Emerging Brands

As Burgerim grew, protection for franchisees fell short

The fast-casual burger chain exploited a hole in franchise regulations, selling more than 1,200 licenses before problems became evident.
Photograph by Christina Gandolfo

This is part three of three in a series about Burgerim. Read part one here and part two here.

Diane Long has invested all of her savings into a Burgerim that her son could operate. She is so close to opening she can feel it. Just a couple of weeks’ worth of work and that restaurant in Dixon, Calif., will be ready for customers.

But she can’t.

Long says a contractor has some of her equipment and won’t deliver it to the restaurant, despite numerous calls. And the lender for her Small Business Administration-backed loan won’t release the rest of her funds until that dispute is resolved. So the work sits undone, the restaurant unopen, while its loan and lease start coming due.

“Every day I wake up, it’s another nightmare,” Long said. “This was an SBA loan. They’re lending people money to start a small biz. How would they loan me an amount of money if they didn’t think this was a viable franchise?”

As the scope and severity of the Burgerim disaster has become clear, such questions have become more frequent.

Within four years, the company went from zero locations to 1,200 licenses sold around the country, many of them to people with little money and little experience in the business. Yet by the time state and federal regulators realized there was a problem, the company had collapsed under its own weight, and its owner had fled the country. Even now, one month after Burgerim said it might file for bankruptcy, only one state—Maryland—has ordered Burgerim to stop selling franchises.

To franchising advocates, Burgerim exposes deep flaws in the system set up to regulate the sale of such franchises. There are few penalties for unscrupulous sales operations that deliberately mislead franchisees into sending in their fees.

It also reveals flaws in the business mindset, where growth is celebrated and franchises are sold like used cars. At the same time, many would-be franchisees are unaware of the risks they face in buying that franchised restaurant.

“The biggest problem isn’t that the system failed, it’s that the system isn’t built to address this,” said Caroline Bundy Fichter, a franchising attorney based in Washington state. “The tragedy is that they didn’t invent the wheel. They took advantages of weaknesses in the system.”

Franchise regulations

Most franchise law is about disclosure and liability, and enforcement tends to be slow. In Burgerim’s case, the company was able to operate for years, selling franchises all over the country with little risk of any criminal penalty.

The federal government, through the U.S. Federal Trade Commission, regulates franchise businesses, requiring them to detail everything about their business in what is known as a franchise disclosure document (FDD). Franchises are required to give that document to prospects. These documents are large—Burgerim’s most recent FDD was 240 pages long—and include the franchise agreement as well as various details about the business, such as fees, royalties, the initial investment, lawsuits against the company, the background of the business and information about existing licensees.

Nineteen states have some franchise regulations, and a few of them feature potential penalties for fraudulent schemes. But there are no penalties at the federal level for bad franchise actors. By contrast, there are stronger penalties connected with the sale of publicly traded stock.

Robert Purvin, CEO of the American Association of Franchisees and Dealers and a longtime advocate for franchisees, notes that publicly traded companies can’t sell stock without meeting certain financial standards. They have to publicly report earnings and have to reveal any material changes in the business.

“There are virtually no protections from scam artists in franchising,” Purvin said. “The fabric of securities regulation is much greater.”

One example is franchise sales and profit disclosure. Franchises can voluntarily disclose revenues or profits for franchise units in Item 19 of the FDD. Most franchises disclose that information, though only about half of “emerging” franchises do, said Jeff Lefler, CEO of FranchiseGrade.com.

Burgerim walked all over this regulation. It did not disclose an Item 19, and therefore its sales representatives were not supposed to talk about it to prospects. But franchisees were routinely given assurances of sales and profit.

One operator was told most franchisees pay off their loans within a year. Another was told the company’s restaurants generate a 23% profit margin, and that the lowest-revenue store generated $800,000 in sales per year.

By contrast, if someone disclosed insider information on a publicly traded company to a stock buyer, they could face criminal penalties. “If this was a stock, everyone would be in jail,” said Keith Miller, a franchisee advocate who has investigated Burgerim extensively.

