Small Business is Hard, Restaurants are Harder
Recently, my friend Dustin published the following essay exploring the unique challenge of funding restaurants, how a company called NuMarket is working to solve this problem, and why food businesses are essential to quality of place in small cities like ours. Locals will know Dustin Mix as the co-founder of INVANTI and co-host of South Bend on Purpose. His newsletter Small City Segment isn’t specifically about South Bend or food, but I believe this essay (while it contains more math than my writing) is important to the conversation we are having here on Food Belt, and I think you’ll enjoy it.
—Kath
If you are an independent restaurant owner, you can essentially eliminate traditional bank financing from your list of tools. Restaurants are notoriously tough to run and finance. They operate on razor-thin margins, have a lot of their cost structure tied up in labor, and suffer from volatility in multiple directions.
JP Morgan did an analysis in 2018 of the cash dynamics of their small business customers, across almost 600k businesses in the most common verticals.
The results were striking. The median business had 27 “cash buffer days” on hand - measured as the number of days the business could survive on existing cash, assuming no new inflows. The restaurant industry was the lowest subset of the sample, with a median of just 16 cash buffer days. On a daily basis, cash inflows for the median restaurant were $968, and outflows were $957, adding just $11 to their cash balance.
If you want a deep dive of what the economics of an actual restaurant look like, here is a great post from 2018 about a family-owned sushi restaurant in Seattle. The summary is that this business did approximately $1.3M in annual revenue, and after accounting for all expenses, and paying the two owners $50k each in salary, the net profit was 1.5%, or roughly $20k (and that was before they made the principal payment on their SBA loan).
Even Sweetgreen, a publicly traded fast-casual restaurant that did over $500M in revenue last year, faces tough economics - and that’s on $15 salads.
There are a lot of adages about the economics of restaurants, but one of the most poignant is, “Best way to make a small fortune in restaurants? Start with a big one.”
Quality of Place
Every city I know of is thinking about how to invest in “quality of place”. Communities are focusing on how to build the infrastructure and amenities that create great places to live—ingredients like robust transportation systems, public spaces, and dynamic Main Street corridors, full of restaurants, retail, and entertainment.
Herein lies the rub—while being notoriously bad investments and as hard as any business to run, restaurants are a vital piece of economic and social infrastructure that cities operate on top of everyday.
Coffee meetings, sales dinners, catering events, informal co-working spaces¹—relationships, including economic ones, are built around food and drink. If restaurants had even a tiny bit of upside in the economic activity they facilitate, it would be one of the economy’s most interesting index funds.
So here we stand with another contradiction—everyone wants to use them, but no one wants to finance them.
Except Those That Do
There is one group that can overcome the cold, rational financial reality of independent restaurants: customers.
We all have those places. Where you know the owner and the chef by name. Where you have a “usual”, but with enough coaxing, will try the new special to give some much-desired feedback. Where you call to host celebrations for your friend’s new job, your sibling’s new baby, weddings, birthdays, and even funerals. The word “restaurant” hardly does these places justice. Regardless of what their day jobs tell them about the economic prospects, even the accountants, lawyers, and bankers have this type of love for their favorite spots.
There is an adage that the best source of funding is your customers. This has historically referred to revenue, but in the last decade it has also come to mean other types of financing, facilitated by new regulation and crowdfunding platforms. From the simplest like Kickstarter to the more regulated like Republic, there are a lot of ways that businesses can engage their fans and customers.
Most of these still don’t quite work for traditional small businesses. The “perks” you have to offer create too much additional work or the compliance feels too complicated and risky.
Crowdfunding has always held the promise of being an end-around to the formal banking sector, but it doesn’t seem to have played out yet for our favorite brick-and-mortar neighborhood spots.
Where Crowdfunding Gets Tough
I recently spent time with a friend who runs a company that makes event and auction software for non-profit fundraising. I had attended a fundraising gala with a live auction, complete with auctioneer, paddles, and spotters. I asked if he had ever considered building features to keep the auctioneer, but replace the paddles with buttons and the spotters with a leaderboard. He said they’d thought about it, but when they pressure-tested the idea with their savviest customers, the unanimous feedback was that it wasn’t a good idea. The room would turn silent, the energy would drain from the auction, and the fundraising numbers would fall. The job-to-be-done was not to automate the auction, it was to make fundraising the most amount of money as simple as possible.
I mention this story because it highlights the idea that the obvious and non-obvious are close cousins. Of course making parts of the live auction process digital and automated is valuable. Keeping other parts analog and manual is just as valuable. Broad insights are necessary, but not sufficient.
