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The COVID-19 pandemic of 2020 negatively impacted many business segments, with a particularly devastating effect on consumer-facing businesses such as restaurants and retail. Several restaurant industry categories, such as casual dining, were already exhibiting distress before COVID-19, which exacerbated the underlying deficiencies in those companies’ operating models. The effects of the changes, contractions, and distress that the restaurant industry underwent during COVID-19 are likely to continue long after we recover from the pandemic.
One interesting aspect of the restaurant industry’s distress during COVID-19 was the significant number of restaurant chains that filed for bankruptcy in 2020 but were unable to enlist any buyers to acquire their assets and help them emerge from insolvency. Ultimately, these companies pursued reorganization through debt-to-equity conversions in which the lenders became the owners of the business. Notable examples include Ruby Tuesday, the casual-dining chain now owned by TCW Direct Lending;  Studio Movie Grill, the movie theatre-restaurant chain now owned by Goldman Sachs and Crestline;  Krystal, the burger chain now owned by affiliates of Fortress Investment Group; and California Pizza Kitchen, the casual-dining chain now owned by a syndicate led by Jefferies Finance.
In these and several other cases, the lenders have effectively become accidental restaurant owners. After no qualified buyers materialized during the bankruptcy process, the lenders were forced to acquire a going concern as a last resort, operate the business, and hold it long enough to sell it to another buyer that would provide at least a partial recovery on the lenders’ loans. The lenders’ ownership time frame is likely to remain uncertain for the foreseeable future because, although there is currently an abundance of capital waiting to be deployed in the market generally, there are now fewer capital providers willing to invest specifically in the restaurant space than even before COVID-19, as evidenced in part by the bankruptcy cases noted above. Capital sources that remain interested in the restaurant sector are waiting for industry performance and valuations to improve before committing funds to properties that were significantly distressed during, and in some cases before, the pandemic.
The typical goal of an accidental owner is to hold the assets for a finite time period and stage the business for an eventual sale. But until that happens, how can an impatient lender be sure it is adding value to its accidental acquisition, and thereby improving its potential recovery, while it waits for the industry to turn around and valuations to stabilize?
First and foremost, the lender should view itself as a caretaker of the assets it has recently acquired. Because restaurants deliver both a product and an experience, being a capable steward of a brand that delivers customers what they want in the way they want it, all else being equal, is critical to preserving asset value and therefore increasing the lender’s probability of achieving a sufficient recovery when it sells the business. Although lenders should not aspire to be long-term restaurant owners, neither should they focus solely on stopping the cash burn with short-term tactical moves that harm the brand, drive away customers, and reduce enterprise value in the long term. This is particularly important if the lender now owns a group of restaurants that are part of a national brand and subject to contractually mandated standards. A lender that adopts a caretaker mindset is likelier to make more measured and thoughtful decisions that increase the value of the business, even for the limited time it holds the asset while it prepares for an exit.
Once the lender has fully adopted this mindset, it should focus on being successful as a temporary restaurant owner. Based on our experience operating both healthy and distressed restaurant chains, we have identified four success factors of temporary restaurant ownership that help stabilize the business and stage it for an eventual sale:
As in any business, having the right people in leadership positions is both crucial and easier said than done. However, in the restaurant business, in particular, even the best-made product falls flat with customers if the service and atmosphere that deliver it are substandard. The impact of a dysfunctional corporate team – one that undervalues its employees, underinvests in the guest experience, raises prices with no commensurate increase in value to the customer, and has no history of managing distressed situations – will reverberate in the field, from the general managers down to the servers at the front line of delivering the product to the guest. Therefore, a lender should assess to the best of its ability whether the current management team is up to the task of stabilizing the brand, improving performance, projecting even-keeled leadership in the face of distress, and increasing enterprise value with an eye toward a sale transaction. The team should be incentivized with a compensation plan that aligns with the lender’s goals related to operational stability, brand management, time horizon, and exit valuation. Finally, if key members of the executive team have departed or the current management team finds it difficult to address this admittedly unique set of challenges, consider hiring an interim-management team to close the gap and achieve these goals more quickly, as a new buyer is likely to appoint its own management team at closing.
