Should I buy in? (credit, lending, loans, sales)

[jimj]

I have an oppertunity to buy into a runing bbq restaurant. It has been open for about 4 years and "seems" to be doing ok though I've not looked at the books yet.
The owner is young (about 25 or so) and has made some mistakes causing some cash flow issues that my investment would fix not to mention I'd replace a paid worker lowering overhead. He bought things when he probably shouldn't have and expanded before he really had the cash to do so but at this point he's still making it though it's real tight for him.
We're talking about a $40k investment plus my time and since the 40k is in the market (it was $110k) I was thinking I'd rather bet it on something I control than on something where I'm just along for the ride. I also think that in a good economy there would be no way he'd let me in for that amount but that's my opinion.
I've wanted to open a restaurant for years but just never wanted to take the risk since 90% fail in the first year or two.
I'm retired and don't need the income from the $40k right now but am trying to look to the future. I've been a cook when I was younger, my wife has a degree from culinary school and has worked in several restaurants and my son is in culinary school now so we have some idea of what's involved. I think we could add some wisdom and knowledge he doesn't current have that would benefit this place highly.
Any suggestions?

[8 SNAKE]

What are you getting for your $40k? What are your exit strategies?

I would have every bit of detail for both of these questions completed in writing before investing a penny.

[sunsprit]

I'm baffled here.

You're going to buy yourself a minimal paying job with your $40K investment in a business that you don't know what the financials are, so you don't know what your exposure is, what other "mistakes" the owner made with the business?

Before you can make any decision about a purchase, you need to know the "full story" in the books and what other obligations the owner has in the woodwork. Get an accountant to review what's going on if you don't know how to read a set of books. FWIW, I do ... but just a little; enough to know that if my initial "look-see" looks OK, then I bring in my trusted accountant to really go over the stuff.

I can't tell you how many times books that appeared OK hid major problems and obligations, or when the rumour got out that I was buying in to a business, other folks who'd "bought in" and walked away when they learned the full extent of the financial problems were now on the doorstep looking for their investment back out of the business or their piece of the action from their percentage of ownership. Last one I looked at, the partners (brothers), deeply devout and very pious in their honesty .... had sold 350% of their business to a fair number of investors. They just didn't mention it to the next buyer they were seeking to get money from ... and that was in addition to having sold "exclusive" marketing rights to others in prime territories for the products. I'd of been sued for all the profits if I had tried to sell in the "exclusive" territories ... and the product niches were narrow enough that everybody would have known of my sales. I literally wasted several major business trips to investigate the product, the company, the potential for sales across the USA. Don't make the same mistakes I did ... know exactly what it is you're looking at buying before spending any further time and money, and before you invest.

[oleo]

What a horrible idea.

You have to be absolutely nuts.

[jimj]

Originally Posted by sunsprit

I'm baffled here.

You're going to buy yourself a minimal paying job with your $40K investment in a business that you don't know what the financials are, so you don't know what your exposure is, what other "mistakes" the owner made with the business?

Before you can make any decision about a purchase, you need to know the "full story" in the books and what other obligations the owner has in the woodwork. Get an accountant to review what's going on if you don't know how to read a set of books. FWIW, I do ... but just a little; enough to know that if my initial "look-see" looks OK, then I bring in my trusted accountant to really go over the stuff.

I can't tell you how many times books that appeared OK hid major problems and obligations, or when the rumour got out that I was buying in to a business, other folks who'd "bought in" and walked away when they learned the full extent of the financial problems were now on the doorstep looking for their investment back out of the business or their piece of the action from their percentage of ownership. Last one I looked at, the partners (brothers), deeply devout and very pious in their honesty .... had sold 350% of their business to a fair number of investors. They just didn't mention it to the next buyer they were seeking to get money from ... and that was in addition to having sold "exclusive" marketing rights to others in prime territories for the products. I'd of been sued for all the profits if I had tried to sell in the "exclusive" territories ... and the product niches were narrow enough that everybody would have known of my sales. I literally wasted several major business trips to investigate the product, the company, the potential for sales across the USA. Don't make the same mistakes I did ... know exactly what it is you're looking at buying before spending any further time and money, and before you invest.

