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Jay Hackstaff worked in outback restaurants for 25 years before deciding to start his own business. He had saved his money over the years and decided to buy a franchise. In 2018, he settled on a Californian upstart named Burgerim, who was selling franchises everywhere.
He received a Small Business Administration (SBA) loan, which a loan broker working with the company helped to close. Cost overruns took the loan from $400,000 to $600,000. The store struggled when it opened and a year later company founder Oren Loni closed the store and fled the country, abandoning the store and its operators.
More than three years later, Hackstaff is still repaying that loan — despite the state of California itself directing Burgerim to issue refunds to franchisees and even though the U.S. Federal Trade Commission has sued the brand and Loni for deceptive operators. Hackstaff often struggles to make the $8,000 monthly loan payment and frequently receives calls from collectors threatening to foreclose on the loan and take his home.
“They assume they’re doing their due diligence and reviewing every single franchise that they authorize,” Hackstaff said of the SBA. “I trust that the government will do its job. And if there are any problems with the franchise, they would say that’s not going to happen.”
Hackstaff is rarely alone. When Burgerim came out of nowhere to sell those 1,500 operators through its franchise offering over a period of just three years, one of the biggest enablers was the US Small Business Administration.
According to a report on franchising by US Senator Catherine Cortez Masto, D-Nev, the SBA has made loans to 119 burgerim operators. These operators received loans totaling $38 million. That sum represents a third of the total number of Burgerim locations ever opened, meaning the brand relied heavily on government-backed funding.
“It really begs the question, is there a government review before the government guarantees loans?” said Keith Miller, a franchisee advocate who has studied the burgerim issue closely. “The fact that the government is guaranteeing loans gives franchisees some peace of mind that they’ve been screened.”
The bigger problem is the personal guarantee. When Hackstaff and other borrowers sign to receive an SBA-backed loan, they must sign a personal guarantee — something that wealthier franchisees who receive private financing don’t have to sign. If the loan fails, they lose their house. In other words, these threats to take Hackstaff’s house are very real.
“They destroy the lives of people who have done nothing wrong,” said Jonathan Fortman, a Missouri franchise attorney. “All they did was try to open a business and rely on people to treat them fairly.”
The SBA operates a number of loan programs. Most notable is the 7(a) program. It was designed to help people get funding that they otherwise couldn’t get on their own. Without them, many small businesses such as catering companies or contractors or installers could not start.
Many restaurants, the most frequent users of the program, could not do this either. The SBA funded more than 10,000 such loans to restaurants during the federal government’s fiscal year 2021 — or about one in five 7(a) loans it made during that period.
Many of these loans fail. One study found that one in 10 SBA-backed loans fail, partly because they go to more vulnerable borrowers and because many businesses ultimately fail.
Franchisees receive many of these loans. About a third of the loans made to restaurants last year and 40% of the amount approved went to franchiseesaccording to federal data.
It’s not certain how many franchise loans fail, but franchises are no safer than any other investment. Caroline Bundy Fichter, a franchise attorney at the Bundy law firm in Washington, estimates that she refers about a third of her franchise clients to bankruptcy attorneys — and most of them received SBA loans.
That’s one of the problems in franchising. Many people invest in franchises because they believe it’s safer than just starting a concept from scratch, but they fail just as often.
2021 SBA 7(a) Loans
Source: US Small Business Administration
While there are many tried and true brands that have franchisees receiving SBA loans, such as Domino’s and Jersey Mike’s Subs, there are many that are designed for systems where problems are common. A number of franchises sell aggressively to anyone willing to sign an agreement. They can also employ other strategies that make it difficult for operators to generate profits.
The SBA will stop lending to franchises with too many defaults, as it eventually did with Burgerim. But it could be a while if it ever happens. Quiznos signed as many franchisees as possible in the early 2000s, eventually becoming the second largest sub-chain in the country. However, it also had one of the highest default rates on SBA loans in the industry. Franchisees complained loudly about a number of things, most notably high fees for groceries and paper.
The brand began closing hundreds of stores in 2009. Today it has less than 5% of the locations it had at its peak in 2006.
The SBA once released default rate data for franchisees whose franchisees received such loans. But the agency stopped doing that a decade ago. That makes it harder to determine how badly franchisees of a brand are struggling.
Cortez Masto introduced legislation last year that would require the SBA to publish quarterly default rates for loans by brand over the prior 10 years. She also reinstated legislation that would require franchisees to obtain historical information on revenue and store closures before they can receive an SBA loan.
“The availability of SBA loans and the lack of transparency on default dates gives people the opportunity to gamble with other people’s money,” Bundy Fichter said. “In the end, it’s the franchisees and the taxpayers who suffer.”
Additionally, she said, borrowers on SBA loans can find it difficult at best to get breaks. While landlords or franchisors may provide assistance to struggling franchisees, the SBA rarely does.
SBA 7(a) Loans by Year
Source: US Small Business Administration
Burgerim officially opened its first US location in 2016. As of the end of 2019, the company has signed more than 1,500 franchisees. The state of California estimates these operators have paid nearly $58 million in franchise fees.
The FTC, in its lawsuit filed last week, said the company intentionally misrepresented the franchise’s risks to those buyers — including promising refunds, the vast majority of which were never granted. It was the first time the agency had taken action against a franchise in 15 years.
The SBA remains an open question. But as part of Burgerim’s strategy to open stores, the company steered a number of franchisees into government-backed loans.
Hackstaff agreed to open a burgerim in 2017 and was approved for an SBA loan the next year. He worked through a broker and the company that did most of the paperwork. They even wrote the business plan that the SBA requires of every franchisee that makes the loan.
The plan included financial projections that indicated the brand would be profitable in the first month and remain profitable thereafter.
That gave lenders the confidence to approve a 50% increase in the loan amount to fund build-out cost overruns, a common problem for Burgerim franchisees who have been able to get this far.
But Hackstaff’s restaurant never came close to matching the revenue projections in the business plan, projections used to fund the loan. And his restaurant was never profitable.
Read more about Burgerim’s problems here.
Just over a year after opening his shop, Oren Loni left the brand, leaving unopened mail and files at the company’s California offices. Operators didn’t hear from the brand for weeks, until a lawyer sent a letter to franchisees in December 2019 saying the company was going bankrupt. That file never came.
Hackstaff estimates he invested $1 million in Burgerim. He’s not confident he’ll see any of it. “I’ll never see a cent of that,” he said.
But he still has that $8,000 monthly payment, a payment that’s inflated by the increased size of the loan along with a variable interest rate. Hackstaff has since given up the Burgerim brand and developed his own concept, the Handcrafted Burger Bar. He said the restaurant is fine, although he keeps it mostly open to pay off the SBA loan.
In some months, this loan accounts for 21% of his earnings. “It’s ridiculous,” he said.
Fortman said the same thing. The SBA, he said, expects franchisees to do their due diligence. “They want a business plan,” he said. “But if the franchisee is cheated and the bank is inevitably cheated, then [the SBA] must bear part of this risk. They gave you the loan.”
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