Restaurant holding companies that filed for bankruptcy were able to close unprofitable locations and obtain landlord concessions during the insolvency process. This improved cash flow and stabilized the business in the near term, but it did nothing to reverse the sales declines that resulted from pandemic-related governmental restrictions and the fear of public gatherings. Although relaxed restrictions and higher vaccination rates are starting to reverse those declines, the high break-even point in the typical restaurant’s operating model means it could take months or years for restaurant chains to generate positive net income, even after the changes they undertook to reduce the cost structure during bankruptcy. In addition to funding near-term P&L losses, lenders who now find themselves in an ownership position may need to fund potentially high deferred-maintenance expenses and one-time reconfiguration costs as guest counts eventually return to normal levels. Therefore, lenders that now own restaurant chains should be prepared to make significant funding commitments after the exit from bankruptcy, especially while guest counts are below break-even.
Management experience alone is not sufficient to stabilize and fix a restaurant chain; having accurate, timely and actionable data, and knowing which data points to focus on, is critical to the success of both healthy and underperforming properties. Most of our middle-market clients have extensive data in their IT systems but are often unable to harvest the information and turn it into actionable KPIs, and restaurants are no exception. Although many restaurant chains were making data-driven decisions before the pandemic, those that expanded the traditional guest experience using third-party delivery, social-media advertising, mobile applications, menu optimization, and targeted promotions survived the pandemic without a more drastic restructuring. The new lender-owners of restaurant chains that exited bankruptcy can deploy the same information-management strategy to determine menu-price elasticity, location-level profitability, promotional effectiveness, guest-count trends, and labor utilization to fix the business post-emergence, all of which can improve performance as guests eventually resume their pre-pandemic dining habits.
Certain initiatives, such as rebranding or concept redesign, have long-term payback targets and a wide variance of outcomes. As these may fall outside their ownership time horizon, lenders should focus on short- or medium-term investments with a faster and less variable payback such as customer experience and food quality, improving third-party delivery platforms, and developing business-intelligence reporting, KPIs, and guest-experience tracking. Other examples such as labor and inventory management and menu-mix optimization may be done quickly with minimal investment while overhauling kitchen flow and procuring new proprietary products require more staged rollouts. Moreover, certain investments, such as the addition of corporate staff to replace outsourced functions, may not yield incremental exit values; strategic buyers tend to leverage their own back-office infrastructure and not compensate the accidental owner for its investment.
Of the four success factors above, getting the right management team in place is the most critical component and the largest driver of exit value. But how does the accidental owner know that the management team is bringing value to the customer?
One advantage of the restaurant industry, along with other consumer-facing businesses, is that the ownership group can observe in person how the management team’s leadership affects store performance. To that end, put yourself in the position of a customer. Make unannounced visits to locations and have a guest experience yourself. Observe curb appeal, interior and exterior upkeep, ambiance, service, hospitality, and food quality. Engage in conversations with servers and managers regarding their impression of the brand, location, and leadership. Finally, consider retaining seasoned restaurant-industry professionals as board members or advisors to complement or assess the management team, physical locations, and business plan.
As with other industries during the COVID-19 pandemic, lenders who have become restaurant owners by default are in the unusual position of being forced outside their mandate to operate a business that they know needs to be sold in a short period of time. Thinking of themselves first as caretakers of brands, then understanding the keys to the success of temporary restaurant ownership, will help the accidental restaurateurs increase the value of their assets and stage the companies for sale – and one day return to those restaurants as guests who can enjoy their experience without having to think about managing these assets after they pay the check.
CR3 Partners, LLC is a national turnaround and performance improvement firm that assists, guides, and collaborates with management teams and their constituents facing any sort of transition, stress, or distress. Sugi Hadiwijaya and Dawn Ragan are Partners in CR3’s Dallas office, and Barak Tulin is a Partner in CR3’s New York office. Peter Feigenbaum, a Director in CR3’s Dallas office, contributed additional research for this article.
 Epiq Cases: https://dm.epiq11.com/case/rubytuesday/info
 Donlin Recano: https://www.donlinrecano.com/Clients/smgh/Index
 In re Krystal Holdings, Inc., No. 2020-bk-61067 (ganb) (Bankr. ND Georgia)
 Prime Clerk: https://cases.primeclerk.com/CPK/Home-Index