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Investing in Restaurants Can Work, but It’s Not as Easy as Pie

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Relaxing in a restaurant, satisfied after a good meal and maybe a glass of wine, it’s easy to dream about what it would be like to own the place.

What has kept this dream at bay, for me at least, is having two friends who invested in restaurants and struggled mightily. One spends every weekend working in the kitchen after spending the week working on Wall Street. The other told me recently that he was still dealing with financial claims from a Manhattan restaurant that closed a year ago, when his former partner moved to Los Angeles.

These are the type of stories that give investing in restaurants a bad name. But plenty of people find ways to run restaurants profitably and make a good deal of money from the enterprise. Bobby Flay, the celebrity chef and owner of Mesa Grill, has done well enough to be part of a group that owns thoroughbred horses. But like people who succeed at financing films, the most successful restaurant investors do not let their dreams get in the way of a focus on the numbers.

Restaurant sales are projected to be a record $632 billion this year, up 3.5 percent from 2011, said Hudson Riehle, senior vice president for research and knowledge at the National Restaurant Association. And, he noted, Americans now spend 48 percent of their food budget on eating out.

“Although the industry is competitive, it continues to grow,” he said. “That said, a basic love of food and beverage is not enough to ensure success in the restaurant business.”

Mr. Riehle said the most successful restaurant investors considered how a style of restaurant fit an area and tracked who their customers are. “Demographics is destiny in the restaurant business,” he said.

Bill Campbell, the former chairman of Visa International, said his priority was finding a good location for his restaurant and inn, Topping Rose House. In 2006, he paid $5 million for the 1842 mansion, which sits on the main road in Bridgehampton, N.Y., but then spent the next five years negotiating for permits with the town.

In 2010, he brought on a business partner, Simon Critchell, the former chief executive of Cartier North America, and since then the two have spent an additional $12 million renovating and adding to the property, which will have 22 guest rooms in addition to a 75-seat restaurant that will open this summer.

“My investment thesis was this had limited downside because it is prime, prime real estate,” Mr. Campbell said.

But it was only last fall, after the project was well under way, that he and Mr. Critchell struck a deal with Tom Colicchio, the television chef and owner of the Craft group of restaurants, to operate the restaurant. He was one of three chefs they considered.

“The profit margins will be what they are — and they’re not great with restaurants,” Mr. Campbell said. “There’s going to be some patience required, and it’s not going to be perfect on Day 1.”

Still, the amount of money they have already put into the project, particularly for two men who spent their careers in the corporate world, seemed huge to me. They did not play this down. But Mr. Critchell said they expected to begin showing an operating profit within a year. He was less certain about when they would see a return on the money they put into buying and renovating the building.

“There are risks,” Mr. Critchell said. “But what keeps me awake at night are the million little details we need to take care of before it opens.”

They surely hope that they will have an experience similar to that of Shawn Rubin, a managing director at Morgan Stanley Smith Barney. He and 10 of his friends put up the nearly $2 million that was needed to open STK, a chic steakhouse in the meatpacking district of Manhattan. On its first night, Sean Combs, the music mogul, had a party there that was prominently reported in the gossip pages.

“We were off to the races,” Mr. Rubin said.

In the last seven years, the members of his group have earned many times their initial investment and have gone on to invest in three other restaurants.

“It’s all been a big, giant accident,” he said. “This path, I could have never predicted. As an investment it had a binary outcome: either it was going to zero, or it was going to be a big win.”

Mr. Rubin attributed the high returns to finding a group that knew how to control building and labor costs. But his advice for would-be investors is this: be prepared to lose the money.

Investing in a smaller restaurant may seem safer than a big-budget production. But while the dollar amounts are lower, the risks are still there — the biggest one being getting people to eat there without the publicity machines that flashier restaurants can muster.

There are manageable risks, like the obligation of the lease and the liability for any injuries or accidents that occur. Investors also need to factor in continuing costs from broken plates and glasses, spoiled food and overly generous staff members who give too much food and wine away.

“Restaurants as an asset class have tended to be bad investments,” Mo Koyfman, a general partner at Spark Capital, a venture capital firm that was an early investor in Twitter. “Anyone who says they like to invest in restaurants is probably not a great investor.”

Still, when Gabriel Stulman, a restaurant manager Mr. Koyfman had befriended, wanted to go out on his own, Mr. Koyfman joined a group of a dozen regular patrons to back him.

“I like to invest in amazing entrepreneurs, and I like restaurants,” he said. “Sometimes those two things coincide.”

He was part of a group that invested in Mr. Stulman’s first restaurant, Joseph Leonard, a retro bistro in Greenwich Village. It opened in 2010, and Mr. Koyfman has put money into the three restaurants Mr. Stulman has opened since.

“I’ve invested in Gabriel Stulman,” Mr. Koyfman said. “He’s a grinder, and he’s possessed the way great entrepreneurs are possessed.”

Investing in a smaller restaurant, in fact, is often a bet on the manager’s ability to keep costs low, quality high and customers walking through the door.

Joanne Wilson, a venture capitalist who also invested in Mr. Stulman’s operations, said she practiced the same restraint with her restaurant investments that she did with her other investments.

“I’m never a lead investor,” she said. “I would never come in and say, ‘I’ll give you half.’ I like to be part of a group of people who are supporting the same thing.”

To her, the risk of any of these investments is obvious but not an obstacle. “Anything that is starting from scratch is a high-risk investment,” she said. “I’m happy to take the risk, based on the idea, the concept and the entrepreneur. But I believe you don’t have to take that full risk.”

For the risk to pay off, it is going to take a lot of patience. Mr. Koyfman said he had been paid back some of his initial investment and hoped to begin receiving profits soon — two years after he wrote the check for the first restaurant.

While the dollar amounts are much higher at Topping Rose House, Mr. Critchell said his partnership agreement with Mr. Campbell explicitly stated that both men were in it together. “I insisted that neither of us would have the right to sell the property for five years,” he said, “no matter what happened.”

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