A Guide to Restaurant Loans: Start Ups & Small Businesses

Few people can finance a restaurant using nothing but their savings or loans from family and friends. Restaurant loans for start ups potentially require six-figure sums, particularly if constructing a restaurant from scratch.

Understanding how to get a loan to start a restaurant requires exploring the various financing options available to you. Your eligibility largely depends on how much you want to borrow, your credit rating, and the size of your down payment.

Let’s examine how to get a loan to open a restaurant and what you can use it for. 

Types of Start Up Restaurant Loans

Before choosing the right loan to start a restaurant, it’s vital to form a complete business plan. Every lender will want to see that you have put serious thought into the amount of money required, what you will use the money for, and your financial projections for those initial three to five years in the industry.

Several factors go into choosing the right start up restaurant loans, including down payments, interest rates, and collateral requirements. Here are three of the most popular restaurant loans for start ups.

Traditional Commercial Loan

The traditional way of obtaining financing for a restaurant is to approach a bank. Bank loans give you access to large amounts of financing, but the application process can take up to six months. Moreover, you will need a high credit score to get approved for these loans.

Commercial loans from banks are characterized by their lower interest rates, which will reduce your monthly repayments. Banks will offer short and long-term loans. The latter, however, is a risk because there are so many unknown factors involved in starting a restaurant.

Banks may request collateral to qualify for these loans, including your home, a vehicle, or even assets from an existing business. If you qualify, traditional commercial loans are helpful, but these lenders are inflexible and unlikely to form an accommodating relationship if you require that extra flexibility.

Pros

• Lower Interest Rates – You can find loans with interest rates as low as 6%.
• Higher Capital – Smaller lenders may not provide you with the capital you need to cover all your expenses.
• Reduced Monthly Repayments – Bank loans often have terms ranging from three to ten years, allowing you to repay smaller amounts over a more extended period.

Cons

• High Credit Score Requirements – Entrepreneurs without a stellar borrowing history may struggle to meet the higher credit score requirements levied by banks.
• Long Application Period – Be prepared to wait up to six months to receive a decision on a loan application.
• Collateral Requirements – Banks will usually ask you to put up personal assets as collateral, meaning if the restaurant fails, you could lose your home.

Business Line of Credit

The easiest way to view a business line of credit is like a credit card. If you’re approved for a business line of credit, you will have a specific amount to work with. For example, if you receive a business line of credit valued at $50,000 and only use $10,000 during your first month, your repayments will be based on the $10,000 borrowed rather than the $50,000 maximum.

Furthermore, these financing options are revolving, meaning you can borrow, pay the amount back, and then borrow again. These are excellent financing options for covering those ongoing expenses.

Interest only begins accumulating once you actually spend the money. Plus, the interest only accumulates on the amount borrowed. It’s a far more flexible way of borrowing to fund your restaurant than a classic term loan. Borrowing amounts are lower than term loans, and interest rates will also be higher.

Pros

• Flexibility – You only pay back what you borrow. There’s no obligation to spend any of the money as part of your business line of credit.
• Revolving Loans – Every time you pay down your balance, money becomes available to be used again.
• Improve Cash Flow – Business lines of credit are excellent options for improving your cash flow since you can instantly borrow without prior approval after the lender accepts your initial application.

Cons

• High Interest Rates – Lenders will typically charge higher interest rates than traditional commercial loans.
• High Lending Standards – Getting approved for a business line of credit typically has a higher bar than other forms of financing.
• Low Capital Amounts – The maximum amount you can borrow is much lower than with other restaurant loans for start ups.

Small Business Loan

Specialized small business lending options are available from most national and regional banks. Banks can offer these loans through partnerships with the U.S. Small Business Administration (SBA).

The SBA is a department of the Federal government dedicated to supporting small businesses across the country with financing. To encourage commercial lenders to give smaller companies a chance, they guarantee a portion of the loans offered, thus reducing the risk accrued by lenders.

There are several SBA programs available, but you want to look into their Guaranteed Loan Programs for restaurants. SBA guidelines ensure that even if a borrower defaults, they will guarantee the repayments, thus eliminating the lender’s risk.

Small business loans require a lower credit score than conventional loans. Most of the time, your credit score can be as low as 650, and you’ll still qualify. You can benefit from lower interest rates and smaller down payments if you are eligible.

Conventional loans may require a 20% down payment on your business, but this requirement is usually waived with many of the SBA’s loan programs. However, if putting down a smaller down payment, you will still be expected to put up collateral to secure your restaurant start up loan.

Pros

• Lower Interest Rates – The SBA aims to take the strain off small businesses by encouraging lenders to lower their interest rates in exchange for guaranteed repayments.
• Borderline Credit Scores – Unlike other loan types, you can qualify even if you have a borderline credit score. This is ideal for entrepreneurs with average credit scores.
• Lower Down Payments – Rather than putting up a high down payment, you can put down some collateral instead.

