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Restaurants are among the most popular businesses in the hospitality industry, making them an attractive prospect to investors. Investors dream of having partial stock in a restaurant that shoots to the top overnight and becomes a major financial success, but how feasible is that? Are restaurants a suitable investment, or are you better off pouring your funds elsewhere?
Restaurants can be a good investment if they have a marginal risk level and projected success. Investors should carefully review the business case, current financials (as available), and restaurant scalability before investing.
This guide will get into the nitty-gritty of restaurant investments, offering tips for finding suitable properties and detailing the pros and cons.
What Makes a Good Investment?
Let’s get underway by assessing the qualities of a worthwhile investment. Although not exclusive to the restaurant industry, many of these qualities apply.
Scalability
A good investment has no immediate glass ceiling. You should identify plenty of room for growth through your funding. Even after achieving financial milestones, the restaurant should still have more pronounced growth goals that your continued investments can help them achieve, making your continued involvement worthwhile.
Investing in a restaurant franchise or chain might appeal more to some investors than standalone single restaurants. The level of scalability will be far higher, so investing is a wise decision.
Good Projected Rate of Return
Cash flow projections will determine the projected rate of return. Some investors require a 20 percent rate of return over 10 years. Others might want a higher rate, while some might not mind a lower rate.
However, dipping too low under 20 percent veers into bad investment territory, as you have a greater risk of putting your money into something that might not yield much ROI.
Reasonable Occupancy Costs
All restaurants will have occupancy costs, which detail the lifetime cost of a building rented or owned. A restaurant should have a good idea of occupancy costs, including taxes, maintenance, insurance, rent, or mortgage.
The costs should reasonably fluctuate, and the restaurant should always maintain enough capital to afford them.
Consistent Cash Flow
The next factor to consider is cash flow. All restaurants should have a good amount of cash flow, but how consistent is this restaurant’s income month after month, quarter after quarter, and year after year?
If the restaurant has many revenue dips, that’s something to pay attention to. The longer they’re in business, the better the restaurant should get at making financial projections that hold true to their earning reality.
They should also understand their clientele and other factors like seasonality and economic patterns to hold mostly steady.
Low Level of Risk
Investments fail, but the lower the risk, the less likely that is to happen. A high-risk investment is volatile, usually lacks regulatory protection, and aims for a high rate of return, even though it rarely achieves it.
You should avoid these risky investments with all your might. You will likely lose your initial investment and countless more dollars, which can impede your ability to invest in other, more lucrative properties down the line.
Matches Investing Goals
Finally, a good investment should gel with your investing goals. Perhaps you wish to branch into a new industry or expand your horizons. In both those examples and more, a restaurant could be a sound investment for you.
The Types of Restaurant Investors and the Risk Level Involved
All styles of investors don’t carry the same degree of risk. Here are four types of investors. Which sounds the closest to your investment style?
Venture Capital Firm Investor
A venture capitalist or venture capital firm investor provides capital for equity.
They usually select businesses like startups and other companies with a lot of growth potential. These businesses cannot afford to grow to the level they do without the help of a venture capital firm investor.
However, a restaurant must have a proven track record of profit or great potential to generate revenue to attract the attention of a venture capitalist.
The risk level of a venture capital firm investor is lower than other types because of the required track record of financial success before striking a deal.
Angel Investor
As the name implies, an angel investor helps businesses that desperately need it, either because they’ve been turned down by other investors or lenders or banks have refused them.
These businesses carry a higher degree of risk, so angel investments require experience sniffing out viable opportunities versus those with little to no income potential.
You should review the restaurant’s financial portfolio and business case. Avoid opportunities that give you pause, as they could be financial disasters in the making.
Active Investor
You’re an active investor if you want a hand in the restaurant’s goings-on. You funnel money into the restaurant in exchange for a stake in operations.
Your close involvement with the restaurant puts you in a position to monitor its income and make financial recommendations to the owner, like putting money into stocks.
However, you must closely study the restaurant’s financials before investing and determine a continued relationship’s viability quarterly or monthly.
Passive Investor
Other investors don’t need so much involvement. A passive investor isn’t part of the restaurant’s regular operations but isn’t blind to what’s happening.
They stay up-to-date to ensure their investment continues to be worthwhile but allow the restaurant to make decisions outside of them. The benefit for them is more time for philanthropy, a job, or other projects.
