Getting a piece of the pie...literally and figuratively.

January 29, 2007 12:14 PM

Investing in a restaurant - how is profit generally distributed among investors?

I recently heard some grapevine news about a restaurant being built for a particular demographic by a particular person who has a rock solid, iconic reputation within that demographic, including running bars/clubs that have been successful. The info I heard is that this person is looking for investors before beginning construction on the location. I have some money and thought this might be a good opportunity, but I know nothing about how partners or investors are rewarded in these situations. Does anyone know how one makes returns on investments like restaurants? Let's say I was a 10% partner - does that mean I get 10% of net annually? Do I get equity in the land and building? Do I only earn money if I sell my interest? How do you approach someone about these types of opportunities? what else should I know and what else am I legally entitled to know about the business before investing?

posted by spicynuts to work & money (9 comments total)

Here's an excellent article.
posted by amyms at 12:23 PM on January 29, 2007 [1 favorite]

Amyms, that article is about how to decide whether opening a restaurant with the investment capital you have is a good idea based on estimated sales generation. What I am looking for is not how to decide whether the investment is a good idea, but to understand how owners payout to their investors. It was interesting nonetheless.
posted by spicynuts at 12:51 PM on January 29, 2007

I think it really depends on what "investing" in this particular restaurant entails.

In most partnerships, if you're a 10% partner, then you own 10% of everything, unless you have some sort of agreement that states otherwise. This may not be a partnership, though.
posted by bshort at 1:05 PM on January 29, 2007

Bshort, maybe then my question is more generic and applies to businesses as a whole. If I am a 10% partner and own 10% of everything, does that mean I get 10% of annual net?
posted by spicynuts at 1:15 PM on January 29, 2007

There are as many answers to your question as there are situations. I think you're approaching this incorrectly. I'd suggest you determine what return you'd like on your capital for tying it up in a non liquid, and highly risky operation such as a restaurant.

Do you really want an equity interest? To be a part owner of this business? Or would you like the relative security of being a lender of capital, financing the enterprise? Someone who is guaranteed a return before the owners, the equity holders are paid? Lenders are higher in the pecking order than owners. Owners get paid last.

Once you've got an idea of your requirements, start to engage your counterparty and see how your expectations align with any offer he puts on the table.

Depending upon how pronounced the gap is, you can either negotiate or walk away, whatever makes the most sense.
posted by Mutant at 1:31 PM on January 29, 2007

Short version: you should get 10% of profits, unless you decide as a group to reinvest profits in the restaurant.

Long version:

As a 10% owner, you have equity in the business as a whole. If the business owns property, then that property value has an impact on what your ownership stake is worth, but you do not personally have any rights to it outside of the operations of the restaurant. In other words, you can't use the restaurant's real estate as personal collateral to my knowledge.

As far as profit distribution, it is up to you and your partners to determine. Many new businesses have an operating agreement that dictates all profits be re-invested in the business for the first X months / years to assure its stability. When it actually comes time to distribute profits though, your share of the amount distributed should be equal to your ownership stake - in this case you get 10% of all distributed profits. There can be exceptions to this, but only if all partners agree to it in the operating agreement.

In practice, if some of your partners are involved in the restaurant operations on a daily basis, they will likely be compensated in addition to their profit share in recognition of the ongoing contribution they are making to the business. These are usually in the form of guaranteed payments though, and are considered a business expense, not a profit distribution.

Although there are variations and it is ultimately up to each partnership to set their own terms, that is usually how things work. The largest variation is generally how you determine ownership stake in the first place. If some of the partners bring intangible assets to the table, such as industry knowlegde and connections that are vital to the success of the restaurant, you'll have to negotiate how to value that in comparison to the hard cash that the other partners are providing.

As far as approaching them - you have already heard this person is looking for investors, so just be direct. Try to meet with them in person, tell them you're impressed with their track record in the industry, and that you are interested in being an investor in their next venture.
posted by chundo at 2:42 PM on January 29, 2007

If I am a 10% partner and own 10% of everything, does that mean I get 10% of annual net?

Yes.

However, that still leaves two huge missing pieces of information:

1. what gets paid out between the gross and the net? For example, your local icon who is building the restaurant may take a $100,000/year "consulting fee" which is deducted from the gross. There are any number of ways that the general partners can pay themselves before any money flows down far enough to be called "net profit." This is the stuff of many, many lawsuits. (Google "Peter Jackson" "Hobbit" and "Royalties" if you want to read some depressing stuff.)

2. when are profits distributed? Again, this will not be up to you. Assuming there ever are any profits, the management will want to retain a lot of these to provide a cushion. Payout schedules may be specified by the investing agreement, but probably not.

The bottom line is read the investment documents, meet the people, and only invest as much money as you can happily lose. The vast majority of restaurants fail. This may be the exception, but you shouldn't count on it.
posted by alms at 2:53 PM on January 29, 2007

Many corporations attempt to have zero (or even negative) year-end net to keep taxes.

My accountant scolds me if I didn't manage to spend all the corporate money by the end of the year. But currently I hold 100% of the stock so I don't bitch too much.

Chundo and alms are spot on. Things to look for in the investment documents:

- When/how are shareholders paid/profit distributed. If at all.

- What ways can you cash out (sell your stock back) in the future. (Written the right way they can hold your money hostage.)

- What happen on disillusionment of the company? Especially important in businesses with a high failure rate, like restaurants.
posted by Ookseer at 7:30 PM on January 29, 2007

Don't foget the simple fact that, as a part owner, you will also own a share of the debts. Depending on arrangements, this could ultimately require you to pony up additional funds.
posted by Goofyy at 11:18 PM on January 29, 2007