PRESENT REALITY Do you remember the first time you went out to dinner? The first meal you had in a public space when you were young? The first booth you sat in, the first menu you looked at, or the first time you were asked if you’d saved room for dessert? Most people don’t. And most of us don’t because eating at restaurants is such a normal part of our lives. Maybe it’s once a month, maybe it’s a few times a week, but we all go out and enjoy our favorite dishes at our favorite spots as often as is desired and financially reasonable. It’s ingrained in the way we live, the way we were raised. It’s ingrained in our culture to the point that we assume we’ll be able to do it tomorrow. We take the experience, and the ability to enjoy that experience, for granted. And eating where we like, at the times that we like, with the people that we like, as a concept, is heading at a medium speed towards an immovable object – the increased cost of everything. My name is Joseph Hollcraft, and I’m a business broker at International Business Associates. I focus on the hospitality industry in Oregon, I’m an allied member of ORLA, and, along with every member of the firm I’m affiliated with, I am an expert at determining the market values of privately held companies, family-owned businesses, and affiliated commercial real estate. As IBA’s lead intermediary in the hospitality industry in Oregon, I screen every food and beverage industry lead that comes into our Oregon office. Historically, IBA as a selective business brokerage firm, took on as clients 1 in 3 hospitality industry business owners who approached us for representation. The reasons for passing on projects in the past have ranged from “foggy” financial records to unrealistic expectations on value. The number of restaurants or bars, post-pandemic, that I’ve found to be marketable enough to take on as a representation project has been significantly reduced from this 33 percent. My most recent transaction was Saburo’s Sushi House, a business I helped Saburo and Joyce Nakajima successfully sell earlier this year. IBA has a reputation in the marketplace for representing businesses that are doing well where people are executing on their vision, doing what they enjoy, and making money. These entrepreneurs don’t need to sell, they want to sell when they call IBA. The number of people who are calling me in this position in 2024 is greatly diminished. This fact, and my concern for the industry at large, is what motivated me to write this article. Keeping active recognizance on the hospitality industry, I have had serious, thoughtful, heartstring tugging discussions with the owners of enough businesses in this sector to see the writing on the wall: the restaurant and bar model that transformed Portland into a food mecca is no longer a highly profitable way to make a living. This opinion is backed up by industry experts, the firsthand reports of restaurateurs, and math. There is no getting around the fact that as the prices of labor and cost of goods increase, while the buying power of patrons remains stable, profit percentages for business owners will inevitably decline. First, let’s look at labor costs. In 2020, the minimum wage in Oregon was $12.00. As of July 1, 2024, the minimum wage in Oregon is $14.70. Servers, bartenders, expediters, and hosts traditionally are paid at that minimum wage rate. Few people can live on minimum wage, so all of these front-of-house jobs traditionally rely on tips to make up the difference between minimum wage living and the middle class. A server at a restaurant with an average plate cost of $14 and two drinks that average out to about $16, with an average seating of three people per table, and turning four tables an hour, makes, with tips, about $54 an hour after a 40 percent tip out. This assumes an average tip rate of 18 percent and includes the current minimum wage. When the minimum wage was at $12.00, the hourly wage of the server above was about $51. But to the restaurant owner, the move from $12.00 per hour to $14.70 per hour was a 22.5 percent increase in the base cost of labor. This is before an employer’s contribution to local, state, and federal taxing authorities that are based on the wages of their employees. Assuming that labor initially accounted for 30 percent of total expenses, this extra $2.70 per hour per employee leads to a 6.75 percent decrease in the bottom line. In many cases, restaurants pre-pandemic were operating on a profit margin of 6 to 15 percent. Current day, and assuming these numbers, that brings the net profit to ownership to between -.5 and 8.5 percent. This explains why I and others that participate in the restaurant industry are starting to see closure after closure of businesses using a model that worked well five years ago, or short staffing with increased ownership/family participation to just get by. Let me ask you a question: if you knew going into it that you would be managing your business 60 hours a week, dealing with the intense responsibility of some large number of employees and customers scrutinizing and relying on your decisions, experiencing the stress that is inexorably imbued in business ownership, and for this would earn a profit between 0 and 8.5 percent, would you move forward with the investment of your personal capital or take