The level of risk is not necessarily lower as a passive investor.
The Pros of Investing in a Restaurant
Now that you’ve had some food for thought, here’s some more. This section and the next will explore restaurant investments’ upsides and downsides, beginning with the benefits.
Stability and Security
The restaurant industry is stable. Although individual restaurants might have experienced closures, the industry found ways to adapt, grow, and thrive in light of the world-altering COVID-19 pandemic. Now, even in healthier times, restaurants have proven resilient and secure.
According to 2023 data from the National Restaurant Association, the food service industry will generate sales of over $997 billion in 2023. Up to 500,000 more jobs will also be added in 2023, for a total of 15.5 million. Those numbers surpass the industry’s job numbers before the pandemic.
While some of the boosted revenue projections are from increasing food and menu costs, the restaurant industry has experienced an upswing since the pandemic.
Great Growth Opportunities If You Invest in a Franchise
Earlier, we discussed scalability as a trademark of a good investment in a restaurant. Investing in a franchise, in particular, drives more growth, as the expansion will allow your investment to go further.
You could eke out other financially motivating growth opportunities elsewhere, even if you don’t invest in a franchise, but these are the soundest investments, according to many financial professionals.
Could Benefit Your Portfolio
Restaurant investment experience looks great on your portfolio, especially if you invest in a financially fruitful property or have other successful bonds, stocks, and funds on the portfolio.
The Cons of Investing in a Restaurant
However, despite how advantageous of a position a restaurant investment can put you in, you must also consider these downsides before proceeding.
Assuming Most Risk
Even though you don’t own a restaurant, you take on a major role as an investor and/or franchisee. That means accepting the bulk of the risk. If the restaurant begins tanking, you’ll feel it, as your money will go toward a failing venture. If the restaurant shuts its doors, you’ll have nothing to show for it.
You won’t want to add the restaurant to your portfolio because it was a failed venture.
Economic Uncertainty
The economy has been poised on the verge of recession several times in the early part of the 2020s, and with rising costs across the board, especially food, economic uncertainty is on the rise. The effects of the United States experiencing a recession could trickle down to the rest of the world, hindering the global economy.
We’ve established that restaurants can survive economic strife, as one has to look no further than the COVID-19 pandemic for proof. However, economic uncertainty can keep people out of restaurants or more eager to cook at home since they spend so much more on food.
That can impact a restaurant’s ability to bring in a consistent customer base, thus making the establishment a risky investment.
High Rate of Failure
Hospitality resource BinWise, with stats from the National Restaurant Association, predicts that only 20 percent of restaurants are successful. Up to 60 percent fail within the first year, and another 80 percent within five years.
That’s a dismal picture. Some restaurants beat the odds and stick with it, but with under 30 percent of them doing so, your investment will likely fail.
So, Is Investing in a Restaurant Worthwhile?
Now that you have all the facts, it’s decision-making time. Should you invest in a restaurant?
Ultimately, it’s your money and your decision. There are certainly upsides to the choice, as you can broaden your portfolio, invest in something you’re passionate about, and dip your toes into the restaurant industry without opening an establishment yourself.
However, there’s more substantial risk associated with investing in single restaurants versus franchises or chains, and those risks cannot be subverted or ignored. Doing so is at your own peril.
Another major downside to account for is the high rate of restaurant failure. You’ll recall that 60 percent of restaurants don’t survive a whole year. Even overcoming that hurdle doesn’t guarantee success, as 80 percent of restaurants don’t make it five years.
The small success rate cannot be ignored. You must anticipate that if you decide to invest in a restaurant, you could likely pour your money into a failing venture. If the restaurant shuts down, gradually or all at once, your money goes with it.
Some investors can assume the risk without financial hardship if the restaurant fails, so they decide to invest anyway. Others assume the restaurant they invest in will be one of the few that survives, which is a major gamble.
Your gamble could pay off, but the numbers don’t lie, and they indicate your investment will fail.
Of course, if you’re still interested in proceeding with restaurant investments, you should review the types of investor roles you can occupy. A venture capitalist role might be better for you to minimize your degree of risk.
Bottom Line
Restaurants can be good investments, but with a high rate of failure and major responsibilities thrust upon the investor, many decisions must be made before investing. All investments are a risk, but restaurants have a higher degree of risk than usual, so an investor must carefully weigh the advantages to determine if they’re worth it.