Cons

• Harder to Qualify – The SBA only gives out a limited number of loans. The qualifying requirements are more stringent than other restaurant funding startup options.
• May Require Collateral – In some cases, you may be required to put down your personal assets as collateral, meaning they will be at risk.
• Long Application Periods – Small business loans often take longer to qualify for because of the multitude of requirements involved.

What Can Start Up Restaurant Loans Be Used For?

The startup costs of establishing and running a restaurant can quickly run into six-figure sums. Obtaining a loan to open a restaurant gives you the capital necessary to get your business off the ground.

In this section, you will learn about some of the most common use cases for your loan.

Commercial Lease

Most startup restaurants choose to rent a location as opposed to buying. Your commercial lease is your monthly payment to secure your commercial space. When opening your restaurant, you need to balance your decision based on the amount of foot traffic available, accessibility, and the asking price.

Restaurant Insurance

A comprehensive restaurant insurance policy is essential to protect your venture from losses that may occur because of doing business. Your insurance policy covers you against employees being injured on the premises, property damage, and lawsuits.

License Fees

Most states have specific licensing fees for your restaurant’s various activities. The most common licenses include general business licenses, Food Service Establishment Permits, and liquor licenses.

Staffing Costs

Even if you start with a small team, you need the capital to cover their salaries and any workplace benefits you choose to offer. Tipped employees are paid at a lower minimum rate, whereas non-tipped employees, such as kitchen staff and cleaners, will need to be paid the state minimum wage.

Kitchen Equipment

Unless purchasing an existing restaurant, you’ll need to buy kitchen equipment. These are usually the first costs incurred by restaurants. The cost of commercial kitchen equipment varies depending on the type of cuisine and the size of your kitchen. Since kitchen equipment is so critical, you should have already costed up commercial kitchen equipment as part of your loan application.

Beginning Inventory

Inventory will include everything from furniture to dishes. Additionally, you’ll need to create a small working menu and purchase the necessary food items to execute that menu. In the initial growth stages, restaurants often choose a limited menu filled with signature dishes.

Working Capital

Your working capital is what you need to cover your operating costs. When taking out a loan to open a restaurant, begin by budgeting for six to twelve months in operating expenses. Working capital will cover the daily running costs of your restaurant, regardless of how many customers come to eat.

Marketing Capital

Launching a new restaurant is a challenge due to how competitive the market is. The most effective form of restaurant marketing is word-of-mouth marketing, but this takes time to generate. Initially, you’ll need to focus on traditional marketing techniques, such as handing out fliers, newspaper ads, radio spots, and social media advertising.

What You Need to Get a Start Up Restaurant Loan

Securing a loan for a restaurant start up begins by getting your affairs in order. Unlike applying for a personal loan, restaurant loans for start ups are more in-depth. The lender will want to see that you’re not just a reliable borrower but have a solid business plan.

Lenders focus on the level of risk involved when assessing an applicant. Your application will undoubtedly be rejected if the risk is deemed too high. Preparation is essential for increasing your chances of being approved for a loan. Here’s what you need before applying.

Loan Application

Lenders will have different systems for applying for a business loan. Most lenders will include the guidelines on their website for what needs to be included. You can also use online loan templates to provide structure to your application.

Consider including a table of contents within your application to allow for easy navigation. Little touches like these make you look more organized and create the right first impression.

Personal Background and Financial Statement

These documents reveal your personal history and your financial history. Remember, since the business hasn’t yet been formed, the lender is basing their decision on you and how you’ve handled debt in the past. Proving that you know how to manage debt and have experience handling money responsibly is an excellent first start.

Profit and Loss Statement

Creating a profit and loss statement for a new business may seem impossible, but every lender will require one. Your figures will be based on your projected figures. Lenders want to get an idea of what your accounts will look like.

Projected Financial Statements

Lenders want to know the answer to one question: how are you going to create a successful restaurant? Produce a one-year projection of your income and the restaurant’s finances. The critical point of your projected financial statements is to keep them realistic. 

Lenders will also ask you to provide a written explanation regarding how you plan to achieve that projection. An example of an explanation could include opening up a concept restaurant or providing a type of cuisine that the local market has yet to cater to.

Ownership and Affiliation Documents

Ownership and affiliation documents are statements of any other companies you own, partially own, or have a controlling interest in. It also goes as far as stock ownership, mergers, and even business franchises. If this is your first foray into business, you simply need to state that you hold no interest in other companies.

Business Certificate

Ensure you already hold a valid business certificate to do business in your state. No lender will authorize a loan if you have yet to be approved to start your business. The expenses relating to obtaining a business certificate must be covered out-of-pocket. Moreover, you should submit the original certificate rather than a copy.

Loan Application History

Include your history of applying for past loans. Entrepreneurs with experience obtaining and paying off business loans will automatically hold an advantage over someone with a blank financial history.

Personal Finances

You should submit a signed and notarized copy of your last three years of Federal income tax returns. If you already run a business, you should also provide tax returns for that business over the previous three years. Include your personal resume and the resumes of any business partners you may be working with to give the lender an overview of who will be operating the restaurant.