out a loan that would use your home as collateral? Because this is where the momentum towards that immovable object comes from – the vast majority of restaurant startups and acquisitions rely on SBA lending. The SBA, or Small Business Administration, is a federal government agency that guarantees loans made for the purposes of starting, enhancing, or purchasing a business. The SBA establishes rules and guidelines, but it does not, itself, give out loans. Instead, it guarantees a significant percentage of a loan given out by a lender. SBA lenders must follow SBA guidelines to get their loan guarantees. But they are on the hook for the percentage not guaranteed which leads them to be thoughtful about who they lend to. They look at experience, personal financial strength, the assets of the borrower, the assets and history of the existing business (If an acquisition loan), and the borrower’s business plan and industry to determine whether the risk associated with making the loan makes sense. During the first phases of the pandemic, restaurants were going out of business at a terrifying pace. Lenders noticed this and almost all of them stopped offering SBA loans to people trying to open or buy restaurants. This was the result of what had become, in the opinions of the underwriters at these lending institutions, too big of a risk. Restaurants go out of business all the time. There is a natural life cycle to most businesses in most industries, restaurants aren’t an exception. As restaurants naturally come to their end-of-service, it’s almost always been the case that the SBA has been there, ready to fill that vacant kitchen with a new tenant. But now we have to ask the question the lenders will be asking – if the average profit margin of an industry is 0 to 8.5 percent, can that profit margin have room in it for both a business owner to make a living and the debt from a loan to be serviced? When the industry is the mid-priced mom and pop bar or restaurant, the answer will be the sound of our collective dining experience making firm contact with that immovable object. As these restaurants go through their natural life cycle and eventually close, and as that profit margin continues to shrink as the result of increases in the cost of labor (and we’ve yet to mention the increases in cost of goods, which have also risen dramatically post-pandemic), lenders may begin to see restaurant loans as more and more risky yet again and elect not to fund SBA loans for restaurant acquisitions and new food service start-ups. As the increases in costs we’re currently seeing have no buffers in place, it is not a question of if but of when. And if lending begins to dry up, the only fundable business models will be ones with very high costs to customers, or a very low cost of labor. Fine dining, counter service, or food trucks. Take your pick, but they may soon be the only options. The era of the successful, mid-market mom and pop restaurant in Oregon may too quickly be coming to an end. THE NEW PATH When the obstacles are insurmountable, and the road behind you doesn’t offer a safe retreat, what course of action is left to you? It’s time for the restaurant and bar industry in Oregon to forge a new path. I’ve laid out the situation business owners in this sector face. The following is a series of possible, tested solutions. Increasing Value – The Shortest Line Between Two Points Business valuation is a sophisticated, nuanced process. It is primarily based on cash flow over the previous 12-18 months, but many factors come into play. There’s an art to it, a subjective science based on experience, industry research and knowledge. But there are consistent rules, the most basic of which is that the more money an owner makes, either through write-offs like non-reoccurring depreciation expenses, direct W-2 wages, or personal discretionary expenditures run through the business, the more money the business is worth. To that end, my first piece of advice is this: get shift hours off the floor. Whether you do this by taking shifts yourself, passing them off to the salaried employees, or reducing worker hours directly, a small daily reduction can lead to a substantial amount of value at time of sale. This is in large part because business valuation uses a multiplier. A multiplier is a number, usually between two and six, that the net proceeds to ownership are set against. If your multiplier was three to four, and you made $250,000 (excluding your labor contribution at a fair market rate) in the past 12 months, then that would put your business’s value between $750,000 - $1 million. Taking this to the practical level, if you remove six hours of shift a day from the floor, and let’s say you’re open 300 days a year, and further that each of those six hours is worth minimum wage + $1.30 in costs like workers’ comp and payroll tax, then those six hours a day add up to $28,800 annually. At a multiple of 3.5, this change in your business model adds up to $100,800 in additional value at time of sale. If you choose not to sell, that $28,800 goes to your coffers to do with as you wish. Reducing labor costs isn’t a new invention. It’s generally a thing done with some degree of pain, especially for a small mom and pop that has strong relationships with their employees. The reality though is that if the