New Location Design Exercise

It's been a little while since I posted last. This is not due to any lack of interest or subject matter, but a family illness that has almost completely consumed my mental attention.
Rest assured I have a cranium filled with relevant topics that I hope will benefit anyone out there interested in starting their own coffee shop.

What I've decided to do is to let all of you in on the exact details involved in the design and build out of my company's new location. The space was chosen after many failed attempts at securing lease that met the following criteria:
1. Affordable Rent
2. Minimum 10 years term
3. Geographically removed from our existing locations so as not to cannibalize sales
4. Located in what is to referred to as "downtown" in my city
5. A corner or equivalent location of high visibility and traffic
6. Existing interior features that would be attractive to customers
7. The possibility of fully operational windows to permit an indoor/outdoor feeling
8. A reputable landlord who cares for their buildings and chooses their tenants carefully
9. Minimum 800 square feet, maximum 1500 square feet.
10. Suitable masthead to accomodate visible outdoor signage

The space we chose is directly across from the oldest continually operating outdoor market in Canada, which serves as an outdoor skating rink in the winter. The square is also home to antique markets, concerts, outdoor movie nights, buskers, water fountain, Christmas tree in Winter and city provided free cafe tables. It is one block from the waterfront, and directly behind our historic City Hall which served as Canada's first capital. The location is not a corner, but the open space across the street permits broad visibility and prominence.
In addition to these features, the interior space has 14' ceilings, exposed brick on one wall, and exposed limestone on the other. The front of the building will be re-pointed this fall, and new operational windows and doors installed that meet strict historical standards enforced in our city.

I have included a JPEG of the layout of the raw space listed as "322" on the drawing, and am encouraging readers to copy the image and sketch out their own versions of what they think the space should look like. Each attempt should include 2 washrooms, seating for at least 20, a service counter (cash and espresso bar). The dividing wall between 318 and 322 is exposed red brick, and the angled wall is exposed limestone. The front windows swing in to open.

Have fun and please respond with your designs in the comments. Don't worry about doing anything overly technical, just draw on it, scan it, and submit it. I hope some of the submissions will spark interesting debate, and will ultimately end up in the finished drawings. As we progress I will produce an equipment list, and budget that will adhere as close to possible to my 50 Grand Business Plan. Impossible you say! Well let's see.

Repayment of Capital Investments

Knowing and understanding our Financial Statements is vital to developing an appreciation of where your business value is currently and where it is headed.
When we look to start a business there is typically an investment made either using personal wealth, or more often borrowed money with the expectation of future profits. Sometimes this equals a substantial amount of money, mostly applied to equipment or leasehold improvements, and sometimes the purchase of another business. These assets are organized in the balance sheet under the heading Long Term or Capital Assets, and conversely, Long Term Liabilities for the outstanding loan amount. (Don't forget that the Long Term Assets value are depreciated by about 20% per year as their usefulness is consumed.)

Any coffee shop owner would hopefully understand that this capital investment needs to be repaid, and therefore any net profit is not in truth profit, but a repayment of capital until the debt is settled. In most cases this period of repayment equals 4-5 years which coincidentally is the same period of time over which the value of the investment nets to zero through depreciation. Usually we have paid monthly for 4-5 years and in the end we have zero value on the balance sheet to show for our investment except a great deal of depreciation. But all is not lost as this is the time where the assets fully return all of the profit to the company rather than servicing a loan and is the most important time in a business cycle. Given careful and attentive servicing, most well purchased equipment and leaseholds can continue to deliver utility beyond their cycle of depreciation.

Do not fall into the trap of replacing perfectly functional equipment and putting yourself back on the repayment treadmill. If your competitive advantage is tied to exhibiting the latest equipment, you have put your coffee shop in a similar situation as a pharmaceutical company that needs to spend constantly on research or risk precipitous drops in revenue. By necessity these business models require constant investments of capital that either carry interest payments, or rob owners of personal net profit.

If we fully comprehend the literal meaning of Repayment of Capital Investments, it is clear that the money spent initially was an investment and not a cost of doing business. We all know that an investment is a wise one if and only if it makes us more money than we spent. Those of us with investment accounts vested in various Stocks can quickly glance at our monthly statements and determine the present value of money invested and make a determination of whether our advisor knows what he/she is doing. As a coffee shop owner, apply the same critical values to your investment in capital expenses. If you are as rigorous with business investments as you are with personal, you will come to the conclusion that the investment only returns value once it has been paid for and that the most prudent path for future capital investments is to pay for them with past savings rather than future profits. Remember: Keep Capital Investments employed beyond the repayment period!

Tenant Allowance (Landlord Contribution)

I've alluded to this in a couple of posts relating to negotiating a lease, and controlling costs but I felt it required a post of it's own given the considerable funds that can be saved.
When negotiating a lease it is customary to ask the landlord for a tenant allowance in order to make changes and alterations to the space and make it more suitable for cafe use. A tenant allowance is normally valued at certain value per square foot/metre and is negotiable. Using a figure of 10-20% of the total value of the lease over 5 years is a good rule of thumb. I have been fortunate enough to benefit from $30 per square foot allowance adding up to over $32,000 on one build.

For example:
Let's say I'm looking at a 1000 square foot space that costs $20 per square foot plus $5 in CAM costs. The space costs me $25,000 per year in rent multiplied by 5 years = $125,000. Using this as a guideline, it is not unreasonable to ask for $12,500-25,000, or $12.50-$25 per square foot in tenant allowance.

