Checks, Please
Restaurateurs Find a New Source of Start-Up Cash: Their Loyal Diners

By Michael S. Rosenwald
Washington Post Staff Writer
Sunday, September 9, 2007

Restaurant owners are dreamers. In many ways, they are like developers, who look at plots of dirt and see tall buildings. For instance, take the corner M and 21st streets Northwest, in the District's increasingly fashionable West End neighborhood.

When Alan Popovsky, the restaurateur behind Felix and the Spy Lounge, looks at the location, he dreams about -- get this -- Henry Hudson, a 17th-century sea explorer. He sees a third place: It's not exactly home, and it's definitely not work. Popovsky imagines "hip and home," a place to explore, perhaps over and over again, for food and drink.

But when he is awakened from his exhilarating little exploration dream, Popovsky also sees dollar signs -- not money being deposited in his pockets, at least not yet, but the money he will need to turn this location into a restaurant he is going to call, of course, Hudson.

Opening a restaurant can cost from several hundred thousand dollars to several million dollars, and Popovsky had several options to choose from. There's his money, of course. There's the bank's, of course. And there is an increasingly popular third option: restaurant goers themselves, particularly those with deep pockets and a desire to reap not only big investment gains but also the psychological income that comes from being part of the action.

For a good chunk of his funding, Popovsky tapped Martin Bashir, a District gastroenterologist. He tapped Anthony Dobranski, a former AOL technical manager. Like 10 other investors, they wrote Popovsky checks for at least $25,000 -- with the hope that they would get a 5 percent return on investment per year, plus a share of any profit. And if Popovsky decides to buy them out, it will be at 2 1/2 times their initial investments. But Bashir and Dobranski are also frequent eater-outers, and Popovsky is counting on them to generate buzz in the food world for the new restaurant. They know it's a risky enterprise.

"You hope to get the money back, but these things are not mutual funds," Dobranski said. "It's less risky than buying art, but there's still a lot of risk."

Many restaurant owners and chefs around the country rely on wealthy private investors with an appetite for risk to help open the doors their new restaurants. Chef Robert Wiedmaier recently tapped private investors for sums of $50,000 to $200,000 for the more than $3 million he needed to open Brasserie Beck in the District. Michel Richard, the world-famous chef behind the seriously expensive Citronelle, raised about $3 million from 44 investors to open Central Michel Richard, a modern bistro.

The restaurateurs are leveraging an increasingly hot celebrity chef and foodie culture, bred partly from hot TV shows like "Top Chef" and "Hell's Kitchen," which feature some of the world's best chefs cajoling, judging, and celebrating the culinary creations of unknown chefs and amateurs who can spring to stardom during sweeps week.

It is not unusual these days to overhear heated debates on the Metro concerning who chef Gordon Ramsay kicked off "Hell's Kitchen" the previous night. The popular food culture is such that Philadelphia magazine, in an article referencing that city's foodies, told the story of a man who was having trouble putting his 9-year-old daughter to bed. The girl said, "But Daddy, they're getting ready to plate!"

"The country is just extremely interested in food right now, much more than ever before," said Mark B. "Chipp" Sandground Jr., a lawyer at Kalbian Hagerty who represents Wiedmaier, Richard and many other District chefs and restaurant owners. "People use restaurants so much now. They are not just for going out for their anniversary. People go out all the time. Pretty much everyone has an opinion on a new restaurant."

But that does not mean the opinions are always positive. The American palate is fickle, and a few bad meals served up to a particularly chatty customer base -- or, worse, a powerful reviewer -- can quickly sink a restaurant. That, in large part, is why Sandground and his chef clients constantly remind potential investors this: Investing in restaurants is not for everyone. As Wiedmaier says, a restaurant investor must be able to say, "If I lose it all, great, at least I had fun." Asked who should invest in restaurants, Sandground said: "Easy. I can sum it up in one sentence: People who can afford to lose 100 percent of their investment."

And that's not just a snarky comment about the tendency for restaurants to tank. Many deals are subject to Securities and Exchange Commission rules governing the raising of capital for small businesses offering private securities, in this case ownership units in restaurants. For the restaurants to avoid having to register with the SEC, a complicated and expensive process, they must sell ownership units only to accredited investors, according to Rule 506 of Regulation D.

Under the rule, the restaurants can raise money only from people whose net worth -- either by themselves or with their spouse -- exceeds $1 million or who had income of at least $200,000 in each of the two years before the investment. Before Sandground will even have a conversation with a potential investor, he sends a one-page questionnaire to see if he or she qualifies under the SEC rules. Then the investor can sit down with Sandground and have a conversation about how the deal would work.

Typically, Sandground, the restaurant owner, and financial advisers have worked out a spreadsheet showing investor returns over 15 years. Of course, this spreadsheet is sort of pie in the sky, assuming that everything goes well and the restaurant is profitable. But nonetheless, it can show what an investor's money flow might look like. Sandground shared a spreadsheet with The Washington Post for a deal he completed, though he declined to identify the restaurant.

The deal had about 50 investors and called for a 10 percent yearly return for each investor. If there's additional money to distribute beyond that return, 80 percent of the profit would go to investors and 20 percent to the owner. The process would repeat annually until the investor got back 100 percent of his principal, at which point the profit-sharing would be 40 percent to investors and 60 percent to the owner. (Oh, and the investors typically get discounts on meals.)

The deals are expensive for even celebrity chefs, who have to sacrifice much of their early profit. If a restaurant is really hot for the first few years, as often is the case after a successful opening, investors would get most of the profit. And only later, perhaps after the hype dies down, would much of the profits go to the chef. Richard said the risk for him is worth it: "They help me achieve my dream of a restaurant."

But how are the deals even found? Chefs and restaurant owners around the District said their investors are typically people who have dined with them for some time. Bashir, the doctor who invested in Hudson, is a little different: Popovsky was initially one of his patients. Popovsky had to pick up Bashir's investment check at the Washington Hospital Center colonoscopy suite, where his investor was working that day.

Many of the investors in Richard's new bistro have dined over the years at Citronelle and have followed Richard's rise to the upper echelons of chefdom. Richard didn't exactly have to beg them to invest; he cajoled them through their bellies. If he heard that a potential investor for Central was dining at Citronelle, Richard sent a tuna burger to the table to show the kind of meal he would offer at the new restaurant.

Then he would stop by the table, which is akin to William Shatner showing up at a "Star Trek" convention. "Everyone wants Michel to show up to their table," Sandground said. And the fact that a trip to a table can help seal an investment also goes a long way toward explaining the motivations of restaurant investors. After all, how many people would buy $50,000 of Lockheed Martin stock just because they met the chief executive? As Bashir put it, "There's an ego reward with these investments."

"The people who invest in restaurants are people that are avid diners who want to be part of the club," Wiedmaier said. "They get the VIP treatment. They are in with a name chef. They have fun doing this. They are going out to eat."