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For I Heart Mac & Cheese, growth isn’t what it appears

The chain is selling units all over the country to new franchisees, but some of its early operators struggled and are filing lawsuits.
Photograph courtesy of I Heart Mac and Cheese

The Florida-based fast-casual concept I Heart Mac & Cheese doesn’t appear to be slowing down this year, despite the pandemic.

The company has been signing up franchises for much of the past two years, its founders boasting of a low-cost model that anybody could operate. It has signed up franchisees across the country and recently inked its 100th franchise agreement, an important milestone.

“It’s a very inexpensive franchise to get into,” CEO Stephen Giordanella said in 2018. “It’s created for the family that may have a little equity in their home, where they could take out a second mortgage, and get into their own business and control their own destiny as a family.”

Yet few of those 100 franchise locations have opened. Some of the ones that did open have closed. Some are struggling to get financing. At least two operators have filed for personal bankruptcy and have filed a lawsuit against the company. I Heart Mac and Cheese has also sued another of its franchisees after she spoke out against the company to other operators. One now-former operator is still on the hook for the lease on equipment inside a store that the company is currently operating.

Franchisees and employees of I Heart tell the story of a company that pushes hard to sign up new franchisees, sometimes giving rosy projections of sales and profitability, or understating buildout costs.  

“When I bought the franchise, I expected systems and processes in place, and that they were profitable,” said Genevieve Prieto, one of the chain’s first franchisees, whose store in Oklahoma closed after just a few months, despite record early sales. “Turns out they weren’t.”

In an interview, Gordanella denied the allegations or refused to comment on specific concerns, citing ongoing litigation. He said the company’s system is simple to operate and attracts people from all walks of life, but also appears to lay the blame at their inability to operate.

“It’s a shame,” he said. “I feel terrible for people who aren’t successful. It’s like any business. You have to work it hard. People are coming down. They’re buying it. But they don’t buy it before they see it.”

Franchising challenges

The disputes and the lawsuits highlight one of the biggest issues in franchising: Early-stage franchises are sold based on emotion as safe investments, using phrases like “be your own boss” or “control your own destiny.” But these startup concepts can be remarkably risky, especially if the companies don’t have proven systems in place to train and support their franchisees.

Franchise regulations in the U.S. are lax and typically not enforced outside of civil lawsuits. That has fueled the rise of numerous companies that aggressively sell franchises to anyone with enough cash to fund the franchise fee.

“It’s a mentality,” said Adam Wasch, an attorney with the Florida law firm Wasch Raines who represents one of the I Heart franchisees suing the brand. “They sell to anyone that has enough to pay the franchise fee and see where the chips fall.”

With few franchise regulations, franchisors are free to include sometimes-onerous restrictions on their operators. A franchisee may pay a $35,000 franchise fee when they first sign on, for instance, but the agreement typically makes that fee nonrefundable. If the operator can’t find a location or get financing, which is frequently the case in newer concepts, then the person loses that fee. There’s little risk to the franchisor in signing up such operators.

But when they do get into the store and find they can’t run it, or that the system wasn’t what they thought, that can lead to bankruptcy and financial ruin.

 

“When I bought the franchise, I expected systems and processes in place, and that they were profitable. Turns out they weren’t.” -former franchise Genevieve Prieto.

Fast casual mac and cheese

I Heart Mac and Cheese is fundamentally simple. Customers can order macaroni and cheese they customize with various toppings, such as brisket or buffalo chicken. The fast-casual concept also lets customers use tater tots, broccoli, quinoa or cauliflower as their base instead of pasta. Customers can also order grilled cheese sandwiches heated with a toaster.

The company was formed by Giordanella, a businessman who previously operated the now-defunct Cabo Flats chain, along with Michael Blum, a Miami chef who came up with the idea of a macaroni and cheese concept.

Giordanella said he wanted the concept to be something “where the average person could get into this.”

