Jim Kessler, the owner of the very successful Lasertron Interactive Entertainment Center in Buffalo, NY, recently posted some comments on a Linkedin group that are very insightful about developing a successful family entertainment center or other type of location-based entertainment venue:
“There is a 3- to 5-year wall that has to be climbed. The wall is paying for all the debt they [the owners] borrowed (whether from a bank, investors, their 401k, etc.). If they don’t get over that wall and get to the point were they can reinvest some of their cash back into their center they are going to die a very slow death (or a quick one if they can’t make their monthly payments to the bank or they can no longer afford to pay their lease).
“People are always surprised when a center that has been open for 3 or 4 years suddenly closes. I’m not – they couldn’t make it over the wall.”
In my 22 years working in the FEC industry, I have seen many causes of why new FECs run smack into that wall, are unable to climb over it and as a result, turn into industry roadkill:
1. Inadequate budget; under estimating the total cost of developing the center – We have seen several recent examples of FECs declaring bankruptcy before they were able to open due to running out of money. The other thing that happens when the cost estimate is inadequate is that when there is a cost overrun. This almost always occurs near the end of construction, so the only costs they can cut are either the level of finishes and furnishings and/or delete some attractions, two of the most important things to the guest experience. Both significantly affect the attractiveness, appeal and repeat business of the FEC. So as a result, revenues are less than projected and the FEC dies a slow death.
2. Phasing development – this is a variation of having in inadequate budget. Entrepreneurs often think they can develop the FEC in phases, believing they can use the cash flow from the first phase to fund expansion. Unfortunately this approach rarely works, as the first phase doesn’t end up large enough to succeed due to too small a mix of attractions and an inadequate critical mass. This approach is no different than a real estate developer building half of an enclosed mall with plans to add the other half later. The problem is that half a mall doesn’t work, as it isn’t large enough with enough anchor stores and a large enough selection of smaller stores and restaurants to have the needed appeal.
3. Developing on the cheap – Simply stated, this is when a FEC developer fails to understand that there is a lot more to a FEC’s success than just the entertainment attractions. The level of finishes, décor and landscaping all affect success as the public has very high expectations based on all the other location-based businesses they frequent. We continue to see “carnival-in-a-warehouse” and “concrete desert” FECs developed that only have short lives. Underinvesting is actually more risky than overinvesting. Underinvesting can result in becoming roadkill whereas overinvesting (not in a large magnitude) usually just means the return is less than desired. There is an investment sweet spot where the facility and business is the perfect match for its market. See, Finding the investment sweet spot.
4. Over-leveraging; borrowing too much money – and as a result having very high debt payments. This leaves no cushion for some unexpected bad times, such as major winter blizzards or the recent Great Recession. If you examine the majority of businesses that went bankrupt during this recent recession, the root cause of their demise wasn’t declining sales, it was being over-leveraged.
It is surprising how many potential family entertainment center entrepreneurs approach our company under the premise they plan to borrow 90% of the cost. That is basically the route to the road kill graveyard. We don’t recommend borrowing more than 60% and only then provided there is a long enough amortization period on the loan so the payments don’t require the vast majority of cash flow. The balance of funds should then be obtained as capital from investors without any guaranteed payouts.
5. Inadequate cash reserves. Jim suggests in his statement that you can wait for reinvestment until the 3rd to 5th year. I don’t agree. There has to be some constant reinvestment in the business from day one. First off, no one can get it 100% completely right at the beginning. I don’t care how experienced or smart they may be. The FEC will miss the mark somewhere and things will have to be corrected. When we are developing completely new concepts for clients, I tell them we probably will only get about 80% of it right on the first try. And for existing concepts, maybe 90% right on the get-go. There needs to be a cash reserve to quickly modify whatever is not working as anticipated, otherwise revenues will not approach what was projected. Maybe the game mix is wrong and some have to be replaced. Maybe the POS software doesn’t perform as the vendor represented and it needs to be replaced. Maybe the air-conditioning system can’t handle a long spell of stifling hot summer weather and some AC units have to be added. Maybe the dishwasher was undersized and needs to be replaced with a larger one. Or maybe a second pizza oven needs to be added. I guarantee there will be a need for some totally unanticipated expenses and reinvestments in not only the first year,, but subsequent years as well whether it is for games, replacement kitchen equipment, or whatever. Believe me, it will happen.
Unfortunately, most FEC developers fail to program in cash reserves for these needs. So what happens is they keep the wrong games or don’t replace games each year, or the facility is too warm during the hot summer weather, or the wait becomes too long for pizza. These all negatively affect the quality of the guest experience. And then the owners wonder why their sales are slowing going over the cliff instead of getting over Jim’s wall.
The other reason there needs to be adequate cash reserves is for those unanticipated times like during the winter when the blizzard effectively closes the business for two weeks or the time when the sniper in Washington DC caused people to not leave their homes for any unnecessary trips for over a month or there is less business than projected for outdoor attractions due to either an excessively rainy and/or hot summer season.
Family entertainment centers are a very complex business and they require an adequate financial structure to have a reasonable chance at long-term success. Starting a FEC business with a built-in financial handicap greatly reduces the odds of achieving that success.