From a question on LinkedIn by Arthur Goldhaber
Q: What cost items get left out when store owners are figuring out what size loan they need to open a second location?
A: Here are some expensive items that owners often overlook. I have several small business clients that have recently gone through this—a restaurant, a bakery, and another company that moved to a larger facility. They were good at figuring the new operating costs, lease and facilities cost, and tenant improvements, but there were several ways they underestimated the cost of the expansion:
The cost of expanded inventory. Some owners try to purchase expanded inventory out of current cash flow rather than making that part of the new-facilities investment, and they soon go into cash crunch. Their cash reserves won’t carry them through the time between when they must pay for new inventory and when they get cash from selling it.
Hiring and training a top manager for the second facility. Assume the owner currently runs the first location, and has an assistant manager. If the assistant manager is not skilled or experienced enough to step into being manager of the second location, then a new and more expensive manager will have to be hired and groomed for some period of time. That is strictly an overhead cost.
Help for owner. Since the owner will be totally absorbed in getting the new place going, someone must take over many of his or her regular responsibilities. This may require hiring extra people. (But may be combined with hiring the new manager.)
The cost of getting needed approvals, negotiating a lease, designing the new interior, overseeing the tenant improvements. These things take a lot of the owner’s time, but they also may require hiring expensive professionals: engineer, consulting contractor, lawyer, architect.
Cost of changes in location #1. The original store may need an upgrade to bring it in line with the snazzy new place. May need changes in the back office to accommodate admin for two locations. They discover that their old systems are completely inadequate, and need an upgrade: POS, inventory control, employee time tracking, accounting, plus the computers and networking—all integrating multiple locations.
Hiring and training staff for the new location before it opens, and before it has positive cash flow.
“Stuff happens” funds, to cover delays, glitches, cost overruns. For example, “At the last moment, the city required us to upgrade our handicapped access.”
The cost of capital. They may neglect to factor in the cost of borrowing the capital they need, paying interest on the investment until the new location is profitable.
Get the right kind of loan. Some businesses try to finance expansion with their revolving line of credit, which must be repaid every year. This can actually force you out of business! You must get a term loan for 5 to 7 years, which allows you to repay out of the profits of the expanded operation.
Never finance long-term needs with short-term capital!
Don’t use revolving line of credit, credit cards, or vender credit–except for quick turnover items or as a receivables bridge.
Do use term loans (including a personal loan), equipment leasing, funds from second mortgage or your own savings.
The good news is, once a company gets its #2 location up and running successfully, #3 and 4 are a lot easier. And since you’ve proven you can do it, it’s easier to attract capital.