Calling All Angels
Finding Financing For Coffeehouse Startups
By Penelope Trunk - Illustration by Dylan Howard

It sounds simple enough. Tom DeGree of Minneapolis, Minn. wanted a coffeehouse where he could hang out with his friends. And he knew there were hundreds of other people like him in his neighborhood who wanted a place like that. He took a university course in coffeehouse management. He wrote a coffeehouse business plan with the help of a consultant. Convinced he had all his ducks in a row, he then made a trip to his neighborhood bank for a loan. The loan officer did not even look at the plan before rejecting it: "We don't do foodservice," the man said.
   Most people don't open a coffeehouse as a get-rich-quick scheme, which is good, because it would be a bad scheme. Coffeehouses take years to build a clientele. But most lenders look for a possibility of high return in a short-term period. Finding financing for your coffeehouse will require working around this basic problem, finding angels of financial support wherever you can.

Beyond The Cold Shoulder
In a perfect world, you'd have all the money you need to open a coffeehouse. Kevin Fuller lives in this perfect world, having opened The Albina Press, a coffeehouse in Portland, Ore. in October 2004 with money he had saved from a previous career as a stock broker.
   Yet even Fuller took out a loan, because, as he puts it, "The best time to get a loan is when you don't need it." This is because banks want to minimize their risk. It's a Catch-22: The more you need money, the less likely you are to get it.
   Most regular banks will refuse to finance coffeehouse startups, mostly for the reason DeGree discovered. Coffeehouses are considered foodservice, and over 90 percent of all restaurant startups fail within the first two years of operation. Would you lend money to a business that was almost certain to fail? Probably not. As a coffeehouse owner, you may know that your business has a different trajectory, and decidedly better prospects, than a restaurant. But you'll go dry in the mouth trying to make this case to an underwriter.
   Another reason for rejection may be, well, personal. Coffeehouse owners are a diverse lot. Since the industry in its present form is relatively young, most prospective owners don't have years of experience or a diploma from a "Cordon Bleu"-type training school to fall back on. Most appear to move into this field after having succeeded-or failed-at other things. And while they are motivated and committed, it's hard for conventional loan officers to put their own jobs on the line for these kinds of qualities. For them it all boils down to points, debt-to-income ratios and the like.
   So after receiving your rejection, you'll want nothing more than to exit the bank with your tail between your legs. But Ed Arvidson, a consultant with Eugene, Ore.-based Bellissimo Coffee InfoGroup, says that you can still use these institutions as a mine of information that can help you in the long run. Arvidson has found that behind every "No" is a tip on where there might be a "Yes."
   "Don't be humiliated if you're shut down by a bank," he advises. "Ask why you were rejected. For example, if the bank says, 'We don't do foodservice,' ask which bank does. Or if the loan officer says, 'You don't have enough money to put down,' ask how much he requires."
   That said, most of Arvidson's clients do not land a loan from a regular bank and end up trying alternative avenues of financing. The good news is that these do not involve grand theft, counterfeiting, check kiting, or any other felonious activity. The bad news is that finding money is a job in itself, equal parts economics, theater and faith.
   After their rejection, DeGree and his partner Dean Schlaak eventually opened Coffee Time in Minneapolis with a small business loan. The requirement for small business loans vary from state to state. In Nevada, for example, it is notoriously difficult to obtain one. But these loans are generally easy to obtain as long as you don't need too much money and you can kick in some money of your own. The Minnesota state loan DeGree took is called a Small Business Administration Low Doc Loan. The name describes the quick, relatively easy process, which is only a one-page form. The maximum amount DeGree could obtain was $150,000, and he had to put up one-fourth of the loan himself. Here's where faith came in. For their share, DeGree and Schlaak took out a home equity line of $50,000, and they heard back from the Small Business Administration in just one day.
   You should check with your state's Small Business Administration for exact requirements, but Arvidson says you usually have to bring one-third of your startup costs to the table. The bank gives you the other two-thirds and the state backs half of the bank's loan. Just as in any lending situation, you should prepare written financials so you can show the loan officer that you have determined startup costs and operating capital requirements.
   Minority business loans and loans for women entrepreneurs are other unconventional channels that you should explore, if you fit the categories for which they were designed. These are more readily obtained in some states than others, and may require you to scale down your aspirations, but can help you get a foot into the coffee door.

