What Kind of Business is a Restaurant?
Opening a restaurant is perhaps one of the most stressful things you could do. The restaurant business is famously tough on newcomers [1] and with so many moving parts, unprepared restaurant managers can quickly get overwhelmed.
It’s essential that restaurant owners have a handle on things such as food, decor, and staff as these are what will get hungry customers through the door. For continued success, however, it’s also very important that they consider the business structure that will work best for them.
Before you make that decision, let’s define what kind of business a restaurant is. Only then will you be able to structure your restaurant in a way that sets it up to achieve your short and long term goals.
What category are restaurants in?
It may be helpful to think of restaurants as a sort of Russian doll. Restaurants and other places that serve food sit in the “food and beverage” category of the hospitality industry. In turn, the hospitality industry sits in the broader service industry [2].
While this classification is broadly correct across the world, different countries will have different codes and business standards set in place. Before you open your restaurant, it’s important to properly research and understand what the government will require from you.
Now you have a general understanding of how restaurants are categorised, let’s go through the various business structures you could choose for your business. The right structure will make the running of your restaurant as simple as cutting an onion.
How to Choose the Right Business Structure
Although it may not be as exciting as putting together the menu, choosing a business structure is just as vital to your success in the industry. The day-to-day of your restaurant relies on getting this right.
In the hospitality industry, restaurant business owners have five basic legal structures [3]. These are:
- A sole proprietorship
- A partnership
- A Limited Liability Company (LLC)
- S Corporations
- C Corporations
By exploring these options in more detail, you’ll be able to make a much more informed decision. You should be aware that depending on the size of your business, the choice may be made for you.
Sole Proprietorship
Sole proprietorship is a business structure for self-employed people. In essence, being a sole proprietor, also known in some countries as a sole trader, means that you are the sole owner of your business. Your personal and business assets are combined and your finances are private.
This structure is best suited to smaller restaurants and food trucks as the simplicity of the structure allows you to get started very quickly with low overheads. Sole Proprietors in the food and beverage sector are required by law in many countries to obtain licences and permits related to location and food safety [4]. As always, make sure you check the local laws and requirements in your country.
If this sounds like the route you’d like to take, be aware that there are a few downsides to this particular structure. As sole proprietors have unlimited liability, there’s no legal distinction between your business and personal assets. This means that in a worst case scenario (for example, a customer has an allergic reaction to an undisclosed ingredient), lawsuits could claim your house or car.
A Partnership
In a general sense, a partnership is similar to a sole proprietorship shared between two or more people. This structure means that the responsibilities and liability of the company are split between the partners [5].
Partnerships can be as simple as the partnerships deciding on their roles and responsibilities amongst themselves. In the US, the partners also have the option to form a Limited Liability Partnership (LLP). An LLP formalises the relationship and means that each partner’s liability is limited to the amount they initially invested into the restaurant [6].
Disagreements between partners can be a major downside to the arrangement. If not handled correctly, these disagreements can cripple your restaurant and lead to closures. Before you form a partnership, sit down with your partners and ensure you are all on the same page.
Limited Liability Company
A limited liability company (LLC) is a very popular option with small to mid-sized restaurants [7]. In terms of a restaurant, an LLC is a legal entity that separates the owners and the business in a similar way to a corporation.
The popularity of LLCs in the restaurant industry can be attributed to the limited personal liability that comes with the structure. If you can’t pay a creditor or if there is a breakdown in communication amongst the owners, your personal assets would be protected [8].
As there are more regulations that come with forming an LLC, it can be more expensive to set than sole proprietorships and partnerships. This may be a roadblock in your decision until your restaurant is firmly established [9].
S Corporations
If you’re already an established business and have an ambition to grow at a sustainable rate, it may be a good idea for your restaurant to become an S Corporation (or S Corps). These businesses are corporations that are owned by up to 100 people. These shareholders share in the losses and profits of the corporation depending on how much they invested.
Once a restaurant has reached a certain level of success, the owners may choose to become an S Corporation. This is a good way to keep the business at a manageable level while also collecting investment that allows them to expand in new areas and markets.
A much higher level of regulation can be a major downside for some S corporations. As an S corp restaurant, you would be expected to have a board of directors, hold board meetings, and keep detailed records of your dealings [10]. It should also be noted that S Corporations are exclusive to the US.
C Corporations
Many restaurants will never reach the level of a C corporation but it is useful to have knowledge of what they are. C corporations could be thought of as an upgraded S corp in that they can have an unlimited number of shareholders. Almost every publicly traded restaurant company is a C corp for that exact reason.
In the US, C corporations are subject to “double taxation”. First, the corporation is taxed and then the shareholders are taxed based on their return from their investment [11]. Just as with S corps, the option to become a C corp is limited to the US.
While it is uncommon for restaurants to become C corporations, it is certainly an ideal for you to work towards.
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