New Restaurant Failure Rates: Fact or Fiction

My wife Mega and I opened our restaurant, Heartland, inOctober of 2002. Having just celebrated our seven year anniversary ofoperation, I got to thinking about other restaurants and their successes andsometimes failures and what leads to the idea that our industry has a failurerate that far exceeds other small business ventures.
In 2003, just after we opened, New York City Chef Rocco DiSpirito appeared in anAmerican Express commercial where he boasted about the two restaurants he was currentlyrunning and how he was planning on a third at a time when nine out ten newrestaurants fail within their first year of business. Thanks for thepublicity, Rocco, but due in part to that commercial and to your often timesunintentionally comical reality series, The Restaurant, not only do manypeople think we restaurateurs are bunch of crybabies but they also think ourindustry suffers from a 90% failure rate. As a member of our club,DiSpirito should know better than to perpetuate this myth, but the fact remainsthat most people believe in its veracity.
H.G. Parsa, an associate professor at Ohio State Universitywith thirteen years experience in our industry, wasn't buying it. Infact, he asked American Express to produce some data supporting thatcontention. In a written statement, a spokesperson for American Expresslet him know that they didn't have any such data and that, as far as they couldtell, none existed. Consequently, Parsa conducted his own study whichtracked 2500 restaurants in Columbus Ohio. Through it, he found that one in four restaurants fail or change hands duringtheir first year of operation and three in five do so by the end of yearthree. While that 60% "failure rate" might seem high, it is nohigher for our industry than it is for any other small business according tostatistics supplied by the Small Business Administration and the Bureau ofLabor Statistics.
Not to be outdone, Restaurant Start Up&Growth magazinecommissioned its own study of the Dallas market and came up with very similarnumbers, that is, a 23% turnover rate in the first year. In other words,according to them a burgeoning restaurateur has a 77% chance of beingsuccessful. That's not bad, statistically speaking.
So what does all this mean? Well, guess what? I'll tell you.
In practical financial terms, it means that many lenders who have latched ontothis myth of a 90% failure rate won't lend to restaurants at all. Thosethat will lend to prospective restaurant owners typically ask for sky highinterest rates or seek significant collateral, such as a person's house, orboth to secure a loan. Since one of the primary reasons a small businessfails is lack of sufficient capital and readily available cash flow, this is amyth that virtually sustains itself.
So how did we get here? Well guess what? I'll tell you.
In many ways, owning and operating a restaurant, especially a relatively highprofile one, thrusts people in the glare of public light. Do you reallythink I would have been asked to write this blog if my name wasn't constantlybeing bandied about in the media? That's not very likely. In similar fashion, those "closed until further notice" and "currentlyunder new management" signs that appear in restaurant windows contributeto the illusion that we are a bunch of clueless fly-by-night operators whocan't manage our ways out of a to go bag. While there might be a few ofus for whom that is an accurate assessment, for the most part, that just isn'ttrue.
Even so, we remain less the victims of misconception than we do of our ownpropensity for creating bad publicity. Let's face it, most stereotypes,no matter how egregious, have at least a flimsy basis in some reality. Unfortunately, in our business we see it every day. We all know of therestaurant owner who creates a much ballyhooed concept only to go belly up in arelatively short period of time and, in so doing, leaves countless individualsholding the empty money bag. An operation like this is a miniature Ponzischeme. The restaurant accepts delivery of supplies from purveyors, issupported by the labor of its staff, leases a building space and soforth. The ownership is continuously borrowing from Peter to payPaul. The wager is that enough juggling of the books can be done so thatcreditors, while overextended, will never call in their notes. The hopeis that as long as customers keep coming in the door then there will always bejust enough cash to keep the dogs at bay. In the meantime, the debt keepsincreasing and the liabilities keep mounting while all the while the owner isbuying a big house on the lake where he docks his cabin cruiser and garages hisMercedes sedan which he uses to shuttle his kids to and from private school.All that is needed for the whole thing to blow up is an unexpected downturn in customercounts or a major unanticipated expense. Once that happens, without anycash reserves it's only a matter of time before the restaurant goes belly up.
