5 Key Challenges Impacting Restaurants in the Pandemic
13 Fund’s Philanthropic Investment Thesis on Small Business Development
Restaurants are an essential part of our cities.
From family outings to date nights, corporate outings to conventions — restaurants form an important component of our social lives. In San Francisco and New York, they provide livelihood for hundreds of thousands, often immigrants of Asian, Black, and Latinx descent.
When COVID hit in March 2020 and shelter in place (SIP) orders took effect, restaurants took a huge hit. One in three restaurants were estimated to close in the US last year. Revenue fell to 30% of the same levels last year. Six million Americans working in the restaurant industry lost their jobs.
We set up 13 Fund to support solutions to pressing issues affecting SF and NYC. The issues facing restaurants right now were clearly paramount to form the Fund’s first semi-annual grant.
To properly identify areas of investment, we spent the last couple months in diligence: mining public data and literature, meeting with affected restaurant owners, talking to government officials and academics. Our focus was on single or small chain restaurants owned by individuals and families rather than large corporations.
Through this research we’ve identified a significant shift in how we eat: from grocery shopping, dining out, and ordering in. We ultimately found five underlying challenges inducing closures of small business restaurants in SF and NYC.
- Falling Sales due to the loss of corporate patronage in urban areas, a shift from urban to suburban demand, delivery fees dominating margins, and an inability to transition cuisine or adopt technology
- Limited Access to Capital due to limited relationships with banks that could provide debt capital, lack of financial history to qualify for loans, and slow distribution of federal releief against an average three-month cash reserve
- Soaring Rent Debt due to inability to reduce commercial lease rates, with slow sales unable to compensate for deferred rent
- Labor Flight due to reduced labor hours induced by shutdowns, as well as high cost of living and closed public transit
- Government Program Stumbles due to unclear and changing requirements for restaurant permits to operate outdoors
In the parlance of finance, this report represents our investment thesis. We seek to make our first 13 Fund grant to a nonprofit working to address one of these challenges for restaurants in the San Francisco area. If you know an organization that might qualify for an investment from our 100k fund, please nominate them here.
An Unprecedented Market Shift
Our initial market research sought to assess the severity of impact on the restaurant industry — specifically small businesses with less than 5 locations. We reviewed reports from nonprofits, public disclosures, and industry insights.
The data was clear. Nationally, 1 in 7 small businesses has closed since March 2020. The impact on restaurants has been more significant in the same timeframe:
1 in 3 restaurants were estimated to have closed.
There was a clear precipitous drop in Y/Y revenue compared to equivalent periods last year. Immediately after SIP, sales dropped to 10% — 15% of their level at the same time last year. It has increased steadily since.
But revenue is still only at about 30% of traditional levels.
These trends were corroborated by surveys and government tax reports. The impact has been a $30,000 revenue shortfall every week for many restaurants in SF, and overall taxable revenue from restaurants in NYC is down 71%.
Beneath the hood, an observed shift in sales patterns has also emerged nationally.
We noted shifts in both the method, type, and time of day in sales.
Dine-In vs Off-Prem sales have flipped. Before SIP, the ratio was roughly 85:15, but has since stabilized to about 60:40.
Industry assessments have noted a marked reduction in sales during lunch periods.
Our own analysis of restaurant closure data via Yelp corroborated this fact — noting a 20% higher rate of closures between restaurants that serve lunch vs dinner.
But this is just the tip of the iceberg.
6 million jobs were lost nationally in the restaurant industry since SIP, as a repercussion to dropping sales.
In San Francisco, restaurants surveyed noted a 50% reduction in staff. Six months later, they have only rehired 25% of those originally let go. In NYC, total restaurant employment dropped from 315,000 to 91,000, and is now only back up to 174,000.
The adaptations to a remote world (off-site delivery, hourly adjustments, etc) clearly don’t cover the loss in sales. Restaurant sales in SF and NYC are still only at 30% of previous levels. So we next sought to move beyond the data and understand the reasons behind the closures and job loss.
Why Sales Are Dropping
The primary reason for restaurant sales reductions have been SIP orders. The simple fact that restaurants can no longer serve food onsite serves as a massive hit to sales when 85% of it used to be onsite.
The unpredictability of SIP orders makes things worse.
Predictability in sales revenue was noted as important for restaurants. It helps them know how many employees to have on staff every week, what hours to remain open, how many ingredients to order, etc. The whiplash of opening/closing every couple months has made it difficult for restaurants to budget cash flow ahead of time.
