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Jay Hackstaff worked with Outback restaurants for 25 years before he decided to go on his own. He’d saved his money over the years and decided to buy a franchise, in 2018 choosing a California upstart called Burgerim that was selling franchises all over the place.
He received a Small Business Administration (SBA) loan, which a loan broker working with the company helped to complete. Cost overruns took the loan from $400,000 to $600,000. The business struggled when it opened, and a year later the company’s founder, Oren Loni, closed up shop and fled the country, abandoning the business and its operators.
More than three years later, Hackstaff is still paying off that loan—even though the state of California ordered Burgerim itself to give refunds to franchisees, and even though the U.S. Federal Trade Commission sued the brand and Loni for misleading operators. Hackstaff often struggles to pay the $8,000-per-month loan payment and often gets calls from collectors threatening to call the loan and take his house.
“You’re assuming they’re doing their due diligence and vetting out every single franchise they approve,” Hackstaff said of the SBA. “I trust the government is going to do their job. And if there’s any issues with the franchise, they’d say this is not going to happen.”
Hackstaff is hardly alone. When Burgerim came out of nowhere to sell those 1,500 operators on its franchise offering over just a three-year period, one of its biggest enablers was the U.S. Small Business Administration.
The SBA backed loans made to 119 Burgerim operators, according to a report on franchising last year by U.S. Sen. Catherine Cortez Masto, D-Nev. Those operators received loans totaling $38 million. That total represents as many as a third of the total number of Burgerim locations ever opened, meaning the brand relied heavily on government-backed financing.
“It really brings up the question of, is there any government vetting, prior to the government guaranteeing loans?” said Keith Miller, a franchisee advocate who has closely investigated the Burgerim problem. “The fact that the government guarantees loans give some sense of security to franchisees that it has been vetted.”
The bigger problem is the personal guarantee. When Hackstaff and other borrowers sign to get an SBA-backed loan, they have to sign a personal guarantee—something wealthier franchisees that get private financing don’t have to sign. If the loan fails, they stand to lose their house as a result. Those threats to take Hackstaff’s house, in other words, are very real.
“They’re destroying the lives of people that did nothing wrong,” said Jonathan Fortman, a franchise attorney out of Missouri. “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. Its most notable is the 7(a) program. It’s designed to help people get financing they otherwise could not get on their own. Without it, many small businesses like catering companies or construction contractors or plumbers could not get their start.
Nor could many restaurants, the most frequent users of the program. The SBA financed more than 10,000 such loans to restaurants during the federal government’s 2021 fiscal year—or about one out of every five 7(a) loans it made during that period.
A lot of these loans fail. One study suggested one out of ten SBA-backed loans fail, in part because they’re going to more at-risk borrowers, and because a lot of businesses ultimately fail.
Franchisees get a lot of these loans. About a third of the loans made to restaurants last year, and 40% of the amount approved, went to franchisees, according 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 with the Bundy Law Firm out of Washington, estimates that she refers about a third of her franchisee clients to bankruptcy attorneys—and most of them received SBA loans.
That’s one of the problems in franchising. Many people invest in franchises believing it’s safer than simply starting a concept from scratch, yet they fail just as often.
2021 SBA 7(a) loans
Source: U.S. Small Business Administration
While there are many well-proven and solid brands that have franchisees receiving SBA loans, such as Domino’s and Jersey Mike’s Subs, there are many made to systems where problems run rampant. A number of franchises sell aggressively to anybody willing to sign an agreement. They may also deploy other strategies that make it tougher for operators to make a profit.
The SBA will stop lending to franchises with too many failures, as it eventually did with Burgerim. But it could take a while, if it ever happens. Quiznos signed as many franchisees as it could in the early 2000s, ultimately becoming the country’s second-largest sub chain. Yet it also had one of the industry’s highest rates of default on SBA loans. Franchisees complained loudly about a number of things, notably high charges for food and paper.
The brand began closing units by the hundreds in 2009. Today it has less than 5% of the locations it had at its peak in 2006.
The SBA at one point published default rate data for franchises whose franchisees received such loans. But the agency stopped doing so a decade ago. That makes it more challenging to determine how much franchisees in a brand are struggling.
Cortez Masto last year introduced a bill that would require the SBA to publish quarterly default rates on loans by brand over the preceding 10-year period. She also reintroduced legislation that would require franchise owners receive historical revenue and store closure information before they can receive an SBA loan.
“The availability of SBA loans and the lack of transparency on default data gives people an opportunity to gamble with other people’s money,” Bundy Fichter said. “The people who are hurt in the end are the franchisees and the taxpayers.”
What’s more, she said, it can be difficult at best for borrowers of SBA loans to get breaks. While landlords or franchisors might provide assistance for struggling franchisees, the SBA rarely does.
SBA 7(a) loans by year
Source: U.S. Small Business Administration
Burgerim officially opened its first location in the U.S. in 2016. It signed up more than 1,500 franchisees by the end of 2019. The state of California estimates these operators paid nearly $58 million in franchise fees.
The FTC said in its lawsuit filed last week that the company intentionally misrepresented the risks of the franchise to those buyers—including promising refunds, the vast majority of which it never provided. It was the first time the agency took action against a franchise in 15 years.
The SBA remains an open question. Yet as part of Burgerim’s strategy to get stores opened, the company steered a number of franchisees into government-backed loans.
Hackstaff agreed to open a Burgerim in 2017, and he was approved for an SBA loan the next year. He worked through a broker and the company, which handled most of the paperwork. They even wrote the business plan the SBA requires of every franchisee that provides the loan.
Included in the plan were financial projections suggesting the brand would be profitable its first month, and remain profitable thereafter.
That gave lenders confidence to OK an increase in the size of the loan by 50% to fund cost overruns in the buildout, a common problem for Burgerim franchisees that were able to get that far.
But Hackstaff’s restaurant never came close to the revenue projections in the business plan, projections that were used to fund the loan. And his restaurant was never profitable.
Read more about Burgerim's problems here.
Just more than a year after his store opened, Oren Loni abandoned the brand, leaving behind unopened mail and files in the company’s California offices. Operators wouldn’t hear from the brand for weeks, until December 2019 when an attorney sent a letter to franchisees that the company would file for bankruptcy. That filing never came.
Hackstaff estimates that he has put $1 million into Burgerim. He is not confident that he will see any of that. “I’ll never see any penny of that,” he said.
But he still has that $8,000 monthly payment, a payment inflated by the increased size of the loan along with a variable interest rate. Hackstaff has since dropped the Burgerim brand and come up with his own concept, Handcrafted Burger Bar. He said the restaurant is fine, though he keeps it open largely to pay off that SBA loan.
Some months that loan amounts to 21% of his revenues. “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 getting defrauded, and the bank necessarily gets defrauded, then [the SBA] has to shoulder some of this risk. They gave you the loan.”
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