Why Food Startups Are Getting Hot

The U.S. restaurant industry grew by 1.4 percent in 2010, interest in new food co-operatives is at its highest level in 30 years, and sales of packaged ethnic foods are booming, fueled by adventurous Gen Yers raised on the Food Network. Even venture capitalists, long focused on technology startups, are grabbing plates and getting in line: Tech entrepreneur Jonathan Kaplan, creator of the Flip camera, reportedly snagged $10 in million in venture capital funding for his grilled-cheese restaurant concept, The Melt. For more than two decades, CPA Karen Burns has worked as a partner at San Francisco consulting firm Sensiba San Filippo to help startup entrepreneurs break into the food and beverage industry. The market may be sizzling—particularly for organic, sustainable products—but poses extra challenges to new entrepreneurs, says Burns. She spoke recently with Smart Answers columnist Karen E. Klein. Edited excerpts of their conversation follow.

Karen E. Klein: Are you seeing a lot of interest from entrepreneurs who want to break into the food industry?

Karen Burns: It has really increased within the last five years. I think what’s driving this trend are the many medical studies that are being done about issues like obesity in children, diabetes, and allergies. A lot of entrepreneurs are making products to help their customers with medical issues.

Gluten-free is an example. No one ever heard of these products just a few years ago. Now you can go into a major market and there’ll be an entire aisle with products that are gluten-free.

What basic advice do you give to people who contact you for help?

Know your product and do that product well. Don’t bite off too much, too early. Have a go-to-market strategy and be very successful with it before you expand. You can have a very tiny menu to start. You don’t have to have 18 different SKUs [stock-keeping units] of products that you’re selling.

Are you seeing venture capital funds get interested in food startups?

Definitely, especially within the last three to five years. An organization called the Pacific Community Ventures Fund is focusing specifically on the food and beverage industry. Now some other funds are cropping up that want to get in on it, too.

What other areas are particularly hot right now?

Ethnic food is big, particularly some of the Asian foods that have not traditionally been so popular in the U.S., like Taiwanese and Filipino. Being in the San Francisco Bay Area, there are so many Asian entrepreneurs who have come to our country in the last generation, all of them with family recipes. They locate in ethnic communities initially and serve people from their own niche, but eventually other people also want to try their menus and they take off in the mainstream.

What are the particular challenges of getting into the food business?

From day one, there are compliance issues: tax returns that need to be filed, even if you don’t owe anything; product ingredient labeling; health department inspections. Like any business, startups need to do budgets and take their cash-flow forecasting to banks and outside investors.

If you want your company to be able to market itself as environmentally conscious, there are green initiatives that you can use to get various certifications in different states. There are some credits you may be able to get for that from a tax perspective and some programs that you may be able to find on your state or local level to help you finance it.

What do you recommend for early startups that want to get their products consumed?

So many of them start at farmer’s markets, which is a great idea. Trader Joe’s and Whole Foods (WFM) walk the farmer’s markets looking for the next great thing. Of course, it can be a trap to get very wide distribution early on because the retailers’ demands are extensive and the margins are very thin. I tell clients to watch their overhead very closely if they do get picked up by a volume retailer.

What’s the funding picture like for small food companies?

I think it’s getting a little bit better. We’re starting to see that financial institutions have cleaned up their portfolios, bad debt is off their balance sheets for 2011, and they’re willing to take on some new risk. Also, there clearly is an awakening in the [venture capital] market to invest in this area.

A lot of food production companies are family businesses, however, and they don’t want to take on outside money. And all startup entrepreneurs should expect to have to personally guarantee the funding. That’s a hard nut—but from the financial institution’s point of view, if you’re not willing to stand behind your business, why should they?

As people are coming out of the recession and trying to get financing, I’m advising them that it’s okay to forecast a break-even quarter and then maybe have a slight profit. The bank would rather see you hit or exceed your forecast than have you forecast all roses and not hit it.

Q: Do you have any tax tips?

Definitely look to take advantage of [research and development] credits and enterprise zone credits at the federal and state levels. If you can locate your business in an inner city area, not only do you get tax relief but you might also get hiring credits and access to advisors that will give you low-cost or free consulting help.

If you’re doing research on making a new product or making your existing products better, you can claim the R&D credit. Even if your business is not making money early on, you can start capturing the data and claiming the credits because there are carry-forward provisions that can be used in the future.

If your company is doing its production domestically, you can file for something called DPAD, theDomestic Production Activities Deduction. You fill out a form that calculates what your deduction is, based on sales relative to domestic production. Companies that do everything domestically get a higher permanent deduction. It’s worth looking into.

Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.


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