So what happens then? Well, guess what? I'll tell you.
Taxes go unpaid. Employees are left with bouncing paychecks. Landlords are left to scramble to make mortgage and property tax payments onproperties that house tenants whom they have no other choice but to evict andthen sue to recover back rent. Suppliers, who are essentially unsecuredlenders, must somehow attempt to survive the loss in revenue from unpaidinvoices. Banks are left with loans in default. People suffer.
This is not to say that every restaurant or small business that does go underis due to unscrupulous behavior or mismanagement. Sometimes the bestconceived and most well run businesses fall victim to circumstance and mustshutter the doors. In those cases, well intentioned ownership will dotheir best to make good on outstanding liabilities. Sometimes they aresuccessful in doing so and sometimes not, but their intentions were never torip people off or to operate dishonest businesses.
Other times, that is not the case. I know of one high profile chef andrestaurateur who fabricated his resume perhaps to con people into investing inhis businesses. How do I know this person was lying? Well, herecited that very resume to me over fifteen years ago when he offered me a job,and it took about fifteen minutes of due diligence on my part to discover hiscon. Nonetheless, he went on to open a series of restaurants, none ofwhich were successful, and, according to reports, left most of his financialobligations unsatisfied. Apparently, those obligations included employeewages. One of my current staff, who previously worked for him, told methat she sat in his office for six hours demanding payment for back wages andgratuities before he finally caved in and had his accountant cut her a checkfor $1,300. A chef who was recently a guest in our kitchen and who was alsoformerly employed by him told me that he is still owed $900 from over threeyears ago. He was not so diligent in trying to recover his money and sohas never been paid. Granted, most of that is hearsay, but there arelawsuits that have emerged that lend credence to these claims. You have tobelieve where there's smoke there must be at least a little fire. Still, thisindividual remains active in our industry and is currently operatingrestaurants that bear his name.
How does this happen? Well, guess what? I'm not sure I can tellyou.
It is not terribly unusual for someone to close down a restaurant and leave atrail of bad debts behind. Still, a landlord will somehow agree to leasea space to such a person for the purpose of opening another restaurant. Somefinagling might occur whereby the ownership of the new restaurant is placed inthe name of a relative or partner, but the identity of the person in charge ofthe day to day operation of that restaurant is no secret.
Usually, the media are complicit in helping to foster such returns to businessas usual because the person in question usually has a high enough profile thatit makes for interesting news. That's understandable. What isn'tunderstandable is the way in which some of these charlatans are lauded by themedia as if they deserve their benevolence and admiration for a job welldone. It is not surprising to see many of these establishments in"best of the industry" features. My peers and I in the businessoften shake our collective heads at this and speculate among ourselves as tohow long it will be before we see a repeat performance.
The harsh reality of this is that as long as someone is willing to give theunscrupulous operator money, lease him a space, agree to his employ and sellhim product, then the whole sad affair will continue to repeat itself over andover again. How many people do you think would invest with Bernie Madoffor Tom Petters if they were released from prison tomorrow and opened their owninvestment firms? It sounds silly, but I'm guessing that there might bequite a few. And if those people lost everything, wouldn't we all look atthem and shake our heads in utter disbelief. Would they be worthy of oursympathies? I think not, and, in much the same way, anyone who wouldcontinue to support the unscrupulous people who are active in our industryalmost deserves what he or she gets in return.
In summary, what we have is both a bane and a blessing. On the one hand,media coverage of our industry helps fuel our businesses and helps drivecustomers to our establishments. Without it, many of us would not be assuccessful as we are. I cannot tell you how appreciative I am of thepress we get. By the same token, the public microscope under which weoperate our businesses contributes in large part to the misconception that webelong to an industry rife with incompetence. That misconceptioncontributes in turn to making our road to success a much bumpier ride than needbe.
We do operate in an industry that is very difficult and requires long hours andsubstantial personal sacrifices in order to successful. But are we reallyany different from any other small business? The statistical researchsays otherwise. Now if only we can get the banks to agree.