based on your needs—what you need to see happen with the business—and your comfort with balancing risk and reward—what you do when the good and bad happen.