Liquidity crunch or not, New York restaurant chain Rosa Mexicano Co., known for its Mexican food, had its eye on expansion when it approached private equity firm Goode Partners LLC late last year. Founded in 1984 by Doug Griebel and Dan Hickey, the restaurant, which first opened on Manhattan's Upper East Side, operated seven restaurants at the time, but the owners felt there was room for more. The company worked on a plan with the New York investment shop that would add at least 20 to 30 more outlets within the next three to four years.

This summer the chain announced that Goode forked over an undisclosed amount for a minority stake in Rosa Mexicano. With a track record in restaurant and retail investments, Goode expects the fresh capital will help accelerate Rosa Mexicano's transformation into "the nation's leading upscale Mexican brand," said Joe Ferreira, co-founder and partner at Goode, when his firm made the investment.

The same holds true for a number of targets acquired this year by private equity buyers. In August, San Francisco's Golden Gate Capital agreed to buy an 80% interest in Romano's Macaroni Grill, an owner and operator of Italian-style casual dining restaurants, for $131.5 million in cash. Romano's had been owned by Brinker International Inc., which runs various restaurant chains primarily in the U.S.

In February, Atlanta-based Argonne Capital Group LLC acquired Stevi B's Pizza Inc., a 28-unit franchise chain headquartered in Kennesaw, Ga., for an undisclosed sum. The following month, Sun Capital Partners Inc. of Boca Raton, Fla., purchased Canadian café chain Timothy's Coffees of the World Inc., also for an undisclosed amount. Timothy's has 166 stores, a majority of them franchises located in Ontario. The company's revenue is between $40 million and $50 million, and Ebitda is around $8 million to $9 million. And in May, New York buyout firm Kinderhook Industries LLC won the 33-outlet Bd's Mongolian Grill, a Ferndale, Mich., chain offering stir-fry dishes.

Before the liquidity crunch, restaurants were tantalizing to private equity investors. The sector enjoyed robust activity between 2004 and 2007. Over a three-month period in 2006 alone, there were more than a dozen transactions, including a $2.5 billion take private of Dunkin' Brands Inc., owner of the doughnut chain and ice cream and sandwich businesses, by Bain Capital LLC, Carlyle Group and Thomas H. Lee Partners LP. And in July 2007 DineEquity Inc., formerly known as IHOP Corp., engineered a $2.1 billion purchase of Applebee's International Inc.

Since that time, flagging consumption trends have eaten away at the bottom lines of the larger restaurant chains, prompting them to cut costs and raise prices at the same time, says Eric Welsch, who heads Keybanc Capital Markets Inc.'s restaurant group. Bankruptcies have been piling up since the beginning of the year.

Welsch believes that liquidity constraints are leading to an industry shakeout that will ultimately result in stronger businesses. "By the time this recession is over, the competitive landscape will be much healthier for restaurant companies, so these investments are opportunities to position for exits once the economy turns," he says.

In the meantime, buyout interest has shifted to smaller, reasonably priced assets such as Rosa Mexicano. Private equity investors have the benefit of time, allowing them to hold investments for as long as five to seven years while working to upgrade the competitive positions of the businesses through operational growth and either organic or bolt-on expansion. In short, they can outlast the recession.

The result: Buyout shops are looking at niche companies where they can effectively deploy capital and generate returns as they grow and recognize value, Birnbaum says.

For example, Café Enterprises Inc., a Taylors, S.C.-based operator of the Fatz Café chain, says it plans to deploy some of the capital from a $60 million recapitalization by St. Davids, Pa., private equity firm Milestone Partners to open more Fatz Café restaurants. Fatz had already expanded from 37 to 45 units from the time it went on the block in October 2007 to when it was sold this past June.

Some of the large chains themselves are thinking expansion. Although the likes of Starbucks Corp. and Cheesecake Factory Inc. have been closing stores and slashing growth projections, others, such as ABP Corp., the Boston operator of the Au Bon Pain brand, see an opportunity to grab more units at attractive prices, particularly those with real estate components.

"Since some other restaurant and retail chains have reduced growth plans, we are starting to see more real estate become available to expand Au Bon Pain, and we are hoping this will continue in the future," says Jeff Perlman, a partner at White Plains, N.Y.-based LNK Partners LLC, which invested about $100 million in equity through a $250 million recapitalization of Au Bon Pain earlier this year. The chain now has about 230 stores. Perlman says his firm had a working relationship with the company's management since before the buyout.

Despite the change in strategy, these remain perilous times. The last three weeks will probably not have an immediate, direct impact on these fundamental issues, says CIT Bielinski, but it's not going to help either.

"To the extent that consumer spending weakens further or capital markets issues extend or increase the severity of an economic downturn, the restaurant industry, along with all other consumer-oriented businesses, will feel the pain," he says. Time to think small.