Other People's Money
Coffee is a passion. And some prospective owners will do virtually anything to open a shop. Like gamblers riding a streak in Vegas, they'll ignore the risks, compelled by their commitment to quality coffee.
   But given the inherently high level of financial risk in a coffeehouse, investing your own money could be a disaster. "If you're not prepared to lose your own money, you should look for money from other sources," says Arvidson. "Don't mortgage a house or cash out a 401K if the loss will devastate you."
   If-or rather, when-the banks turn you down, and you are unwilling to risk your own money or just plain don't have enough of it to risk, you can either postpone your dream of coffeehouse retail, or scale it down. Denise Gulgren wanted a coffeehouse, but the realities of her minority small business loan required her to scale back her vision to a coffee kiosk, a very modest endeavor with very small financial requirements and little risk. Once she found success in that venture, she moved into a full-fledged shop. At that point, she had an established customer base, an established business model and a track record that could impress a bank.
   If you remain committed to your vision, come what may, you may have to take a more serious look at obtaining other people's money.
   So called "angel investors" are people who know you well and may want to do you a favor. This could be a friend, family member or professional investor, though this latter category will be tougher on you. As one anonymous portfolio manager at a Seattle, Wash.-based hedge fund puts it, "For me to be interested in funding a coffeehouse, you'd have to have a viable way to rise to the level of Starbucks."
   But there are ways that even normal fallible mortals can structure a deal so that friends and family feel like it's a decent investment. Arvidson suggests paying higher interest rates than a bank. You could also offer a piece of the business. For example, agree to pay back the loan plus pay five percent of the business profits. Think hard before going this far. Five percent is a potentially limitless amount over which you have little control, and as the business grows, the angel is likely to be interested in monthly financial statements and other paperwork that will be burdensome to you.
   You may not think angels exist. But you'd be surprised at how many coffeehouses rely on them for getting started. Consider the case of Lara Miller, co-owner/operator of Blend Coffeehouse + Cafe in Portland, Ore. Miller had a background in corporate sales and marketing, but no experience in foodservice or coffee. She knew she wanted to open a shop where she could be herself and contribute positively to the neighborhood. But she also knew she didn't look good on paper. Business plan? "I didn't even go there," she laughs. "I knew there was no way a bank was going to give me money." But her godparents did, free and clear, without even being asked. Combined with retirement money and the assistance of her mother, their contribution enabled her to purchase an established coffeehouse for $55,000. And Miller has proved herself, increasing business at the location over 50 percent in just over a year and a half.
   Robert Stell, owner/operator of Redlands, Calif.-based Stell Coffee and Tea, has been in business for just over a year, courtesy of an angel investor. Stell had been working for five years at a coffeehouse, and had struck up an acquaintance with a regular customer who had a background as a day trader. It happened that the man was also known to Stell socially, through other friends. When Stell's idea of buying into a franchise from his employer fell through, he learned that the coffee-loving customer was looking for new investment opportunities. Something clicked, and a new business was born. In this case, the angel brought 100 percent of the funding to the table, while Stell and his other business partner brought experience in the coffee industry. "He had already seen us in action," Stell recalls, "and knew our work." Stell retained creative control and a 35-percent share of the business, a percentage that is growing through sweat equity. Stell and his partners have just opened their second store. In this case, the angel invested over $100,000. It helps that he owned the building and did capital improvements himself, so the company is basically renting from itself.
   When putting together your pitch to angel investors, it's important to be forthcoming about the risks involved, and the expected rate of return. Your presentation should be thorough and professional, even if you know the prospective angel well. The coffee business will generally not hit the high figures that angels usually strive for. But on some level, these people come to the table based on their trust and respect for you. And this trust and respect is what you are trading on when it comes to angels. By all means, do not mislead potential investors. You don't want to end up in a court battle with someone you once considered such a good enough friend that you could ask for money. Even though Stell's investor was familiar with legal matters, and their agreement was what Stell refers to as "loose," the partners used an attorney and a certified public accountant to make sure all aspects of the deal were handled properly.
   Tom Matzen, founder of the San Diego, Calif.-based consultancy, Quantum Growth Coaching frequently speaks about how to line up angel investors. He advises listing everyone you can think of who could possibly loan you money. Then divide the list into A's, B's and C's. The A's are people who have a lot of money and a lot of investments. The B's are financially stable people who would think very, very hard before forking over $25,000. The C's are people who don't really have the financial resources to invest in your operation, but they might, in a blue moon, come through.
   Practice your pitch on the C group. Send an e-mail to the list briefly outlining the proposition. If someone responds then go ahead and meet with that person to practice your dog and pony show. Remember to personally guarantee that the angels will get their money back. Say you might not be sure when, but they will get it back. Then go to your B list and do the same thing. By the time you get to your A list, you'll be ready with your pitch. In fact you'll be good at it, and you'll be much more likely to land an angel, or even two.
   Stell wants prospective coffeehouse owners to know that the relationship with angel investors does not end with startup. "If you do find an investor, make sure you have the same vision. On paper everyone might be happy, but you have to be able to weather the hard times. Investors don't work from opening to closing, and if you're not on the same page, the owner could become bitter. Even with big-time financial help, it is still your responsibility to pay the bills, train the employees and all the rest."