Let's see if I can "unbaffle" you... I know I've got to have the books gone over before laying down any cash, I'm in the investigative (mulling it over) stage at this point. I've talked to his suppliers and he always pays on time and has a good rep with the suppliers. The people I talked to (including a couple of employees) all seem to have the opinion that he could really use someone in with him that is a bit older and wiser (I know I fit one but I always question the other).
An example, a Famous Daves chain BBQ place moved in about a year and a half ago and this has not impacted his bottom line as of yet, in fact people I've talked to prefer this place over the chain.

I know he's a sole proprietor and has sold nothing to others at this point. The mistakes he made so far have not been insane mistakes, just mistakes of a young inexperienced person that a cash infusion should fix.
I know it can be a low paying job but it can also be a good paying one as well and if you enjoy what you're doing that means alot too. If things go well and the economy picks up this place could grow and be sold at a later date for some decent profit or he could buy me out.
I'm just at the point that I've lost $$$$$$$$$$$$ in the market and am tired of letting others totally control what happpens with my invested money, as a 50% partner I'd at least have some day to day control, have hands on participation and be able to see and handle the results.
As for what am I getting and such, it'd all be in writing down to how much each of us will work and share duties and what will happen if we decide to split.
I guess what I'm looking for is some kind of reassurance that I'm not completely nuts to do this with the current market conditions. I can buy in now just because the economy is slow and I "think" it can survive but I guess the big question is if it gets worse will people stop eating out all together and how long this downturn will last...

[harry chickpea]

I would absolutely not invest a major nest egg in a restaurant at this point in time, especially a situation like this. If your $40K "bails him out," what other tangible investment does he have, and where will the money come from for the next set of problems?

You will be going into another dog's turf, trying to make changes, and working as a subordinate. See anything a little crazy about that, something where there could be friction?

I'll give you just one reason why you should be suspect of restaurants in general. In another forum that I frequent, a poster was lamenting that a cooking oil company whose main business was the restaurant industry had cut production back from about 6,000 gallons a day to 800. While that one company could be a fluke, if you look at the overall picture there are more stories of the same ilk. The middle of the supply chain is using up inventory at this point and production is winding down.

IMO, we are about to go into the next phase of this economic mess - shortages. With the banks not lending, the consumption drying up, and trade cut back to other countries, makers of core products are starting to fail. Will the cooking oil company I mentioned fail? Quite possibly. Dairy farmers, cattle farmers, chicken processing plants, and just about all the agricultural sector were all hit hard by the recent high fuel costs and are struggling to stay afloat. In one case reported elsewhere, a huge dairy farm is losing money to the tune of $100,000/mo.. Farmers will continue to go out of business, even as the retail price of their goods remains high. Go back to the great depression and you'll see where government supports had to help farmers stay afloat. The thrust of the Federal support package isn't there now. The attempt is for economic stimulus from the top down. It will fail. The stimulus has to come from the bottom to work. Gas at $1 per gallon, and electricity at 5 cents per KWH TOTAL (no taxes or hidden charges), would stimulate growth. Giving money at 0% interest to banks, so that they can lend it at 6% interest does diddly-squat for growth, even if they do deign to lend it and not shore up their bottom lines with it.

Why is all this important? A restaurant is at the very tip of a "crack the whip" game. It depends on customers with free cash, it depends on a steady supply of meats, oils, and other food supplies, and it depends on the ability to either purchase at a low cost or pass on cost increases. All those factors are negative now. When there is a little movement by the first person on a crack the whip line, the end moves substantially. When lots of movement occurs all along the whip, all going in the same direction, the tip goes supersonic and is flung away or destroyed.

The current situation for restaurants is horrible. Say you have a pulled pork sandwich that currently costs a dollar to make in materials, and another dollar in overhead, based on selling 100 sandwiches per day. You sell it for $3.00. Now the cost of materials goes up by fifty cents, and the number of customers drop to 75. You start losing money on every sandwich you sell, so you bring the price up to $4.25, and that price turns away many of the loyal customers, who have grown to expect a particular price point. You now get down to 50 customers, and see the writing on the wall that many of them won't be back.

I'll tell you how my personal price-point thinking has gone for many years. If I eat at a fast food place just to refuel, and I am alone, I'll spend about $3 total. If that means dropping the drink purchase (the only area where a fast food joint makes real profit), fine. If it means getting two or three items from the dollar menu, fine. If I spend up to twice that amount, I'm splurging. I won't spend more than that because at the next price point I can usually find a "meat and two" meal at a mom-n-pop. The price point at a mom-n-pop goes from $6 to $12 for the entire meal. When I'm under economic stress, that $12 per person figure is my limit. Other people have similar price-points, even if they can't detail them off the tops of their heads.

