High Net Worth (HNW) individuals are always being sought out whenever someone has more vision than venture capital and needs others to fund the possibility. As a general rule of thumb, such ventures are usually a bad idea. Private investments violate one of our ten questions you should ask your financial advisor: Safeguard #3: Insist on Publicly Priced and Traded Investments.

Perhaps one of the three more popular venture ideas is a restaurant. Everyone eats and likes to eat and has strong opinions about what makes a good place to eat. Because we are both a University town and a retirement town Charlottesville has a high percentage of committed foodies. At one point Charlottesville was noted for having more restaurants per person than any other city in the United States.

It was therefore with great interest that I read a two part series by Jeff Joseph in the Investment Advisor Magazine entitled “An Appetizing Investment” and “An Appetizing Investment: Second Course“. Both articles focus on what it takes to avoid the third of restaurant businesses that fail in the first year.

My rule of thumb against private investments is a good rule unless you are intimately involved in running the business and have sufficient experience and time and energy to work whatever hours it takes to make the business profitable. Nothing is more rewarding than running a small business, but nothing is more time consuming or risky than running a small business either.

If you want to invest in the restaurant business, you need to have a reason why you will do better than PowerShares Dynamic Food & Beverage Portfolio ETF (PBJ). That is a much easier way of investing and consists of all publicly priced and traded stocks. Jeff Joseph’s articles may sober some of the naive excitement about what will make a successful restaurant business.

I recommend reading both articles before ever considering starting a restaurant, but here are some choice excerpts:

Location – The single most important criteria in terms of assessing the probability of achieving the pro forma sales assumptions, and consequently the viability and sustainability of the business. A high-traffic area with robust commercial activity is always preferred. There is an obvious reason why quick-service restaurants and gas stations end up across the street from each other. Key elements of location consideration include population base, demographics, traffic volume, parking, accessibility, commercial attractions and visibility.

…

Food-to-Beverage Ratio – The top line revenue expectations are only valid if the operator is successful at controlling the critical variable key costs: food, LBW (liquor, beer, wine), and total payroll. Such that LBW costs are generally lower, and in turn produce a higher profit margin, the investor should favor ventures that are likely to provide larger LBW revenue relative to food. Generally speaking, costs for liquor are between 15% and 18%, between 20% and 25% for beer, and between 30% and 40% for wine. Food costs, on the other hand, can run as low as 25% (in a pizza restaurant, for example) to as high as 35% for fine dining.

I found this information fascinating, and also sobering. We don’t consider Food and Beverage to be a sector which will out-perform the index. I am terribly cost conscious when I eat out and will notice small differences in cost or proportions. But then I am frugal, and consider frugality a virtue.

Think thrice before investing in a private venture with a one in three chance of losing everything.