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The International Franchise Association (IFA), a trade group that represents franchise businesses, argues that there are remedies through existing regulators for “bad actors.” But it says regulators need more resources to take action.

“We agree this is egregious,” said Matt Haller, senior vice president of government regulations and public affairs for the IFA. “The people behind this action should be held accountable. Regulators need more resources. There’s a healthy conversation to be had here in the industry about how to prevent situations like this.”

But, he added, “No amount of regulation is going to stop somebody who is hell-bent on exploiting holes in the system.”

The IFA also argued that the Burgerim case is “extremely rare” and cautioned about developing regulations influencing all operators simply to focus on a few problems. “You can’t legislate to the extreme,” said Stuart Hershman, an attorney with DLA Piper who works with the IFA.

Selling strategies

Another problem within the system is the way franchises are sold: Many are sold more like used cars than as investments that have the potential to wreck a person’s personal finances and cause them to lose their home.

Systems like Burgerim play to prospective franchisees’ emotions. It sold franchisees on being their own boss. Plus, the food was great, the design was spectacular. And the brand deliberately targeted people who couldn’t get into other franchises either because they didn’t have money or experience or both. “Go f---ing sell them the dream,” Oren Loni, the company’s owner, frequently told employees. “Sell them the American Dream.”

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This idea of playing to an emotional sale isn’t uncommon in the franchise process. While Burgerim was extraordinarily good at franchise sales, many franchisees bought into the brand based on those emotions. “The reason they’re able to sell franchises without a proven concept is the consumer-driven mindset,” Lefler said. “A lot of investors in the franchise space buy a franchise because they love the taste of the food. That drives a lot of bad investments into the industry.”

Ironically, the buyer of a used car probably has more protections than the buyer of a franchise. “It is the only area of consumer protection where the principle of ‘caveat emptor’ (‘let the buyer beware’) still prevails,” Purvin said.

Another problem is the perception that franchising is a safe investment. Many franchisees buy into a brand in part for that reason, believing there is less risk than if they simply operated their own concept.

Photograph of Michael Sarkisoff by Brad Ziegler

Photograph of Michael Sarkisoff by Brad Ziegler

“The reason I bought a franchise is it would guarantee people through the door,” said Michael Sarkisoff, who has rebranded his Burgerim in Troy, Mich., after struggling to generate profits for months. “As long as you can provide proper service, people were going to come because they liked the food. None of those things panned out.”

Franchises can be safer investments. But the safest ones are large, established systems such as Burger King, Wendy’s or Applebee’s. The challenge: Most prospective franchisees can’t get into those systems, which typically target larger, multiunit franchisees. Systems that target single-unit franchisees, especially those with less experience, capital or both, are far riskier.

Arguably the biggest restaurant chain collapse in history was another brand that sought out smaller franchisees: Quiznos. In 2006, the chain had nearly 5,000 units and was the recipient of a $600 million leveraged buyout valuing the company at $2 billion. Today it has around 300 U.S. locations.

Franchisors can make mistakes that put franchisees out of business. And franchisees, because they are operating that brand, are restricted from making changes that could keep them in business, such as cutting staff or other costs, eliminating costly food items or raising prices.

Plus, franchisees also have to pay a percentage of sales to the brand in the form of royalties. Those royalties mean franchisees have to profit off of 93% of their sales.

Of course, Burgerim didn’t collect those royalties—and still most of its operators are losing money.

closed burgerim interior

Photograph by Christina Gandolfo

The Small Business Administration

Much of Diane Long’s ire was directed at the SBA. She felt that the association’s willingness to back Burgerim’s loans was a sign of safety.

The SBA will guarantee loans made to small businesses. Such loans are designed to encourage business development, enabling people to get financing when they otherwise cannot. These loans come with lower interest rates, thanks to that guarantee, and they take longer to pay off, making the payments easier for the business to swallow. But they also require borrowers to put up collateral—and that usually means their home.

But an SBA-backed loan is not a guarantee of safety. In fact, about 1 in 5 SBA-backed loans to franchisees fail, according to a 2015 study.