The same goes with crowdfunding. Thus far, most crowdfunding has reflected existing funding paradigms. Kickstarter and IndieGoGo feel closely related to the “donations-for-perks” fundraising model of non-profits. Republic and Mainvest closely resemble the formal finance tools used by professionals and accredited investors. I think they all have their place, but none feel custom built for main street business needs. Mainvest might be the closest, but they don’t exclusively focus on customers and it appears they are shutting down next month².
The nuance in crowdfunding is not the insight that turning to your customers is an interesting way to finance your business. The nuance is in the how—what’s the best mechanism to align customers, businesses, and the facilitator in a way where all can win sustainably?
NuMarket
I met Ross, Founder and CEO of NuMarket, almost three years ago when he was just starting the company in the depths of the pandemic. It is a crowdfunding platform that actually makes sense for Main St. businesses, starting with restaurants and food businesses. What separates them is the mechanism they’ve chosen for funders to be repaid. Instead of creating new perks exclusive to campaign funders or going through the process of formal financial products, NuMarket makes it simple - if you fund the campaign, you get 120% of your contribution back in credits to use at the business. No “exclusive experiences”, no complicated legal documents. Customers simply pay upfront for things they’d buy anyway, and are rewarded with a premium for doing so. Here’s how it works:
Restaurants and food businesses identify an investment need (2nd location, moving from a pop-up to a storefront, a new stove, launching a CPG, etc.)
They launch a campaign for their investment need in NuMarket and market it to their customers
Customers contribute to the campaign, and for every $100 they put in, they get $120 back in the form of credits to be spent at the business
Once the campaign is over, customers receive their credits via email in equal installments over 6 months, used with a simple code at checkout
The goal is simple—strengthen the customer relationship, but don’t fundamentally change it.
Revenue is still the most powerful form of funding—but small changes in the timing of that revenue opens powerful possibilities.
It’s Always about Cash
One of the most powerful business model dynamics is a negative cash conversion cycle. Or in plain English, business models where customers pay before you have to spend money to serve them. Insurance, Costco, and annual software subscriptions all have this negative cash conversion cycle working in their favor.
There are different ways to build this dynamic, but one of the easiest is to get customers to pay upfront. Annual software subscriptions are the easiest example to think of here. You pay upfront for a year of service, and in return receive a discount to the monthly price.
If a restaurant can figure out how to do this, it can be impactful in multiple ways. Nick Kokanas, co-founder of Alinea in Chicago and founder of Tock, explains here what happened when he figured out he could get people to pre-pay for reservations at the restaurant:
…And this happened when COVID started so it's a good segue to that, every famous chef that went on TV said, "This is the kind of business where this week's revenues pay for bills from a month ago." And when we started to bring in money through deposits and prepaid reservations, tickets, I suddenly looked and had a bank account that had a couple million dollars in it of forward money. Like a lot of other businesses. Like the computer business. If you buy a computer then they ship it to you five days later kind of thing. So you have a float. So I started calling up some of our big vendors for big expensive items. Proteins, meat, fish. Luxury items like caviar, foie gras, that sort of stuff. And wine and liquor. And just said, "I don't want net 120 anymore. I want to prepay you for the next three months." And they had never had that phone call from a restaurant before. So basic economic theory would say well, how much should they discount it?
Let's say we're going to buy steaks and they were $34 a pound wholesale for dry aged ribeye. We're going to pay $34 a pound wholesale, get net 120. And I called the guy and said, "I'm going to use 400 pounds of your beef a week for the next four months for our menu, which is about $300,000 of beef. What do we got if I prepay you?" And he was like, "What do you mean?" I'm like, "I want to write you a check tomorrow for all of it for four months." And he was like, "Well, no one's ever said that." So he called me the next day. He said, "$18 a pop." Half. Half price.
…I went, "I'll pay you 20 if you tell me why." And he said, "Well, it's very simple. I have to slaughter the cows. Then I put the beef to dry. And for the first 35 days I can sell it. After 35 days there's only a handful of places that sell it for more than 35 days. Dry aged. And at 60 days I sell it for a dollar a pound for dog food. Literally." So his waste on the slaughter and these animals’ lives and the ethics of all of that are because of net 120. Seems like someone should have figured this out. As soon as he said that, everything clicked and I just went, "We need to call every one of our vendors every time and say we will prepay them."
An interesting way to frame NuMarket is that they are enabling restaurants to build temporary negative cash conversion cycles.
In essence, NuMarket allows businesses to pull forward 6 months of revenue from a subset of their customer base. They give them a discount for doing so, but are able to meter the redemptions by issuing the credits over a 6-month period. For a certain time, with a certain customer base, the business has an entirely different cash flow profile, opening up opportunities to invest in their growth without external financing.
But It’s About More Than Cash
There are clear financial advantages to doing this. Funding growth on cash flow rather than loans saves money in tangible ways. However, it’s not just about the financial advantages. There are other reasons this makes a lot of sense, even if it was cost neutral.
