Tips and tricks to help you navigate the restaurant world’s many contracts, from leases and kitchen design to financing and general contractors.
By Cliff Bramble
Contracts! It’s so easy to sign a name across a contract but challenging to get out of one.
Some of the most important contracts for restaurants include the lease, bank commitment letter, operating agreements, kitchen design and the general contractor. Knowing the ins and outs of these types of contracts can help you navigate the process when it comes time for you to wade into the contract waters.
Right now, many restaurant operators may be taking a hard look at their current lease. Many questions are probably going through their heads, too. For instance, “What happens if I close the restaurant?” Or, “If I close, will I be personally responsible for the term of the lease?” That’s probably the most critical question on people’s minds.
While it may be too late to change language in the lease, one should know the lease terms and language. The questions that need to be answered right now are: How much longer is my lease? Did I sign a personal guarantee on the lease? If so, was it limited? Are there provisions in my lease that will allow the business to close without financial consequences? And most importantly, “Will the landlord work with me?”
As for the lease length, it’s essential to know since there may be additional options for future years. The length of the lease ties in with the personal guarantee, too. If there is a personal guarantee on the lease and the lease still has 10 years to go, the financial consequences may be significant.
On the personal guarantee side, if there is a personal guarantee on the lease, can you get out of it with no expense or a smaller than the required dollar amount? Will the landlord even entertain the thought? If so, great. If not, this may mean the person who signed the lease may be responsible for all costs of the lease for the remaining terms.
This could be a substantial financial burden. Many attorneys recommend never to sign a personal guarantee or at least place a limit of one or two years on any guarantee.
Either way, if there is a personal guarantee in the lease’s language, this may become a costly and problematic issue. Speaking with the landlord about it first may help, but a commercial contract attorney would be the next move after that.
What about provisions in the lease that may allow the lease to be terminated? Is there any language that allows this to occur? Are there clear definitions of the words in the lease? If the language is unclear, this may assist the lessee. It all depends on the language and the final interpretation.
What is the best time to perfect the language in the lease? It’s before signing a letter of intent, which will allow you to complete any due diligence on the property, too. Start with what you must have and what you want. Get together with the landlord, work on a mutually beneficial agreement, and add your language to the letter of intent. The letter of intent should have the final desires requested by the lessee and the lessor. It should also have an expiration clause in it.
Before signing any letter of intent or lease, ask an attorney to review the lease. You may walk away with: 1. Not having a personal guarantee on the lease. 2. Having an out clause in the lease. 3. Not having escalators on the lease. 4. Placing the lease in the corporate name and not in your name. 5. Knowing the amount of tenant improvement the landlord will pay. And 6. Not having to pay rent until the first day of sales or later. Without an attorney reviewing the lease, however, the profits may flow freely out the front door before the restaurant even opens.
If you already have a restaurant, you may have this in place already. If you’re planning on opening a new restaurant and have more than one partner, though, this may be an excellent time to get this in place. By having an attorney create an operating agreement for the business, the contract will address the ownership structure, responsibilities, membership, corporate management and the general management provisions.
While it may cost thousands of dollars to get completed, it will cost a lot less than having no agreement in place. Typically, this contract should be executed before the business has started, and all partners should agree.
Topics covered in the agreement may include legal structure, ownership percentage, corporate manager, company members, corporate buyout options, definitions of language and party signatures.
Bank Commitment Letter
Are you thinking of expanding? You’ll probably need the help of a bank. Before any contract gets signed or before a check gets written, the financing must be completed. More than likely, the funding will come from the owners, a bank or investors.
If the funding is from the bank, there will be a bank loan commitment sheet presented. This commitment letter is considered to be a contract leading to the final loan papers. You have to apply for a loan at the bank to receive this letter. Be prepared to get rejected, but don’t give up. The bank will request information on the owners, the business plan and the items being placed up for collateral.
The commitment letter will have all terms of funding by the bank. It will have the timeline, the collateral for the loan, the company name and the company owners, along with all of the financial data requested in receiving the loan.
Pay careful attention to the term length, loan amount, interest rate and due date in the commitment letter. For commercial loans, it may be due in five years. Another commercial requirement typically calls for no more than an amortization period of 20 years, so watch the amortization schedule.
