The Four Most Common Reasons Restaurants Fail

Do you aspire to open your own restaurant? Don’t let financial and management problems squash your dream.
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With the right location and enough capital, your restaurant will be on its way to success.(Photo: Roman Sigaev/Shutterstock)

Running a restaurant is a dream for many, but no one ever claimed it’s easy. In fact, 30 percent of restaurants fail within their first year of operations, according to Cornell University. Everything from staff mismanagement to unaffordable expenses can cause a restaurant to go belly up.

Knowing the most prevalent perils can help you avoid them. These four top the list.

Running out of money

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Steve Zagor, the dean of the School of Business and Management Studies Program at the Institute of Culinary Education in New York, stresses the importance of having capital. (Photo: Steve Zagor)

“It’s been very well documented that the number one reason why restaurants fail is undercapitalization — running out of money,” said Stephen Zagor, dean of the School of Business and Management Studies at the Institute of Culinary Education.

It’s not surprising that the sky-high start-up costs overwhelm many new owners.

“What happens is that you find a location and it takes a lot of time and money to build the place,” said Zagor. First-time restaurant owners tend to underestimate how long this process takes and the costs they’ll face without much revenue coming in, he noted.

Even for experienced owners, there are no guarantees. “No one’s perfect. It’s really easy to lose money even if you know what you’re doing,” said Zagor.

He recommended building an extra layer of capital into your budget at the inception of your business. “We tell our [students] to take all their costs, including rent, payroll and insurance, and add another 20 percent. Assume that very little business will come in for the first six months.”

Clueless management

The appeal of running a restaurant draws many inexperienced people into the food business. Just because it’s your first time doesn’t mean you’re destined to fail, but many first-timers mismanage their restaurant to its demise.

“It’s a sexy, intoxicating business,” said Zagor, who has more than 30 years in the industry. “But you really need to know it’s not easy to plan for success.”

There’s a major learning curve associated with buying inventory commercially, for example. “You make money in the food business based on how much you buy.” This requires a deep understanding of estimating costs and patronage on a given week. “Maximizing flow, sales and the average check is a complicated business,” he added.

Another way amateur restaurateurs bungle the management side is by violating labor laws. Employment legislation can be extremely complicated and result in costly legal battles when things aren’t up to code.

“Understanding how to pay employees is difficult. Owners get sued because they just don’t know [the laws],” said Zagor. And those laws change. For instance, the U.S. Department of Labor overtime rule goes into effect December 1, 2016.

Taking the time to learn from an industry veteran before you invest in your own restaurant will increase your likelihood of success. “Work for someone else for awhile before you start your business. Learn on someone else’s nickel,” said Zagor.

He also recommended partnering with someone who has strengths in areas you are weak in. For example, if you have a knack for aesthetics and design but you’re clueless about crunching numbers, team up with someone with a good business sense.

“If you don’t know what you’re doing, find a partner or a key employee you can rely on. Know what you know and what you don’t know.”

Location, location, location

A lack of understanding of what defines a truly great location is another common trip-up. Finding a space in a highly visible area with great foot traffic, and one that you can afford, is a balancing act.

“Can you pay the lease if sales don’t get where you need them?” said Zagor. Rent should be 10 percent or less of sales if your restaurant is in a major city, and 5 percent or less if you’re in a less populated locale, he said.

Start by looking for a location that was home to a restaurant once before. Potential customers will already associate that area with a place for a (hopefully good) meal, and it’s more likely to have a built-in setup to get you started.

The most important thing, said Zagor, is going into your real estate search with the right mindset. That involves checking your emotions at the door and keeping a purely objective outlook on the finances. “Don’t fall in love with a space,” he emphasized.

Investing the wrong amount

There’s an art to investing the proper amount in a restaurant. Invest too little and it’s unlikely you’ll get the restaurant in a good enough shape to entice customers. Investing too much makes it that much harder to get a decent return.

“Minimize your investment but don’t spend too little,” said Zagor. “Capital improvements can be exorbitant.” Find a space with good infrastructure and you’ll get to spend money on personalizing your restaurant’s aesthetics.

“The best thing you can do is to try and buy a business or take over an existing business,” said Zagor. “If you can take over a place for a reasonable amount and it meets code, you’ll save a lot of money. Then you can come in and change the design and set yourself up for success.”

Just because you don’t see a for-sale sign doesn’t mean you can’t take over the restaurant, noted Zagor.

“Most locations aren’t for sale but are actually available.” If you have a place in mind, “go in with someone and ask the owner if they have an interest in selling. You’d be surprised at how many people want to sell.”

Once you figure out the financials, strategize your management and find an ideal location, your biggest challenge will be getting customers in the door, again and again. Believe it or not, that’s not a bad place to be in your first year.

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