This has forced businesses to consolidate. Restaurants in regions of SF were especially dependent on corporate lunches, conferences, and catering.
With the majority of urban foot-traffic dissipated, restaurants have migrated to suburban / residential areas not dependent on corporate patronage.
In San Francisco there’s been a higher closure rate in urban areas like FiDi than there have been in residential areas like Russian Hill.
The other driver of consolidation centralization efforts is delivery. As offsite dining is the primary source of revenue during SIP, restaurants are consolidating sites for delivery or setting up ghost kitchens (delivery-only restaurants). Reports indicate nationally the number of independent restaurants will fall from 53% of the market to 43% in 2021.
A problem arises though for restaurants unable to make these transitions. Restaurants specializing in lunch, and therefore dependent on corporate foot-traffic, are now seeing a 15% higher closure rate than other restaurants nationally. Cafes and bars have seen a 20% — 40% higher closure rate. It has been difficult for these restaurant types to adapt their entire operations quickly enough.
Even restaurants that have been able to make the shift from lunch to dinner or onsite to offsite it have not been able to return to their original sales volume. Offsite dining and delivery in SF & NYC has shifted from 15% to 40% of total sales, but overall revenue is still only 30% of historic levels.
Restaurant owners we interviewed indicated a particular reason.
Delivery providers charge commissions of ~20–30% — while restaurant margins remain ~15%.
This means that at best, every delivery sale is break even. Restaurants owners noted that pre-COVID, delivery commissions were justified for bringing in new patronage, but now that it’s the only means of sale, it’s simply eating into their overall margins.
Additionally, the technical literacy and effort required to sign onto a delivery platform or build a website can be a barrier for many restaurant owners — especially for immigrants for whom English is a second language.
In summary, the reduction in sales has been due to a combination of loss of corporate patronage in urban areas, a shift from urban to suburban business, delivery fees dominating margins, and an inability to transition cuisine or adopt technology.
Access To Capital Is a Limiting Factor
With sales reduced, restaurants need to tap additional capital to stay afloat. However, access to capital — either savings or credit lines — is limited for most restaurants.
Breaking down the income statement of a typical restaurant we interviewed, we noted that nearly 50% of costs are consumed by Cost of Goods Sold (COGS) — 30% labor, 25% ingredients, and 15% rent. Margins on a sale, before taxes or investor dividends, averages 15%. Most restaurants don’t have any assets they could truly sell.
With such slim margins, restaurants typically have little to no emergency funds available.
Most restaurants report operating with 2–3 months’ cash reserves.
This lack of cushion has driven the high closure rates in the face of such a significant reduction in overall sales due to SIP.
Normally, a business could take on debt. However, experts we interviewed noted that most small business restaurants in SF and NYC are run by people of color.
Specifically, restaurants commonly have BIPOC owners, often immigrants, who have limited financial history, or lack the banking relationships, to qualify for loans.
And most banks don’t offer loans in the < $50K increments a small business restaurant would need. If they do, they charge high interest rates.
This explained a counterintuitive finding in our data. We noted that fine dining restaurants — obviously dependent on onsite dining — actually have a 100% lower closure rate than other restaurant segments. Anecdotal evidence in our interviews indicated that this is because the owners of fine dining establishments have banking relationships or rich patronage from which to access loans.
An additional source of capital in 2020 has been PPP, but this has limitations.
A majority of the PPP loans went to large franchises, not small businesses.
But it was also due to other factors. Of those that did apply, 23% were rejected, according to an SF survey.
Others couldn’t qualify at all. New restaurants often don’t have financial history to apply for PPP loans. Others employ a significant portion of undocumented workers, who also don’t qualify for federal aid or PPP. Even when funds were approved, it would take 1–3 months to receive — which is pushing the average 3 month cash reserves a restaurant has to begin with.
Accordingly, these issues of access to capital — limited banking relationships that could provide debt capital, lack of financial history to qualify for loans, and slow PPP processes eating into avg 3 month cash reserves — explain the difficulty many small business restaurants faced in staying afloat.
Rent Costs Are Contributing to Capital Debt
The second most common noted contributor to restaurant closures has been the inability to control rent costs.
Whereas costs like labor are variable, rent and lease payments for a restaurant are fixed.
A restaurant can reduce their hours to compensate for the lack of lunch traffic, but they still have to pay their monthly rent.
Accordingly, rents on commercial leases were one of the biggest sources of anxiety for restaurants interviewed. While landlords were empathetic during the beginning of the SIP orders and allowed deferral, as SIPs have been extended, rent forgiveness has been minimized.
