Should Restaurateurs Consider Revisiting Their Operating Agreements Under COVID-19?

By Kurt S. Kiess  |  April 16, 2020

Restaurant owners often reflect on the start of their businesses and how they could have done things differently. During my career as the accountant for many well-known restauranteurs, I have worked with some who entered into very unfavorable ownership structures at the beginning of their careers. A chef may have the passion and talent to open a restaurant, but lack the requisite capital for fixed assets, leasehold improvements, security deposits and training of staff. They may reach out to friends and family members to contribute in order to open a new restaurant. What happens, as I have seen too many times, is that the subsequent simple operating agreements of these scenarios only calls for a split of the income in terms of everlasting ownership interests. Such an agreement limits the amount of compensation to the founding chef, resulting in an overallocation of the continuing profits to those initial investors and a less than favorable allocation to those chef partners who operate the restaurant on a daily basis and are responsible for its success.

Why do I bring this up now? Well, with the industry-wide shutdown caused by COVID-19, the present time may be an occasion to revisit your operating agreement and make adjustments if necessary. There will be many steps to take to reopen your restaurant once the COVID-19 crisis recedes, but nearly every step requires one thing– capital. Drastic changes to the operating environment may mean revisiting operating agreements with your investment partners, all with the goal of protecting the future of you and your restaurant once the industry returns to something like business as usual. Sure, opening a restaurant is risky, and it is appropriate that those who put up the capital should be rewarded.  But, how long should that reward last?  Once a predetermined amount has been distributed to the initial investors, in some cases, a change in the allocation of profits to favor the operating talent is warranted. Some well-structured agreements I have seen indicate that initial investors receive a preferred return, and once that is received, there can be a change in the income allocation. This reallocation sometimes occurs when the investors have received their original total investment through distribution of profits.

One of the first steps to reviewing your existing operating agreement is to check for “capital calls.” Some (but not all) operating agreements provide for capital calls of all partners, a requirement that partners contribute more capital under an agreed upon set of circumstances. During this crisis, you should check whether your operating agreement (or shareholders agreement) provides for a capital call. Should those provisions not be included, you may find that initial investors choose not to put up any more capital during this crisis. If this happens, consider buying out those investors pursuant to mutually acceptable financial terms. This action will assure that the remaining partners will be the sole beneficiaries of the huge effort to reopen your restaurant and that they will receive the corresponding profits from their effort.

If no agreement can be reached with the existing investors, consider this seriously: is it best to not reopen the restaurant, and, if possible, to start a new venture? No one is sure what the future holds, but I think everyone can agree that it will take an enormous effort on the part of many passionate restauranteurs. If so, take this opportunity to address any prior issues in your operating agreement and be sure you will be rewarded for the recovery effort. Restaurant operators must ensure that they will receive the benefit of their renewed efforts to reopen successfully.

There are many steps you can take now to be better prepared when you reopen your restaurant. The sooner you start, the better positioned you will be. Speak to your lawyer and accountant about whether restructuring your agreements is appropriate, and as always, best of luck to all in the restaurant industry as we weather this storm.

 

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About Kurt S. Kiess

Kurt S. Kiess, CPA, is a Partner at Marks Paneth LLP. He has a broad background in the audit and tax aspects of his profession. Mr. Kiess concentrates on serving clients in the real estate, retail, insurance and manufacturing industries. With a public accounting background spanning more than 30 years, Mr. Kiess was a Partner at Marks Shron & Company when it combined with Paneth, Haber and Zimmerman LLP to form today's firm. He has developed... READ MORE +


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