25 Worst Franchises to Buy, 2011

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With foodservice about 50% of franchising activity, one can&#39;t talk about loan failure patterns without&nbsp;noting restaurant issues. While said many times in many ways by many people on this site, a few common denominators deserve noting again:</p>
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(1) heavy sandwich chain loan chargeoffs show up so often partially because the sandwich business&nbsp;inheriently appeals to one daypart: lunch. Of course, breakfast, dinner, catering, snack and overnight options can exist, but our experience is that restaurants need <strong>more than one daypart</strong> of (at least) &nbsp;<strong>steady business</strong> to survive. The same trend is true of snack&nbsp;concepts: treats might be very tasty but you have to have daylong demand to make it.</p>
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(2) franchisee economics are such that&nbsp;royalties must be paid to the corporate parent. That fact, and the fact that almost always the franchisor has access to more territory to develop and access to lower (or any, for that matter)&nbsp;cost of capital, means that franchisee (especially single unit zee)&nbsp;economics will be challenging.&nbsp;</p>
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(3) The item 19 FDD &quot;earnings&quot; disclosure isn&#39;t earnings. It&#39;s gross sales (not net sales, for which you keep), if shown at all.&nbsp;Sales does not equal profit or earnings!&nbsp; We have opined many times that we&#39;d be so better off if average weekly net sales and store level EBITDA (before owners return, taxes, depreciation) etc could be tracked or revealed. In fact, franchisee associations can take the lead to track and own that information ! Most franchisors don&#39;t have that data, really.</p>
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(4) the restaurant physical plant&nbsp;must be&nbsp;renewed and remodeled, new equipment must be purchased, and the franchisor will specify upgrades from time to time, for which there is a real cash expense. Most in store&nbsp;financial statements are missing depreciation expense. Without depreciation expense and (its)&nbsp;cash flow being generated, fixes and upgrades will always be a unpleasant surprise and&nbsp;store level costs&nbsp;understated.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;</p>
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John A. Gordon, chain restaurant earnings and economics experts, <a href="http://www.pacificmanagementconsultinggroup.com">www.pacificmanagementc…;

It would seem that the list refers to some huge money lost overall and also individually to some spectacular brand disasters. As a prompt for the SBA on safer lending practices surely it must register the financial performance of the worst of the worst franchise brands as an indicator that it should pick up its act.

SBA would seem to have ample dealings with enough disaster brands to determine that it is lending to many of the wrong franchisees and to many of the wrong franchise brands.

Surely SBA would sample some of these bigger disasters to look at its performance in handing out such loans and work out where lending decisions went wrong?  Surely SBA would have enough history to look at the accuracy of financial performance projections provided on loan applications and question what might obviously seem to be a common thread [or a lending system for franchising if you prefer] of inaccurate applications.

Can anyone seriously look at these costs of failure and not at least suspect that there is more at work here than poor business performance from franchisee operators.

I’d suggest SBA look for where the inaccurate information originates, whether failure rates are grounded in organized fraud and what influences have encouraged such massive losses to continue for so long.

When there is serious money up for grabs there will always be those who will take it. Here it seems that the SBA loan process has been manipulated and abused and most probably it involves organized systems of fraud and a web of culprits.

Such practices always cost someone and in this instance the first to pay will be US taxpayers followed by gullible franchisees and to at least some degree this has got to undermine traditional lending.

Take a look at the list for 2008 and you'll find Mr. Goodcents ranked 9, Philly Connection ranked 16 and Cottman ranked 20. I would expect that since it takes a period of time for the loan defaults to take place these franchises reflect a significant period of poor performance. Also, since the SBA doesn't lend but rather guarantees the loans perhaps the banks that lend under the SBA program have caught up with these poorly structured franchise concepts. I agree  that certain conglomerates do more harm than good. Operating a large diversified franchise organization requires strong successful brands, profitable franchise programs, excellent management and a keen understanding of franchising. There are some pretenders out there and only one Yum Brands. BTW, we need more information like this. Thanks, Don

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Those are thoughtful comments John, especially around EBITDA and depreciation. My review of franchisee financials across industries indicates the rule of thirds is alive and well, with only a third making acceptable EBITDA given the personal effort, stress and risk involved in buying and operating the business. High caliber multi-unit operators seem to be faring better. Also as you suggest, the refurbishment costs can also dent ROI significantly. As the internet continues to change customer buying habits it will be interesting to see how Non food retailing is further impacted.

Talk to a The UPS Store owner who has owned their store for more than two years. The reason the SBA loan failures might not be that high is that it's nearly impossible to get a loan for one of these money pits in the first place. Owning one of these stores is a nightmare. UPS keeps stealing our shipping, and the franchisor thinks we should concentrate on printing and copying in order to survive. Many owners want to close but are tied to personal guarantees. The latest tactic by MBE/UPS is to try to get existing owners to buy other failing stores for pennies on the dollar. Other owners are in lawsuits and are afraid to file for bankruptcy because they may not receive a settlement. As a TUPSS owner you work for UPS, and you pay them instead of the other way around. In 2008, as a network, the stores took in more prepaid UPS packages than paid packages shipped through the stores, and it's gotten worse since then. Now UPS wants (and will force) the stores to receive packages for them for the convenience of UPS's customers. This is to save money on the cost of residential deliveries. On top of that, if an incoming package is lost, UPS will only pick up the first $250 in value. From $251 to $5000, we have to report it to our own insurance companies.

You may have a list compiled, but I know where I would put The UPS Store. Maybe you could put a list together based on "biggest nightmare."

Any guidance on tax prep franchises would be appreciated. I know it is a seasonal business model. Liberty Tax appeared on the SBA list and I had ruled them out before reviewing the list due to all the negative online press from dissatisfied zees. Their director of sales also spooked me at a IFA convention when he baiscally blamed those who failed rather than LT. Are any of these companies reputable????

A large part of the propfitability of this business was the refund anticiption loan interest/fee revenue. The IRS used to publish the refund information so that it could    be reliably determined who was getting what refund. You knew how much to lend and had some chance for repayment. The IRS no longer provides that information, so the level of security about whether the anticipation loan will be repaid is no longer there.

This "payday loan" business is no longer available, and the lenders will no longer participate in providing loan capital. The franchisees used to have a big spread between what interest they paid and what interest they charged. Not any longer.