Mark Masinter still remembers the phone call. "A friend of mine who was very smart about retail called to tell me about this guy named Steve Gordon who had a four-store chain based in Eureka, Calif.," says Masinter, who admits he was skeptical. "She said it was a hardware store, but it also sold eclectic gifts. They needed some help expanding their company."

That was six years ago, and the company called Restoration Hardware has become a retail sensation with 65 stores open in 25 states. "Of course, out of the hundreds of deals we look at, only a few turn out to be another Restoration Hardware," says Masinter, one of four partners in Dallas-based Restaurant & Retail Growth Capital LP. "But you don't need many deals like that before you start attracting attention."

If you haven't heard of Restaurant & Retail Growth Capital (RRGC), then their client list should ring a bell. During the past three years, the private investment partnership has funded some of the hottest new retail and restaurant concepts, including Colorado Pen Co., Texas Land & Cattle Stake House and Bikes USA.

Other clients include restaurants Quizno's Classic Subs, Left at Albuquerque, Foodstar Restaurant Group and retailers America's Service Stations and Elizabeth Arden Red Door Salon.

Tapping the SBA Working under an often overlooked Small Business Administration loan program, RRGC has helped fuel the takeoff of a disparate group of companies ranging from an auto repair chain to an art supply superstore.

"We act a lot like a venture capitalist, but we structure it as a mezzanine investment," says RRGC CEO Raymond Hemmig, who with partners Masinter, J. Eric Lawrence and Joseph Harberg, is always prospecting for the next winning retail or restaurant deal. "We want businesses that have some legs and have some room to grow. We want to add to these businesses the value of what we have learned from other businesses."

On average, RRGC invests $2 million with these companies provided from the SBA's Small Business Investment Corp. loan program. Under this program, RRGC borrows the money from the federal government, then lends it to qualified small business borrowers taking their own interest spread.

Most of the firms are too small to fund significant expansion out of sales, but not yet big enough to tap Wall Street fundings. RRGC provides fixed-rate, long-term subordinated or mezzanine debt for the businesses, and usually takes a minority shareholder position in the companies.

"We take the liability with the SBA that the money is repaid," Hemmig says. "We were the very first SBIC lender to target the retail and restaurant industry, and to my knowledge we are still the only one."

Most of the program's loans go to small manufacturing companies. "Retail and restaurant businesses are a lot more complicated," he says. "The retail and restaurant business -- when it works -- is awesome. Of course, when it doesn't work, it's terrible."

So far, RRGC's deals have been home runs -- like Colorado Pen, which got a $2 million investment from RRGC in 1996. Recalls Lawrence, "Everyone thought they were nuts -- a chain of fountain pen stores? Well, 53 stores later, they still have no competition."

RRGC provided funding for the Denver-based retailer when the company had only about a dozen locations. "They came to use when we had proved the concept," says Colorado Pen founder Terry Hordinski. "Their product allowed us to build our capital base without taking the dilution you would get with a straight-up venture capitalist. It cost us only 10% dilution (of company ownership) to get them in there, and it got us out of being personally signed at the bank."

But more important, Hordinski says, the deal with RRGC got them an investor with retail and real estate savvy. "Their advantage in the marketplace is that they have a strong core knowledge of retail and the restaurant business," he says. "Those are two businesses that scare everybody else to death."

That next growth chunk of capital Hemmig has had plenty of experience with both retail and restaurant. After stints at JCPenney, Hickory Farms, On the Border and Grandy's, he was CEO of ACE Cash Express Inc., a national chain of 700 retail finance services stores. While there, some of his investor partners began looking at additional retail prospects.

"We invested together in Restoration Hardware, and the success with that was so good we began looking at other deals," Hemmig recalls. "We thought it would be great to put a ready fund together so that when we found a deal we wouldn't have to go hunt money."

RRGC now has a $60 million fund backed by investors that include Hunt Capital Group, Simon Family Group, Cardinal Investment Co., Rauscher Pierce Refsnes Inc. and Armata Partners. They concentrate on deals that are too small for an investment banker but require more onerous terms from a bank, Hemmig explains.

"The retail and restaurant industry does not have a tremendous number of people looking for deals in the scope or range we work in," Hemmig says. "There are lots of small businesses out there in the $5 million to $20 million sales range that need that next growth chunk of capital. We are not investing in startups; we are investing in companies that have gone through the stages of determining where they are going."

For example, Massachusetts-based The Art Store was a chain of art supply superstores that owner George Granoff had bought out of bankruptcy and was expanding. "When they came to us, they had seven stores -- six in California and one in New York," says Lawrence. "When George called and told me he sold art supplies, I didn't jump out of my chair. But I soon learned there is $2.5 billion in annual sales done in this country in art supplies, and no brand leader."

Last September, RRGC provided $2.5 million in capital to help finance The Art Store's nationwide expansion. RRGC's typical deals pay back in three years, and the partnership keeps its detachable warrant positions in the companies.

"We try to influence the business and to be a strategic adviser," Hemmig says. "We are prohibited from being in a control position -- we are minority shareholders."

Plus, the small RRGC management team doesn't have the time to help operate its clients' businesses. "We give them the money and they have to run the business," Hemmig says. "That's why we spend a majority of our due diligence on the character of the management team."

Masinter states the obvious: "We eat at a lot of restaurants and visit a lot of stores."

How many?

"We have seen over 900 concepts in the three years we've been in business," Hemmig says. "No, we haven't picked too many. We've seen a lot more deals we are happy we didn't do."

Betting on the right concept To pass muster at RRGC, a potential client must get a unanimous thumbs up. "All four of the general partners have to agree before we do a deal," Hemmig says. "If one guy votes no, it's out of here."

To date, the game plan has worked out, in part because of the partners' expertise. Lawrence, a former senior retail consultant at Arthur Andersen, picks apart the companies' financial picture. Harberg is an attorney and former officer at Sharper Image who worked on the retailer's initial public offering. Masinter's background is in retail and restaurant leasing. Masinter and Harberg formed a retail real estate consulting business in 1988 to help clients avoid property pitfalls.

The real estate side of the business is still a key concern for RRGC. "If you've got a great concept and management team, you can still screw up quickly by making bad real estate decisions," Masinter says. "That's because the capital outlay is so significant."

RRGC's real estate department acts as an outsourced real estate team for its clients, evaluating current contracts and negotiating new ones. "We try to get them to look at where they want to go, and whether they have the capital to do it," Masinter says.

Getting the attention of clients is becoming less of a problem for RRGC these days. "For a long while we spent most of our time telling people who we were," Harberg recalls.

But with a growing client list, RRGC isn't cold-calling for deals. "By 1998 we saw the table turn, and our name was out there and we were getting a good deal flow," Lawrence says. "These days we are referred by people we don't even know. I would like to think we are seeing most of the opportunities in the areas we are focused on."

That puts even more pressure on the partners to continue to bet on the right retailer or restaurant.

"The concept is the easy part," Hemmig says. "But in order for us to be interested, they have to have the cash flow and the management team to make things work. If everything works out and they treat the capital well, it will repay itself in three years. Where else are you going to get that return?"