Why Restaurants are L.A.'s Second-Riskiest Investment (Analysis)

Risky Investment Illustration - H 2013
Illustration by: Tomi Um

Risky Investment Illustration - H 2013

Most business managers say "run," but that hasn't stopped everyone from Ryan Seacrest to Phil Rosenthal from spending on eateries.

This story first appeared in the June 7 issue of The Hollywood Reporter magazine.

Everyone in Hollywood knows about "dumb money," investments made by glamour- and ego-driven outsiders who lack requisite knowledge to discern a smart film deal. What Hollywood players often don't know, at least until it's too late, is that dumb money -- their own -- can be spent on restaurants, too.

Industry machers have been plowing cash into eateries -- often losing it -- for years. Preston Sturges threw good money after bad at his Players Club, while Cecil B. DeMille found success with The Brown Derby. Robert De Niro has made a bundle on Nobu, whereas Steven Spielberg and Jeffrey Katzenberg's underwater-themed Dive! ran out of oxygen. Then there's TV producer Phil Rosenthal, who has had a hand in a Joe DiMaggio-like run of critical and commercial triumphs, from Providence and Tavern to Red Medicine and Umami Burger.

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Some do it because they're insatiable foodies, others because they love getting great tables. Sometimes both impulses are at play. "I love food -- it's one of my personal passions. So when some friends suggested I explore investments in this area, it seemed like a no-brainer. Who wouldn't want guaranteed reservations?" says Ryan Seacrest, who has a piece of Bouchon in Beverly Hills as well as such Innovative Dining Group spots as Boa and the new RivaBella. And what better way to impress friends than to be able to call the spot of the moment "my restaurant"? At one popular industry joint, one of its many Hollywood investors loves to walk the room -- "as if he really owns the place," snarked a restaurant consultant recently.

Then there's the keeping-busy impulse (Ryan Gosling spent downtime renovating his Moroccan spot Tagine several years before his film schedule became jam-packed) or fondness for promoting a favored cuisine (Michael Ovitz with sushi spot Hamasaku, or Justin Timberlake with Dixie-minded Southern Hospitality in New York). For many, the sheer fun of it is justification enough. "Maybe it's a midlife-crisis thing, but I'd rather do this than a Porsche," says The Simpsons executive producer Matt Selman, who's involved in acclaimed chef Neal Fraser's upcoming Redbird in downtown L.A. ("We did the deal the main way we do deals here in L.A.: meeting through our kids' preschool.") Adds entertainment lawyer Joel McKuin, who's a part of Mozza and the soon-to-arrive Republique in the former Campanile space: "Most business managers say, 'Run!' But I love to be supportive. There's a sort of psychic income."

What hardly anyone brings up is the reliability of actual income. "Keep your day job," advises Electus head Ben Silverman, who has had happy restaurant experiences (investing in Santa Monica's Blue Plate Oysterette) and troubling ones. "I did one in New York called Cafe Socialista with Sting, [producer] Charlie Corwin and Harvey Weinstein," he adds. "That ended up going out of business when a bartender serving Ashton Kutcher's birthday party had hepatitis. Luckily nobody got it, but once the news broke, that was it."

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Restaurateurs insist the dining world's bad business reputation is unfair. "If you pick the right group, the right operator, you can yield a solid return," says Terry Heller, a former music video director and owner of packed West L.A. gastropub Plan Check, which is bowing a second outpost in the Fairfax District in June. "It's not the concept of investing in restaurants that's risky; it's the type of people that get involved that create the risk."

Many note the similarities between dining and entertainment investments: Both are informed gambles (at best) in which the profit motive might blur with a sense of artistic benevolence, whether in backing an auteur director or an inspired chef. "My experience in the film industry is that I've never been able to figure out where all of the money goes," says producer Michael LaFetra, a partner with McKuin in Mexican restaurant Tinga. "At least with the restaurants, if everyone's friendly, it's much easier to track what's going on."

The typical investment is a $25,000-to-$50,000 unit share of an overall "raise" that might include as many as two dozen investors. This buy-in is seen as the sweet spot for the targeted demo of multimillionaires because it falls below the chump-change threshold, allowing it to elude severe money-manager scrutiny.

Proposals can carry a wide range of red flags. The primary one is a too-stingy total raise. "The biggest reason restaurants fail is that they're undercapitalized," leaving an insufficient cushion for such contingencies as fluctuating food and labor costs and permit delays, says Gay Harwin, an attorney who has handled deals for Ink and Hatfield's.

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Another cause for concern is the presentation of an overly aggressive deal. "A 50-50 split, after return of initial capital to the investors, is standard for a chef-restaurateur without a track record," counsels venture lawyer Bob Sutcliffe, who has established partnerships for heavyweight chefs Joachim Splichal and Michael Mina. Investors also can expect to pay a management fee of 3 to 6 percent on top of salaries. It is kosher, though, for more generous financial rewards to be doled out to management once a restaurant recoups its initial investment, typically three to five years into the run. (It's estimated that 60 percent of restaurants go under within a half-decade.)

Altogether, veterans caution that expectations be kept modest, even with a seemingly surefire deal. "The restaurant business isn't Apple stock," says Sutcliffe. "Margins are low." Business manager John McIlwee, whose clients include Ben Stiller and Courteney Cox, goes further: "I'm not even really interested in my clients making money on any restaurant project. I just don't want them to lose it."