restaurant or bar you own or manage goes out of business then everyone loses their job. This is the type of hard call that, in my experience, separates the talented entrepreneurs from the passionate hobbyists. I’ve had conversations with something approaching 100 business owners in the last four years. The thing that distinguishes the average from the good, and the good from the great, is their ability to see the landscape their business operates in with clarity and then make the right decision, regardless of how hard that decision is. I’m a resource available to anyone reading this should you wish for an analysis of your business and a conversation around ways to increase profitability. The Service Fee Model There is a restaurant on the East side of Portland, just off the main thoroughfare of Morrison and close to downtown, called Kachka. Established in 2013, they’ve been through the boom and the bust of the Portland restaurant scene. During the most worrisome parts of the pandemic, when customer-facing brick and mortar businesses were closed or, in the case of restaurants, take out only, Israel and Bonnie Morales, the owners at Kachka, made a hard call. They eliminated tipping at their restaurant and instituted a service fee of 22 percent. This service fee goes directly to the top line of Kachka’s books as income and brings with it both benefits and challenges. The decision to move to a service fee model wasn’t taken lightly. Israel and Bonnie reviewed models and found that, given the options in front of them, a service fee model was not only the most likely path to success but potentially the only one. In a series of meetings with management and the staff, they began instituting their plan. They understood the importance of staff buy-in. To that end, the first move ownership made was to increase the wage of their management team. Traditionally, restaurant management is salaried and makes far less than the front-of-house employees they’re tasked with supervising. This is an upside down model that Israel and Bonnie thought should change. Restaurant management is often responsible for everything from ordering, scheduling, inventory, to filling in shifts when needed. For them to be compensated at a rate approaching 50 percent of the staff they manage just doesn’t make sense. This generally isn’t the case in any other industry. With this first change a couple of things happened. The first was that management’s standard of living rose. Some were able to buy houses for the first time, and they were all more satisfied at work. That bred a loyalty to the company that lent itself to bringing the rest of the staff on board with the new model. Additionally, a path of upward mobility opened up for the general staff. In the old model, a server would take a financial hit should they choose to take their skill and experience to the next level in the corporate structure. Now, getting promoted to management has position, experience, and financial benefit. This brings a sense of “top down” order that most restaurants currently lack. The next step was to increase the benefits package to Kachka’s employees. Israel and Bonnie reduced the minimum number of weekly hours necessary to qualify for healthcare from 30 to 17.5, with 17.5 being the legal Federal minimum. “Healthcare is a human right,” says Israel. There is new PTO and vacation pay for management, as well as the ability for all staff to use their state mandated sick leave as flex pay. Twice a year, the management team opens the books at an all-hands meeting, discusses the profitability for the period, and, if profit is substantial enough, hands out profit share checks to vested employees at all staff levels. Imagine being an 18 year old dishwasher making $25 an hour and being given profit share, flex leave, healthcare, and having a clear path of upward mobility. This is not how restaurants are done, but, as Israel and Bonnie are proving, it can be. The challenges, though, are substantial. With the removal of tipping in lieu of a service fee, the wage paid to staff had to go up. Way up. That brings with it ancillary costs. Workers’ compensation insurance, for example, is based on total payroll. When your payroll doubles, so does your workers’ comp bill. Employer contribution to taxation at the local, state, and federal level all went up as well. And they lost the tip credit that every business with tipped employees benefits from. Changing to the service fee model has benefits to staff and the business, as well as hurdles that need to be effectively navigated. But there is a third component to the switch to a service fee model: public opinion. There have been restaurants that have tried this and been met with backlash, not just from their employees, but from the general public. A perception exists in some parts of Oregon that businesses and their owners are perpetually wrong-headed and anything other than total loyalty and commitment to the quality of life for employees is incorrect. This perception, while false, is potentially an issue any owner switching to a service fee model will have to take into consideration. Judging by the experience of Kachka, management buy-in can help tremendously, but that won’t stop the public from potentially attacking a business on social media. The final component of the successful, broad