Forum: Restaurant chain’s second-half bankruptcy filings could offer new opportunities
Anyone who’s worked the back of the house at a popular restaurant knows how chaotic the kitchen can feel during a restaurant rush hour – line cooks and sous chefs furiously prepare food and send it out. The same intensity will also mark what the restaurant bankruptcy industry as a whole will experience from the remainder of 2020 until at least the middle of 2021.
But out of the haze of bankruptcy filings, there will be golden opportunities for a savvy private equity firm or other restaurant chains with an appetite for a bargain.
It should be noted that before COVID, Chapter 11 or 7 chain restaurant bankruptcy filings were on the rise despite a strong economy. In 2019 alone, companies seeking bankruptcy protection included Perkins, Houlihan’s, Restaurants Unlimited (several sites including Kincaid’s), Kona Grill, Granite City and The Palm. Excessive competition caused in part by cheap money and relatively low barriers to entry have helped fuel the upsurge in bankruptcies as well as excessive bank debt to finance expansion; poor real estate locations or rental conditions; an increase in delivery/e-commerce eroding restaurant margins; minimum wage increases in several cities; and changing consumer tastes. Additionally, restaurants have replaced retail tenants in many malls and malls, resulting in an overall decrease in potential customers for restaurants.
Even in pre-COVID 2020, at least five restaurant chains have filed for bankruptcy. The fact that COVID-19 was not even on the radar two weeks before the wave of virus-related shutdowns should be predictive of the massive additional impact of these temporary shutdowns.
The Paycheck Protection Program (PPP) helped slow the tide of failures among smaller chains, but for some, the PPP money was just prolonging the inevitable. COVID-19 has dealt an additional untimely blow to the casual dining space that cannot transition to a take-out-only model as quickly. Additionally, as restaurants begin to reopen — potentially more than once, as several states have rolled back some of their earlier opening plans — casual restaurants are dealing with reduced seating capacity on top of a litany of other unknown COVID-related requirements (providing and requiring personal protective equipment and requiring seat reservations).
In the meantime, several restaurant companies are renegotiating (or attempting to renegotiate) rental terms — most after at least missing the April rent payment — as well as renegotiating their loan operating covenants. In my experience, banks are more understanding than landlords, perhaps because landlords also have banks to deal with. Historically, landlords have generally been adamant about threats of bankruptcy when dealing with delinquent tenants. This may change with the realization that there may not be many new tenants available. Frankly, financing the growth of new restaurants is not going to be very easy from an equity or debt perspective.
So where does this leave us today? Some restaurant chains, like those in the fast-food space, will continue to fare better. For other chains, like those in the casual dining space, bankruptcy may be the only option. Other than a lucky buyer, there are few winners in a Chapter 7 filing.
Stock owners and owners are the losers. Even secured creditors usually receive a paltry sum of their initial investment; used catering equipment sales were weak before COVID-19, so one can only imagine how dire they will be after COVID-19.
For restaurants whose creditors are willing to fund bankruptcy, a Chapter 11 bankruptcy filing may be the only option. To be clear, a Chapter 11 is expensive – requiring teams of bankruptcy attorneys, “turnaround” management companies and other professionals who all require secure and expensive upfront payments.
However, whatever the flaws in the process, it’s inevitable that there will be a flurry of Chapter 11 filings for restaurant chains through the rest of 2020 and likely well into 2021.
On the positive side, for some potential buyers, whether other restaurant businesses or private equity firms, there could be substantial opportunities to reject those expensive pre-COVID leases for something more suitable. to the New Restaurant Model Diet. Restaurants, unlike physical retail, are not going away; people are social. We have to eat, after all.
Potential buyers of distressed restaurant assets are expected to begin their search soon. There are a myriad of investment banking firms available to help unearth potential deals. In my experience as an advocate in this area, these procedures take a little work and a good deal of strategy, just as any chef will tell you that a good menu requires careful planning.
Doug Holod is a partner at Maslon LLP, Minneapolis. He primarily represents technology/manufacturing and restaurant/retail clients.