Big money is flowing into small growth chains like never before. Here’s how to get a piece of the action. Selwyn Yosslowitz was ready to take his seven-unit Marmalade Café to the next level. All he needed was pockets deeper than his own.
Since 1990, when Yosslowitz and two partners opened their first high-end casual eatery in Santa Monica, California, they’d paid for each $2.3 million unit the old-fashioned way—by mortgaging their homes. That worked fine as long as they were opening only one store every three years. But now they had 15 markets on deck. On the advice of a colleague, Yosslowitz called back one of the private equity firms that had been ringing him up.
After a yearlong courtship, he took on a new partner: Parallel Investment Partners in Dallas. The firm’s investment in the restaurant company is undisclosed, but Parallel typically puts in $10 to $20 million. Part of that money goes to the founders, for a share of ownership. The rest will help grow the chain to 30 units and push into Nevada and Arizona.
“It’s the best of both worlds,” says Yosslowitz. “We’re partly cashing out, and we can focus on the future.”
Not so long ago, it would have been unthinkable for a private equity firm to invest in a small restaurant chain. Today, foodservice, once an ugly duckling of the investment world, is being embraced as a swan. Instead of begging from friends and local banks, entrepreneurs can tap the same kinds of growth capital as national chains.
“There are forms of capital available today that weren’t available five years ago,” says Paul Cantieri, vice president for brand finance of GE Capital Solutions, Franchise Finance in Hoffman Estates, Illinois. “Both lenders and private equity firms are looking at smaller concepts now.”
One reason is that there’s a lot of free-floating capital looking for a home. Last year, facing a sluggish market for publicly held companies, big investors like pension funds pumped a record $434 billion into private equity funds worldwide, according to research firm Private Equity Intelligence. This year could raise another $500 billion.
A second factor: The dot-com crash of 2000 turned investors towards industries with genuine cash flow. “The restaurant industry is a real business that everybody understands,” says Chris Thomas, CEO of Restaurant Acquisition Partners, an Orlando-based buyout fund specializing in foodservice. “I have no idea how Yahoo makes a billion dollars a quarter. But we all eat in restaurants, and we understand how the restaurant industry makes money.”
While large private equity funds will pay $2.4 billion for a Dunkin’ Brands, some firms focus on smaller chains. Thomas seeks a restaurant company with $25 to $40 million in sales. Blackstreet Capital, in Washington, D.C., will invest up to $15 million in chains with as little as $25 million in revenue.
Where bigger funds aim to fix broken companies, smaller funds want the opposite: healthy concepts with room to grow. An ideal prospect, say equity execs, has climbing same-store sales, quick payback on new stores and success in several markets. Bankroll more growth, and they can sell their stakes for a pretty penny five to seven years down the line.
To win those bets, they’re putting more than just money on the table. “We bring resources like relationships we have on the operations side and the real estate side,” says Jed Johnson, managing director of Parallel. “They enable the management team to continue to build the business with greater success.”
The trade-off, for an entrepreneur, can be a share of your independence. Parallel required Marmalade to set up a board of directors, and claimed three of the five seats.
“Private equity funds are very hands-on, and owner-operators need to get comfortable with that,” says Aldus Chapin, managing director of Blackstreet. “We don’t want to run your company, but we want to know everything.”
For operators who hate to give up any control, there’s an alternative to equity investors: borrow the money. Big lenders have also gotten interested in small restaurants. GE Capital Solutions, the nation’s largest restaurant lender, is funding chains as small as three units, for amounts as low as $100,000, though its average loans run from $500,000 to $30 million.
“Five units was our minimum, but we’ve ratcheted down,” says Cantieri. “It’s a very important part of our business to get in with folks while they’re a little bit smaller. We have the capital and resources to grow with them.”
Mercantile Commercial Capital, in Altamonte Springs, Florida, aims even lower. This Small Business Administration lender specializes in restaurant startups, up to three units, for up to $6 million. It offers easier terms than most banks, with longer maturities and lower payments, and covers up to 90 percent of construction costs.
“After you have two to three units up and running,” says CEO Christopher Hurn, “if you’re operating them profitably, there are all sorts of capital to take you to the next level.”
If you’re intimidated by both monthly payments and nosy investors, there’s a third option, says restaurant investment banker Craig Weichmann of Weichmann & Assoc. in Greenville, Texas. Mine your existing units for more profit.
He suggests enclosing a porch to create more dining space, or adding a few parking spaces and a take-out counter. “I could incrementally get a 35 to 40 percent payout on those incremental investments,” Weichmann says. “If I build a new restaurant, I may just get 5 to 10 percent. Remember, your cheapest capital is what you generate internally.”
Another internal source, he says, is to convert your existing buildings into capital. Under a sale-leaseback, a restaurant sells its real estate to another company and leases it back. The proceeds can be used to build more restaurants.
With so many financial options to sort out, where does a restaurateur begin? Consider hiring an investment banker, suggests Rod Guinn, managing director of Wells Fargo Foothill in Albuquerque, a bank subsidiary that specializes partly in restaurant lending. More and more are friendly to small businesses. Or seek referrals from your colleagues. “Through your local and state restaurant associations,” Guinn says, “you can talk to people who are going through the same thing.”
Whatever the source, says Yosslowitz, it’s a great time to be a little guy looking for capital. “It’s unusual for a private equity firm to invest in a group of seven restaurants. But they [Parallel] wanted to get in at the ground floor. It’s good for our industry, because we’ve never had these opportunities in the past.&rdquo
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