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John Gordon - April 2019

Is there really free lunch?

How to think about TI (Tenant Improvement) Fundsby John A. Gordon, Principal and Founder of Pacific Management Consulting Group In the numbers intense restaurant business, we are pushed to converse in financial phrases that don’t really convey what we mean. One of course is the use of the infamous of earnings before interest, taxes depreciation and amortization (EBITDA) as a financial and debt stress metric.  EBITDA came into vogue in the 1980s and 1990s with the entry of US leveraged buy outs, corporate raiders and then big mergers and acquisitions entering the restaurant space. The problem is, as Warren Buffet says, is EBITDA is “profit before everything”. Many charges and outlays are missing or have to be inserted after the EBITDA number; I insert G&A, maintenance CAPEX and debt service to the analysis I do for clients. Another form of questionable shorthand exists with the common narrative pattern and analysis of landlord tenant improvement funds. Some discussion will be helpful. What is TI? Tenant Improvements (TI) is often expressed initially in a lease letter of intent and must be negotiated and finalized in the lease itself. It is an inducement to sign you, as the landlord offers to offset a part of the buildout of your restaurant. It is typically expressed as a dollar per square foot, or a fixed dollar amount. Tis for chain restaurants might run $50,000 to as high as $700,000 for one very expensive casual diner I saw documented.<1> The amount of the TI will depend on the financials of the developer, as the landlord has debt service and a capital budget just like you do. The landlord wants early lease signings and just the right brand to complement its retail development mix. Your credit history and brand strength are very important, as is the amount of demand for new sites. A very nice restaurant lease downloadable reader is: Is there free lunch? Answer: No! The developer/landlord is a risk taker, just like you. They are hoping if they develop it, it will be leased. It is like you and hoping customers will come after you build. To get their financing, landlord/developers have to submit a multiyear financial projection like you do. If they give you TI, it helps you in getting built out with less of an upfront dollar investment before you open. But is it smart?  The landlord understands that restaurant sales may ramp up after a build to maturity stage. They have to recover the TI outlay somehow over time, so you will see future year rent escalations. One suggestion: analyze and negotiate both ways, with and without TI. What is the total cost to lease over the lifetime of the lease with and without TI?  Can you get some other concession (like CAMS or competitive lease intrusion terms) that might be more valuable? New Store and Remodel ROI Analysis: What Not to Miss Thinking About Chain restaurants including including franchisors, will occasionally discuss their “cash on cash return” for the new unit or remodeled units on earnings calls or in investor presentations. This is also sometimes called the “simple cash on cash return.” They add the hard and soft costs<2> to open or remodel, and subtract any Tis received.  The store EBITDA is then divided by the TI reduced buildout cost. While virtually all restaurant ROI numbers are displayed this way, there are several things to think about with this approach.

  1. What is the time period in the cash on cash return calculation? Is it year 1 or year 3? We all would hope that the year 3 cash on cash return is more favorable to the year 1 number, but sometimes not.

  2. Knowing that the landlord has to recover the Tis, what will the cash on cash number be after rent begins to escalate? The capital investment to build or buildout your units are one of the most important cost outlays and drivers to your financial return. In the last ten years, more restaurant sites have failed or filed Chapter 11 or 7 because the economics of placement of the new stores and remodels haven’t worked. One way to avoid this is to keep score the right way. John A. Gordon is a long-time restaurant veteran, with operations, corporate finance staff and management consulting experience. He knows which rocks to look under, and works complex restaurant analysis for investors, operators, franchisees, attorneys and others. He is a Master Analyst of Financial Forensics (MAFF), and can be reached at, office: (858) 874-6626, website: <1>  Yes, one company actually pocketed the Tis granted in New York City but did not open the stores! The CEO went to prison. <2>  Hard costs typically refer to new construction, building improvements and equipment, while soft costs refer to permitting, A&E, training costs, etc.

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