If you invest in this restaurant, you are entering into and investing in a business that has at least a couple years of bad times immediately ahead. I've worked in businesses where you desperately wait for someone to come through the door, where you know that just the overhead of the electric will make the day a total loss. I've seen almost my entire industry go into bankruptcy as a means of shedding leases that could not be met. I had a business where I spent a couple years wages in startup costs, realized it wasn't going to fly within two months, and bailed. My take on the whole thing was that it was a cheap master's degree in business. I know the signs. I know where this economy is going to lead a lot of restaurants.

Here is an alternative for you if you really want to take a chance and have more money than the $40K to risk. Wait for the restaurant to fail and buy it lock stock and barrel in an assets only purchase. Negotiate two years of free or reduced rent. Hire the previous owner as YOUR employee and install a solid security system. Try to streamline the supply line by buying direct from local farmers and having a butcher shop on the premises that sells to the public as well as acts as your supplier. Eliminate every middleman you can. Keep traffic high and prices low and hope for the best.

[sunsprit]

Originally Posted by jimj

I have an oppertunity to buy into a runing bbq restaurant. It has been open for about 4 years and "seems" to be doing ok though I've not looked at the books yet.
The owner is young (about 25 or so) and has made some mistakes causing some cash flow issues that my investment would fix not to mention I'd replace a paid worker lowering overhead. (snip)

Thanks for some of your clarification, but here's the biggest problem I see.

Despite your mention that you don't need the income, the implication that you're coming to work to replace a paid worker to reduce overhead is that you're going to work for less money than a current worker. That leads us readers to the conclusion that you're putting your $40K investment into buying a job that pays almost nothing ... with a hope that your 50% ownership of the restaurant will sometime be worth a lot more in cash flow or cash out. And what that money is doing is helping to dig out of the hole that the restaurant is already in. Where will the money come from to improve the net situation into the future?

As another poster had pointed out here, the food industry is "shaking out" right now on a lot of trends. The discretionary dollars that folks may have for dining out in the near term may not necessarily be available.

I know we're seeing cash flow problems in the production side of the food biz. The price for many commodities has been falling dramatically, close to a losing proposition for dairy products these days. I've watched one local dairy send 3,000 head to the sale barn in the last month ... the ones that weren't top producers per feed input any more. Their intent is to dry up supply so that the demand side will be forced to consider raising the price back to realistic levels. And so it goes for much of the USA food supply, which is being outsourced more and more every day.

[jimj]

Sun and Harry thanks for the advice!
I've been mulling this over for about a month now, going back and forth and thinking alot along the lines of Harry.
Yes the idea was that I'd be buying and expecting to make some money in the future while helping keep the place afloat by lowering overhead and lending some age/wisdom.
I don't "think" he's in a bad hole now but he is on the brink since spending all of the capital reserves and maxing his credit out on things to improve the restaurant and buying a liquor license (he seems to be fairly honest in what he's telling me is going on).

I tend to agree at this point that if things keep swirling around the bowl as they are now eating out will be one of the first things to go and maybe only Taco Bell and such will survive, that's why I've been mulling for so long. I'd hate to think we're headed down this road but it seems we may just well be...

As for places "shaking out" well, that fits with what the restaurant supply house told me a couple of weeks ago. One of the top sales guys told me while we were discussing this deal that "you'll be surprised at the restaurant landscape within the next 6 months if not sooner" and "you'll be amazed at who's no longer in the valley when it happens, places are going under". I know we've had some failures in the last 90 days in fact a place we used to go to semi regular and has been operating for 15 years or so went under, but on the same line a new bbq place that's hooked to a bar opened not 15 miles from the one I'm looking at.

[harry chickpea]

The supply house sales guy has it right. He's given you tips from an insider and as much as told you to wait. What surprised me is the news that in our state even the liquor sales are down. That is NOT what one normally expects in a downturn, since bars and movie theatres used to be recession proof. That new place? Wait six months. Most restaurants start out undercapitalized.

[8 SNAKE]

Jim, if you end up going into this venture (though it doesn't sounds like you will), see if the owner will secure your $40k against some of the hard assets of the business. That may not be possible, depending on the structure and number of loans already in place. However, it would be worth checking out. That way, if the business failed and had to be liquidated you could be at the front of the line for recouping your investment.