Start Real, Stay Real
Coffeehouses do not actually fail at the 90-percent rate of foodservice establishments. But financial problems still drive the majority of coffeehouses to the point of liquidation. It's easy to blame banks and lenders for this, but many owners set themselves up for failure by not getting "real" about the scope of their liabilities and the prospects for success. The most common cause of these early business failures is underestimating startup and operating costs.
   Financial whiz Fuller remembers his incredible surprise as he unearthed taxes and fees that he had never predicted. City and state permits were seemingly endless for his Oregon business. For example, he paid a $20,000 "system development charge" because he wanted to turn an art gallery into a coffeehouse, which increased city traffic. And, like any construction project, cost overruns are inevitable, so you need to plan for the unexpected. Fuller recommends doubling all your estimates.
   Once the financial spigot is open, it will stay that way for some time. Arvidson says it is not unusual to burn through $18,000 in the first month. This doesn't mean you'll have an astronomical burn rate forever, but the first few months are tough, with very little money coming in. In Arvidson's experience, people underestimate the operating cost because they tweak the financial plan to fit their capabilities, and are incapable of separating their emotions from the business. "In their head they can hear the guitarist in the corner and the poetry in the background and smell the coffee brewing," and pay no heed to bad signs.
   All of this plays into your business plan or concept, which is what lenders or angels will look at to judge your chances for success. If it's not reality-based, don't expect a lot of support.
   Once you have finally cobbled together financing from a variety of sources, you must still stay true to the honest accounting you have initiated in your startup pitches. Now it's time to re-evaluate your numbers, to make sure they are realistic. These should be conservative, perhaps even pessimistic on the side of your required financial commitment. Arvidson notes that half of all the people who come to him for advice on opening a coffeehouse ultimately decide they don't have enough money to do it. That is a sign of maturity, and success. The industry doesn't need more fire sales.
   What it does need are entrepreneurs who combine a passion for coffee with an understanding of small business, and even big business. The skills of an entrepreneur are unlike those of anything else. Ardvison cautions that the skills required to manage a coffeehouse are very different from the skills required to raise money for the venture. Conrad Bland, owner of Belgium Beans Café, cites commitment as the most important trait. And the ability to pull yourself through unstable, difficult times: "You're going to hurt for a while," he warns newcomers.
   You're also probably going to make mistakes. But bad decisions needn't derail you entirely. Know which decisions are crucial and where you can make a mistake and work around it. For example, Arvidson warns against signing a lease that's too expensive, a decision that will set you on track for failure, regardless of the quality of your coffee. On the other hand, paying $400 for a brewer when a much cheaper airpot would have sufficed for your needs, is a goof you can live with. It's all a matter of scale, and researching the market will help you keep expenditures in balance, relative to one another.
   If you plan on diversification from the outset, you are more likely to impress investors, and hence more likely to attract support. Most coffeehouse owners know enough to develop a manageable food menu. Denise Gungren bakes scones for her own coffeehouse and also sells them wholesale to her competitors. DeGree sells food and wine, which makes customers' orders a little larger and DeGree's margins a little higher.
   You can also lower startup costs by creating your own construction team. DeGree recommends that you find a partner, friends and even family who can help with the build-out of your coffeehouse. The nature of construction is that costs are difficult to keep in line, and timelines are hard to control if you are not your own contractor. If you have someone on your team who does this for a living, you won't have the battle of cost overruns. DeGree's partner, Schlaak, is a construction worker and he oversaw the large group of family members who pitched in to help.

Visualizing Success
Like everything else in coffee, financing is about establishing and maintaining relationships. You are not trying to amass a ransom to be left in a suitcase beneath the Brooklyn Bridge for people you will never see. You're building a foundation for success that may include an expansion and possibly even transformation of your concept. So it's important to choose your funding source with the future in mind, making sure that you share the same goals and aspirations. Relationships can help you through the difficulties that inevitably challenge every startup. For Stell, who found an angel after a disappointing franchise bid, the key is to take what the situation allows. "Don't force it," he cautions, philosophically. "If it's meant to happen, it will happen."