Business Overview

Finally, you should include a business overview. Think about what your restaurant is all about and its story. It should only be a few paragraphs and carefully detail what you need the money for. There’s nothing wrong with saying you need the loan to cover its startup costs in its entirety.

How to Get a Loan to Open a Restaurant

It’s important to understand that getting a loan for a restaurant start up can be challenging. Lenders are naturally reticent about lending money to people in an industry that is universally perceived as volatile. Failure rates are high, hence why lender requirements are more stringent than in other sectors.

Assuming you have already gathered your documentation, here’s a basic step-by-step guide for getting a loan to open a restaurant.

Step One – Find a Lender

The first step is to find a lender that suits you. You’ll weigh up the different restaurant funding startup options outlined above and determine which one works best for your business plan. For example, many business owners fail to qualify for traditional commercial loans, but they may be eligible for a startup loan backed by the SBA.

It’s strongly recommended that you avoid entering into any agreements until you receive authorization for your loan. Failing to qualify for faster financing options could mean putting your plans on hold for several months. Create a shortlist of lenders you will apply to and don’t put all your eggs in one basket.

Step Two – Determine Your Eligibility

Before applying for a loan, make sure you qualify. Lenders will always make their criteria available on their websites. Some examples of essential points to focus on include:

• Time in Business – If your restaurant is already open, you will need to have been in business for at least a couple of years. However, if you have relevant industry experience, you may already qualify.
• Personal Credit – Your personal credit score will be used to approve or deny your application. SBA loans require just borderline credit scores, but traditional commercial loans will have a higher bar to cross. Most lenders will also automatically deny loans to those with a history of delinquency or bankruptcy.
• Collateral – Not all loans need to be completely collateralized, but most do. If you have collateral, including personal assets, lenders will typically ask you to guarantee the loan personally.
• Down Payment – Like a mortgage, you will need to come up with some form of down payment. SBA loans can be as low as 10%, but many lenders may ask for up to 30% in the form of a down payment.
• Commercial Real Estate – If you’re using your loan to finance a commercial real estate purchase, the property must be at least 51% owner-occupied.

The most important thing is that you take the time to investigate the lender’s requirements — there’s no point in applying for a loan you don’t qualify for.

Step Three – Create Your Business Plan

Your business plan is the crux of any application for a loan for a restaurant start up. Several aspects make up your business plan, including:

• Market research
• Your sales strategy
• Personal background
• Restaurant background
• How much financing is needed
• What you will do with the financing
• Financial projections covering three years

You will find plenty of templates online to create an organized business plan. The chances are your lender will grill you on your business plan, so make sure you’re ready with well-prepared and thoughtful answers. Additionally, try not to be too ambitious with your business plan. Unrealistic projections will only see your application being turned down.

Step Four – Submit Your Application

Now that your documentation is in order, it’s time to submit your application. Each lender will usually have its own process for applying. If you’re applying to a local bank, you may choose to visit them in person. Alternatively, you can send your application online. Lenders may even have a dedicated online platform for business loans.

Once you’ve sent everything, all you can do is wait for them to get back to you. Be prepared to supply any additional information they request promptly.

FAQs

Negotiating the pitfalls of the restaurant loan application process is a challenge for newer entrepreneurs. Here are the answers to some of the most common questions regarding restaurant loans for start ups.

Why is it harder to secure financing for a restaurant?

There’s no getting around the fact that getting a loan to launch a restaurant is more arduous. Failure rates are high across the industry, and the restaurant business is notoriously volatile. Lenders have often turned down applications for these reasons alone. However, it’s becoming easier to get loans for restaurants due to alternative merchant funding services like L3 Funding.

How much is an SBA restaurant loan worth?

The SBA backs loans for both new and existing restaurants. How much a loan is worth to you depends on the program. Microloans offer up to $50,000 in financing. Applying for an SBA 7(a) loan, on the other hand, could provide you with up to $5 million in capital.

What’s the right amount of capital to apply for?

There is no one-size-fits-all answer to this question, as the amount will depend entirely on what you need from your loan. You don’t want to borrow too little, and you don’t want to borrow too much. It all goes back to the importance of your business plan. To maintain your cash flow, come up with realistic projections and aim to cover six to twelve months of operating expenses.

Could I lose my personal assets if my restaurant fails?

Short answer: yes. Lenders will ask for some form of collateral, whether a home, a car, or another business. Your personal assets will be at risk, so it’s essential to think carefully about your restaurant idea before applying for funding.

Find Your Funding with L3

Restaurant loans are critical to starting a new eatery in your hometown. This is an ultra-competitive industry with an extremely high failure rate. Before moving forward, make sure you craft your business plan and get expert advice on your business concept.

At L3 Funding, we support entrepreneurs in launching their restaurants by securing the funding they require at competitive rates. If you’re ready to make your dream restaurant a reality with reliable merchant funding, get in touch with L3 Funding today.