market move to a service fee, should that be where the future takes the industry, is political action in the public sphere. Should the task towards service fees be taken up by restaurant and bar owners as a whole, it will become incumbent on those with influence in the public sphere to spearhead a campaign that makes the realities around this move crystal clear: if something doesn’t change, a way of life we’ve all enjoyed since childhood will simply go away. Looking Forward – Positioning A New Restaurant At The Outset Aaron and Jessica Grimmer, long time Portland residents and the former owners of seven different food and beverage businesses are opening their latest endeavor in a post-pandemic landscape fraught with challenges. Their two most recent businesses, Picnic House and Bar Low, both fell victim to the changes in the downtown landscape during lockdown and immediately after. Formerly located across from the Arlene Schnitzer Concert Hall, they were a huge hit with the pre-show crowd, as well as with daily patrons from the surrounding office buildings. Their new endeavor is named “High Noon.” The concept is simple – deliver high-quality food in a high-quality atmosphere while not alienating customers based on price, dress code, or a haughty attitude. “What made Picnic House and our other projects so successful was that we priced them to be elevated, but not unreachable. We would rather our guests visit us regularly as opposed to only for special occasions. That being said, we do need to maximize our PPA (per-person average) and the value of each seat for each turn. Our menu will reflect a high value to guests as well as highest return on investment.” “On the COGS side, it’s really important to construct a menu that relies upon ingredients that are price stable and seasonally available,” said Aaron on the topic of cost management. “We all know food prices have gone up, but a big challenge for restaurants is actually unpredictable fluctuations in pricing. With properly planned menus and using technology such as MarginEdge (an app that monitors your COGS), we won’t be caught off guard with suddenly shrinking margins or having to scramble for ingredients that are hard to find.” Aaron and Jessica also believe in a holistic approach to management. They involve their staff at the base level to ensure higher quality control and buy-in towards cost savings: “We see value in teaching our team the importance of cost management. We found when we get staff engaged and invested in the menu construction process, they’re more likely to be more pro-active when it comes to managing waste and keeping COGS within a healthy margin.” Experienced labor, the kind that Aaron and Jessica insist on, comes with a cost. “As far as labor goes, Oregon (and Portland especially) has a lot of challenges when it comes to keeping labor costs in check. We remember feeling the labor pinch back before COVID and the environment has only become more challenging since then. And we can’t just directly pass these costs on to our customers in the form of higher prices. We have to be more creative.” One interesting idea to enhance take home pay for food service workers being floated by both Presidential candidates, as well as Oregon’s state government, is to eliminate income taxes on tips. The devil will be in the details of the final bill(s), but they would hypothetically result in more take home dollars for low- and middle-class workers and create an incentive to enter the food service profession. The most important takeaway is that from main street to Washington DC, people are talking about wages and benefits for food service industry workers. When you have a plan, make sure you have a back-up plan as well. “We’re also considering other ways to make the numbers work. Some restaurants in town have gone to a service charge model in order to cover labor costs and create a more balanced wage distribution between front and back of house. While we’ve yet to decide if that’s the right path for us, our goals are to create a unique and quality guest experience, pay our staff a fair and living wage, and be financially successful. This is the biggest (even existential) challenge our industry is facing right now and we’re all working together to find innovative solutions.” There is no “right” way. There is no one path. That immovable object isn’t going anywhere and if you, as a food and beverage industry business owner or employee, can make it through to next year, and the year after, and the year after that then you should be lauded for your successes and rewarded with appropriate financial compensation. But the old way isn’t working anymore. Restaurants more than any other type of business are bastions of culture and inclusion. They allow us to experience the flavors and traditions of the entire world simply by showing up and sitting down. We can’t, we can’t, we can’t lose those experiences or deprive them from the future. It’s incumbent on all of us to support, encourage, and preserve this way of life. | Joseph Hollcraft This guest blog was submitted by International Business Associates (IBA). For more information on guest blog opportunities, contact Marla McColly, Business Development Director, Oregon Restaurant & Lodging Association.
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