At some point, the loan will need to be refinanced. When it’s time, be sure to reduce the amortization time, too. By this, it means if the loan began at a 20-year amortization, and the refinance is five years later, be sure to finance the loan for 15 years, thus reducing the first five years of the loan that have been completed.
Some of the bank terms may include a personal guarantee, (limit it) collateral of money or a lien on an asset (real estate), and possible life insurance on the principals signed over to the bank. There will be some hard decisions on this subject, and the consequences of not paying the loan back will have to be addressed. Always think about the worst-case scenarios and be prepared to answer the banker’s questions.
If the funding is from individual investors, they may have to be included in the operating agreement since they may be owners. If they invest based on future equity and sign a SAFE contract, they may not need to be on the operating agreement. The investors will also have to sign and hand over their investment.
Overall, this contract, once signed, is another legally binding contract many of us have had to work with yet have hardly read the entire agreement. Be prepared to know the consequences of not paying it back, because it’s mentioned somewhere in the contract’s language. Most importantly, always use an attorney in the review and completion of these contracts.
If opening a restaurant is on the horizon, one of the first contracts will be for the kitchen design. The kitchen design team will work with the architect and design a kitchen working in unison with the remainder of the restaurant. The engineers will get the correct gas, electricity, water and kitchen setup. Lastly, they will work with the owners and chef to ensure they have proper ventilation and cooking equipment.
Remember, the kitchen cannot be designed unless the menu has been completed. The kitchen equipment cannot be selected until a rough menu is finalized.
It would be an excellent plan to review the contract as many times as possible and always look for alternative equipment with low, medium or high pricing. The kitchen designer’s job is to sell equipment. Your job isn’t merely to say you will take everything on their sheet. Your job is to review the contract and ask for different equipment brands with better pricing.
Once the equipment has been decided, the kitchen designer will send you an equipment schedule and the pricing/spec sheets for each piece of equipment. Review it, change it, review it again. Only sign the contract after all of the questions have been answered.
Many of the day-to-day contracts will consist of the linen, the beverage and coffee machines, copier, cable, internet, music services and more. Before any of these contracts are signed, always be sure all agreements are in the corporate name and not a personal name. That way, if the company goes out of business and there is a long-term contract, the corporation may be responsible for the payment, not the individual owner.
Additionally, it’s best to keep these contracts at three-year terms and no longer. The reason is a lot can change within three years.
Think about this – once the general contractor’s contract is signed, the business owner will be at the contractor’s mercy. So what does that tell you? Hire the right one!
The most important item here is to make sure the general contractor has experience building restaurants. Add whatever language you want to their contract. Any contract can be changed, and this one should be considered thoroughly. If they disagree with your changes, find someone else.
Keep this in mind: The job must be completed on time, within budget and without mistakes. The contractor must know how to read restaurant plans, have a lineup of subs and have a guaranteed schedule to complete the build.
The key here is referrals. Get as many referrals from other people the contractor has worked with so you know you are hiring the right company. If the GC does not have the correct experience, it will make life miserable. Hold them accountable on pricing, timelines and due dates.
Remember this: As soon as something on the plans has to be changed, the GC will be the first one asking you to sign the change order forms. Those change orders cost the restaurant owner at least 10% more than expected. So do not be afraid to add your wants and desires into a contract before you sign it.
So there you have it – a primer on the many contracts you may encounter as a restaurant owner. Hopefully these tips will help guide you to calmer waters as you move ahead in your business.
With 40 years of restaurant and hotel experience in all restaurant segments, Cliff Bramble has built restaurants from the ground up, retro-fitted restaurants, opened Marriott Hotels and, since 2004, has co-owned and operated nationally recognized restaurants throughout Atlanta. Cliff co-founded Rathbun’s, Kevin Rathbun Steak, Krog Bar and KR SteakBar and was the owner of Noble Fin until June 2020. He has first-hand knowledge in banking, finance, development, real estate and overall business expertise, assisting in all levels of business. Look for Cliff’s new book, Planning for Profit, which provides 18 steps to analyze data that makes a restaurant more profitable this August. Currently, he owns Hungry Hospitality, a hospitality consulting firm focusing on all aspects of the restaurant business.