In this case, the SBA did little to determine whether Burgerim was a workable concept, then backed loans to inexperienced operators who risked their homes to take a chance on the brand.

“They’re going to lose every asset they have,” Miller, the franchisee advocate, said. “I don’t see how the government, the Federal Trade Commission, can look at that and say that’s OK.”

He noted that an independent business would be required to detail financials to get an SBA loan, along with a plan to make the loan work. And that business would not be able to open a second location until the first one succeeded.

“They gave out over 100 loans before they ever found out whether this company was legitimate or their business model a success,” he said. “If you and I can’t get a second loan for the same business, how can franchises get hundreds of loans when they haven’t proven they’re a success?”

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The SBA has pulled its backing since problems with Burgerim first emerged late last year. But Burgerim still has the SBA logo on its franchise sales site.

There are some efforts to change this. U.S. Sen. Catherine Cortez Masto of Nevada introduced legislation last year that would require franchises receiving an SBA-backed loan to provide more financial and franchise sales data.

Three other logos remain on the Burgerim website as of Thursday, including one that says it is a member of the IFA and another that says it is a member of VetFran, a registry created by the IFA and the Franchise Education Research Foundation. That registry connects franchises with with war veterans.

Haller said on Thursday that Burgerim was actually kicked out of the association six months ago and has been the subject to cease and desist letters to remove its logo.

But Burgerim was still on the VetFran registry until it was removed this month, continuing to court veterans with discounted franchise fees.

When asked why Burgerim was on that registry even when the association ended its membership, Haller said VetFran and the IFA are “separate databases” and “two separate organizations and staff.”

Growth mindset

As Restaurant Business investigated the Burgerim disaster, it became clear that we were part of the problem.

In July, the publication and its sister company Technomic put the chain at the top of our Future 50 ranking, a coveted list of the fastest-growing small restaurant chains. Even today, the company boasts on its website that it is “the fastest-growing restaurant chain in the U.S.”

Sales pitches to prospective franchisees sent in December and January, after the company was in restructuring, featured that ranking prominently. The ranking is based on sales and unit growth figures, and Burgerim skyrocketed in both in 2018.

Much of Burgerim’s growth fed on itself. As the company sold more and more franchises, others wanted to jump on board. Several operators we spoke with saw the number of people investing in Burgerim and wanted to be part of it. And as locations opened, media fawned over the brand and its mini burgers, with few questioning whether Burgerim was the house of cards it turned out to be.

“This industry worships growth,” Fichter, the franchising attorney, said.

“This set of practices is very standard,” she added. “The difference is Burgerim was more shameless and more aggressive about exploiting weaknesses in the system.”

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Indeed, there are signs everywhere that Burgerim’s incredible growth won it business. The chain received rebates from vendors, at least in part on its promise of additional locations. And that growth likely played a role in its ability to get SBA financing.

But there were also many red flags. Lefler, of FranchiseGrade.com, saw them years ago simply by analyzing the FDD. Franchise Times magazine and Keith Miller later saw large numbers of franchises sold but relatively few open—an indicator of a major potential problem, because it reveals a franchise concerned more with sales than long-term sustainability.

Lenders, too, saw problems as loans started to fail. Landlords and real estate brokers saw numerous red flags as they received applications from franchisees they knew should not have a location.

Yet regulators have only recently started looking into the business. And meanwhile, Burgerim continues to sell franchises, pushing its business on new potential operators they hope will replace those in danger of going out of business.

“Over the last 10 years, Burgerim has proven its sustainability by expanding in a variety of different countries,” one sales pitch went. “Most recently, our brand has become a hit in the USA. Our concept, business model and branding are very unique. The versatility of our concept helps to meet your specific area’s demographic needs.

“Burgerim is the fastest growing fast-casual franchise in the USA!”

Part one: The Burgerim disaster

Part two: Burgerim franchisees pick up the pieces

UPDATED: This story has been updated to correct the SBA's full title and to add new information.

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