NYC reports that 87% of restaurants did not make their rent payments in the fall of 2020. Many restaurants are taking on debt — through loans or deferrals — to get by. And that debt is accumulating every month against a reduction in sales.
And so many respondents have noted that they didn’t know how they were going to address the “mountains of debt” they are accumulating.
As opposed to factors like sales reduction and access to capital, to which we saw some attempts at adaptations (i.e. changing delivery methodologies or PPP loans), there were no clear solutions being utilized to address the issueof accumulating rent debt in our research. Some proposals for a moratorium on rent that could have assisted were promoted in the CA legislature, but unfortunately did not pass.
Labor is Fleeing
An important but often less talked about issue is the loss of labor talent. In fact, next to rent, this was the biggest concern of most restaurant owners interviewed when looking forward into 2021.
This is explained by the primary governing metric of restaurants: sales / labor-hour.
With sales reduced and rental costs fixed, the primary lever left to restaurants to reduce costs was labor-hours.
That has meant unfortunately furloughing or laying off most of their staff. Restaurant owners we interviewed noted that consequently, many restaurant employees have moved out of the SF and NYC metro areas to suburban locales or other cities with less strict SIP orders.
Restaurant labor was already incredibly competitive in SF and NYC. Cost of living combined with poor public transit options made it difficult for restaurants to hire talent to begin with. This flight of restaurant talent has restaurants concerned that even when SIP is lifted and sales resume, restaurants will not be able to easily hire the staff they need to recover.
There’s lots of conversation about tech talent fleeing SF and NYC, but unfortunately lost amidst the headlines is the flight of restaurant labor, which will have a more permanent effect on the restaurant industry long after the pandemic is over.
Government Programs are Slow and Have High Overhead
The last factor that emerged in our research regarding restaurant closures was the facet of government programs for small businesses.
One such facet indicated as a blocker were government permits. There are a variety of permits required to start a restaurant in SF and NYC, ranging from general business licenses to location permits for where food could be served.
We heard the process of applying for permits is difficult for most small business restaurants to navigate however.
The logistics to get a permit in SF appear designed to have lots of paperwork to limit the expansion of large franchises, but at the consequence of making it very difficult for any new business to get started.
Prop H and the Shared Spaces Initiative were passed in 2020 in SF to streamline some of the processes to apply for restaurant permits, but several advocates interviewed indicated the process is still too complicated for most small businesses owners to navigate — especially considering a majority of them are immigrants for whom English is a second language.
Confounding matters is that the permitting process often requires phone calls or meetings with government staff — instead of being fully digital.
But with government hours of operation limited during SIP, it’s even more difficult for restaurants to navigate and get the services they need to process their permit requests quickly.
Respondents also suggested that the government could support small businesses by increasing funding for small business grants. While difficult to execute at the city level in SF, due to the reduction in primary tax revenue (business/sales/hotel taxes). Proposals at the CA state level for grants are in process.
Despite all the money and attention directed at venture startups, non VC-backed small businesses are truly the economic engine for this country, comprising nearly half of all private sector jobs. The food and hospitality industry is the second largest industry for small business employers, and sadly, the neighborhood restaurant has been decimated during the past 9 months.
Through our research, we’ve determined that saving San Francisco’s small chain & family owned restaurants will require a combination of driving up sales, increasing access to capital, addressing rent debt, ensuring affordable labor talent nearby, and streamlining and enhancing government support programs.
We are looking to partner with a nonprofit organization that is tackling one or more of these issues to support small chain & family-owned restaurants in SF. If you are aware of nonprofit organizations that might be a fit, please let us know so we can consider them for the first semi-annual grant of 13 Fund.
13 Fund is deeply grateful to the following people who agreed to be interviewed in the research to prepare this Report:
Alex Dang (Opportunity Fund), Anna Schember (Opportunity Fund), Danny Sauter (Neighborhood Centers Together), Ellen Kim (Roti Mediterranean), Jenais Zarlin (SF New Deal), Kristy Wang (SPUR), Lenore Estrada (Three Babes Bakeshop), Marcia Hu (Send Chinatown Love), Michelle Huttenhoff (SPUR), Scott Kramer (Amplitude), Scott Weiner (CA State Senate), Stephen Zagor (New York University), Sophia Tu (IBM Foundation) William Ortiz-Cartagena (SF Office of Small Business), Wilson Tang (Nom Wah Foods)