Customers are signing up for a 6-month relationship with the business. This can lead to greater retention and deeper relationships, both of which influence future business prospects.
It’s simple to implement. Once the campaign is over, the only obligation to funders is keep running their business. No sprints to deliver special perks, no new loan payments to make.
Customers feel invested in the business in a new way. They participated in a mechanism that opened up new possibilities for their beloved local business to continue pursuing their vision.
It works at small scales. The underwriting time for small loans is just tough to fit into the cost structure of a bank. But customers do their underwriting every time they come in for lunch or stop by for that scarce baked good. Whether it’s $10k or $100k, if customers love the product, that’s good enough. As Ross explained to me, “The biggest indicators of success are your existing community and your willingness to share the campaign to find new community. A coffee shop in a small city with a close relationship to 50 customers might raise more money on NuMarket than a 50,000 sq ft restaurant in Times Square in New York City. What we do is connect real people with the places they love and need, that's where the magic is.”
You can rinse and repeat. After a successful campaign and redemption period, businesses can run additional campaigns as new needs come up (many already have on the platform) and the customers already know the drill.
The Math of the Business
NuMarket’s business model is simple—they take 9% of the funding raised in a campaign. There are no minimums for campaigns to hit, so any dollars raised are released to the business, regardless of if they hit their stated goal.
Let’s look at how the economics work out for a campaign of $50,000. First let’s create a sample restaurant with realistic economics.
Now let’s look at a campaign wherein they raise $50,000.
Let’s make a few conservative assumptions:
All customers who participated in the campaign were existing customers
100% of them redeem their credits over the 6 month period
They don’t spend any additional money above and beyond their credits during that period (this has proven false thus far - when customers redeem, they spend an average of 1.6x their credit value)
The investment project doesn’t start producing new income until after the 6-month redemption period
If the above are true (very conservative), then the credits owed per month represent 24% of the example business’s typical monthly revenue. When the customer redeems credits, the direct cash outlay of that redemption is really just the COGs (assuming they are doing enough non-credit business to cover labor and overhead costs already). If that’s the case, here’s what the cash flow looks like:
So even if they were to set aside the COGs of the credits, they open up $27,500 of cash flow for investment. At first glance, you might say, “Wait a minute though - they raise $50k and only get $27.5k?” But that’s not quite right - the business is getting $27.5k to invest that they don’t have to pay back. At least not when it comes to cash.
Even if you get more conservative and say, well it’s not just COGs, there is also a labor component (combined, called “Prime Costs”), the business still has $6.5k to invest that they don’t need to repay in cash.
None of this accounts for the fact that based on the behavior they’ve seen so far, the 20% premium for credits is essentially a marketing expense. A customer who contributes $100 and receives $120 of credits, ends up spending an average of $192.
This might seem like magic, but it’s not. It’s the simple beauty of receiving funding in cash, but paying it back in value. In other words, the power of revenue.
It’s Early, but Showing Signs of Working
NuMarket got its start in late 2021. Since then they’ve facilitated over 100 campaigns worth over $2 million dollars. They have plans to beat both of those numbers this year alone.
These are still relatively small numbers in relation to the need and what it will take for NuMarket to build a robust business itself. However, Ross has been really careful and strategic about capitalizing NuMarket and stayed away from the venture capital path thus far. They are building the business campaign by campaign, focusing on staying lean and building tools that enhance their own efficiency and economics. When you spend all day with restaurant owners, I imagine their grit, resilience, and commitment to independence rubs off on you.
The Impact on Small Cities
A pushback on small cities is their “lack of interesting things to do”—restaurants, retailers, and entertainment options. Providing a great place to live means having this kind of infrastructure. Unlike roads and parks, these aren’t things a city government can just choose to build - we need small business owners and entrepreneurs to do that. And they often need some sort of modest capital to make things happen.
NuMarket offers a new way to think about enabling that capital. When I recently talked to Ross about how things are going, he told me they had just launched their first campaign in a small city—fancy’s in Burlington, VT. He said it had already “blown him and the team away”. Within two days they had raised $18k or their $20k goal to open a brick-and-mortar location after running a successful food truck. He also said that within 24 hours of the launch, four other businesses from the area had reached out about doing their own campaigns.
I think that’s where small cities and NuMarket really intersect. The relationships between these establishments and the residents of small cities are incredibly strong. The word-of-mouth network between business owners is established.
NuMarket is pushing a vision of investing by fronting the money we plan on spending anyway. And the businesses, in turn, pay us back with what we really value - the care, love, and dedication that show up in their food - something money can’t buy anyway.
1 - I’m literally writing this from The General in South Bend, co-working with my friend Susan
2 - Interesting side note, Mainvest raised a small “community” round on Republic themselves
Photography by Jacob Titus