Some landlords are extremely frugal in offering an allowance and in these cases it is best to walk away from the space. Recently I was informed that Starbucks received a $75 per square foot tenant allowance on a new build in Canada. (I don't want to be more specific because the info is confidential and could get my buddy in trouble) For a typical 1000 square foot build, that equals a contribution of $75,000 to improving the space for use. Anyone who has undertaken a new build understands how far 75k goes, and is a significant advantage weighing in Starbucks favour when trying to compete with them.
Chain wide the allowance granted to Starbucks is huge and could represent a $1,500,000,000 off balance sheet gift to the company. Given these depreciating assets are not paid for by Starbucks they are not on their balance sheet, certainly something to be concerned about if you're an investor in SBUX.
Remember the importance of reducing the depreciable assets appearing on your balance sheet (SBUX has), since it usually represents a 20% loss per year on your income statement, and having a healthy income statement is how your make money.

What Went Wrong (with my lease negotiations)

Last week things went sour in my effort to obtain a lease for a third location in the downtown area of my hometown. I want to share with you my experience to show you that even when you make every effort to do things right, they can go wrong.
I have been looking for a third retail location for quite some time, with my primary focus on the downtown area of my city. This past summer I was approached by a landlord who had a corner space available, which I rejected it because the space required extensive renovation. I did however notice that there was a space in the same building that was of interest to me and asked the landlord if that spot was available. I suggested that he speak with the occupant to determine if they would be interested in selling the location (equipment and leaseholds) to me. I didn't hear back from the landlord so I moved on.
In late November I noticed a For Rent sign appeared in the window of the business I had asked about and immediately contacted the landlord to view the space. That very day I had a handshake agreement to purchase the equipment and leaseholds for $35,000. I viewed this as an excellent price for:

1. walk in refrigerator
2. double glass door cooler
3. double glass door freezer
4. single glass door cooler
5. large gas convection oven
6. gas grill
7. gas cooktop
8. gas stove
9. gas soup stock pot units
10. commercial dishwasher
11. cabinetry
12. flooring
13. 2 handicap washrooms
14. tables
15. health unit approval to use the space.

The main caveats were that I obtain a 30 day fixturing period to begin once I had a signed lease document, and that I obtain clear title to the equipment and fixtures. I asked my lawyer to put the verbal agreement into writing and submit an offer to lease based on my discussions with the landlord. Rather than negotiate the offer, their lawyer suggested we negotiate a lease document to save time which I agreed to. The month of December I waited on a document from the landlord which I could review and make changes to. When the document arrived, I made the changes I required and sent it back for signing. Early in the New Year after two weeks of no contact with the landlord's lawyer, I was informed that he didn't wish to sign a lease, but wished us to purchase the equipment and simply take possession and pay rent based on a verbal agreement. As I made clear in my post about Leasehold Improvements, those costs remain with the space after the tennant leaves. Given the landlord was refusing to provide a signed lease document, all of the money attached to leaseholds, as well as the money that would be spent on installation of equipment, would be lost should the landlord decide he wanted the space vacant in 60 days. While I could take the equipment with me, it is worthless unless I have a viable location to house the business.
Given the refusal of the landlord to provide a lease, I chose to pass on this location and keep looking. I remain disappointed because the space was ready to go with very little additional money required, and it afforded us an opportunity to bake and prepare our own food to be supplied to our other locations.
The main thing I hope to share is that no matter how many benefits a location offers, if there is a significant problem, walk away. In my case, the possibility that I could be evicted on 60 days notice wasn't worth the benefit of purchasing the leaseholds and equipment so cheaply.

Leasehold Improvements

Leasehold Improvements appear as a line on our Balance Sheet under Capital Assets, and typically have a note attached identifying accumulated depreciation. They include all improvements a coffee business makes to a rented building that typically remain with the landlord or next renter after your lease expires. Things like cabinetry, countertops, washroom fixtures, lighting, flooring, anything that is attached to the building and not easily removed. Sometimes a coffee business may choose to identify items they consider proprietary and therefore specifically identified with the business, (ie logo signs )and may wish to have them excluded in the signed lease document. If not identified within the lease as exempt, all of the money a business spends to get a building to operational condition is considered a leasehold improvement.
It is very important to consider how much leasehold improvements cost a new business when preparing a business plan. These expenses are likely the most significant any business faces when opening a new location, and servicing any debt needed to pay for them cause a huge obstacle to profitability and positive cash flow. Like all capital costs, we are expected to depreciate the value over a period of time, most likely matching the period over which any associated loan is to be repaid. For example, if a company borrows 200k to build out a new cafe, and has arranged to repay the bank over 5 years, we would choose to depreciate the value 40k per year over 5 years. In some cases, you and your accountant may choose to depreciate the leaseholds over the period defined in the lease, 10 years for example.

The important thing to remember is leasehold improvements only are useful to a company if they still occupy the building. Therefore, when negotiating a lease it is useful to obtain a 5 years initial lease period, with an optional 5 year period to follow. That way the company can continue to use the assets past the point that they are paid for.

The last point I want to bring up when considering leaseholds is how to take advantage of someone else's mistakes. When a poorly run or struggling coffee shop closes, the money spent on fixtures and improvements remain within the building. This is an opportunity for the right operator to benefit from the huge savings to be had. Even the cost of installing mechanical, plumbing, and electrical in a cafe can be significant, and if all a building needs is some new paint, counter tops and lighting, you have given yourself a minimum 100k head start towards profitability.