While some segments of the economy have started to show the first signs of recovery, most industries—including restaurants—are still suffering. Many concepts have had to declare bankruptcy, including casual-dining chain Max & Erma’s just recently in October.
There are several reasons restaurants can find themselves facing bankruptcy, but Scott Stuart, executive director of bankruptcy management services at Donlin Recano & Company, says liquidity issues are primarily to blame.
“Credit’s not really available at the level restaurants are used to,” he says. “The models that aren’t working as well are now showing their cracks.”
Ron Paul, president and CEO of Technomic, says lack of credit should hurt only companies in growth mode—which are few and far between these days.
“The driving force [in increased restaurant bankruptcies] has really been poor sales,” he says.
In a poll conducted by Mintel Menu Insights at the beginning of the year, more than half of respondents said they would eat out less in 2009 than they did in 2008.
“Dining out is definitely down,” says Maria Caranfa, head of Mintel Menu Insights, “but it’s not dead.”
And even though customers aren’t looking to cut back their spending on dining out like they were in the first quarter of 2009, the majority of them expect to keep their spending and the frequency of their visits at current levels, according to consumer research from AlixPartners.
As a result of slow traffic, many restaurants have been unable to cover their rent or interest payments.
Companies that find themselves bound by leases that make demands they can’t meet have two options: file for chapter seven and liquidate or file for chapter 11 bankruptcy.
“Chapter seven is basically saying, ‘We’re going out of business,’” Paul says. The concept sells its equipment to try to recoup some of its losses, but “in that situation, the creditors usually get very little, if anything, back.”
Chapter 11 bankruptcy, on the other hand, is more of a second chance; it gives companies a chance to renegotiate leases, and it forces them to make a plan for turning around their business and eventually paying creditors what they’re owed.
Stuart says more restaurants can expect to face bankruptcy, despite whispers that the recession is ending.
“Even when the economy seems like it’s going to recover, bankruptcies lag,” he says. “Small and mid-sector businesses won’t fully see the fallout until 2010.”
Paul doesn’t think restaurants will really recover until employment and consumer confidence pick up.
“If they’re not working, they’re not going out to have lunch at a fast-food restaurant,” he says.
To avoid bankruptcy, operators should think twice before expanding, experts say.
“Be very careful before adding any new locations until you’re sure your concept is working,” Paul says.
Also, he warns operators to maintain their level of quality.
“Cutting corners oftentimes is a mistake,” Paul says. “It will just drive away current customers. The pie is smaller right now, so you need to make sure you get at least your fair share of it.”
Mintel’s Caranfa agrees—especially since there’s a consumer emphasis on quality that will likely continue through 2010.
“Focus on premium quality and what your food is made of in your marketing efforts,” she says. “McDonald’s has done a really good job of this with their See What We’re Made Of campaign.”
In the case of bankruptcy, staying on-trend can also help a company survive the storm and emerge with a clean slate.
“The challenge of chapter 11 is that there still needs to be an exit strategy and financing to operate,” Stuart says. “You have to really understand what’s not working in your model and take it out.”