They ultimately settled on an idea in which the food is largely premade and heated at the restaurant—Giordanella calls it a “scoop-scoop-scoop-oven type of product.”

I Heart started opening company-operated restaurants in South Florida in 2016 and began franchising in 2017.

“We found out fairly quickly that it had legs from the South Florida stores,” Giordanella said. “People prior to us even being ready to franchise were coming to us to inquire about franchising. We did an FDD (franchise disclosure document). We got some interest. We started selling franchises.

“The biggest challenge I thought we were going to face was selling them. I had no experience in franchising.”

But the company did sell. The Florida-based I Heart has earned a lot of recognition from business publications, something the franchise is quick to boast—it was named a “top new franchise” last year by Entrepreneur Magazine. USA Today earlier this year called it one of the 10 best fast-casual restaurants. Its name is right up there with chains like Portillo’s and Chipotle.

“People are coming down from all walks of life,” Giordanella said. “Police officers, computer technicians. We have people with one restaurant, people with multiple quick serves. They like how easy it is to run.”

But few of these operators have managed to open a business yet. According to Giordanella, the chain currently has five company-owned units and eight franchisee-owned locations—13 total restaurants. Franchises with a lot of locations sold but not open is widely considered to be a major red flag by franchise experts because it means a brand is selling a lot of agreements to inexperienced or undercapitalized operators but getting few units open.

Franchisees argue that many of the company’s locations will never open because of financing or other challenges. At least five units have closed, according to franchisees and searches on Yelp, and the company reopened two other franchisee-owned units that closed. Prieto, meanwhile, estimates that at least 25 franchise agreements sold will never materialize.

Giordanella, however, blames the pandemic for the lack of openings. “We would have had many more open if COVID hadn’t hit,” he says, adding that the focus on real estate was largely suspended for six months.

“People are coming down from all walks of life. Police officers, computer technicians. We have people with one restaurant, people with multiple quick serves. They like how easy it is to run.” - I Heart Mac and Cheese CEO Stephen Giordanella.

Big opening

Prieto was one of the company’s first operators. She was a former four-unit Domino’s franchisee who liked the idea of a macaroni and cheese concept that was simple to operate. She decided to become a franchisee in 2017.

Prieto in her lawsuit against the company says she was given financial projections of revenues and profits before she signed on to becoming an operator—even though the company did not provide financial performance representations in its franchise disclosure document.

The four projections featured revenues ranging from $520,000 per year up to $1.2 million, saying they would make annual operating income of between 14% of sales and 39% under the rosiest scenario, or $481,106.64, according to the lawsuit.

Franchisors are not required to put financial projections in their franchise disclosure document, the thick prospectus required of all U.S. franchises. If they do not, however, they are not allowed to provide financial information to franchisees before a sale—that requirement is rarely enforced and is typically a subject of litigation.

I Heart also allegedly misstated its anticipated buildout costs. The company’s 2017 franchise documents say the initial investment is expected to cost between $175,000 and $271,000. The next year that range was increased to $197,500 to $327,000. It cost Prieto more than $373,000 to open her restaurant—well over the $250,00 Prieto and her partner budgeted, according to legal filings.

That restaurant opened on April 16, 2018. She marketed the location heavily before the opening, with radio ads, newspaper mailings and social media. The location’s Facebook page had 12,000 followers by the time the location opened, more than the brand itself at the time.

“We had a great first week,” Prieto said. The company had the highest opening-week sales of any restaurant in the system.

Yet, she said, there were “a lot of hiccups.” Prieto said its approved food supplier lost its entire shipment of cheese sauce, forcing the franchisee to make cheese sauce on site for the first two weeks.

Prieto said food costs were “extremely high” at first, of 41% to 42% of sales—which she blamed in part on the company’s 3% rebate from its food supplier, Sysco. Vendors frequently increase charges to franchisees to offset rebates sent to franchisors.

But sales would end up being the worst problem. They declined almost every week. By September of that year, weekly sales had fallen 82%. Prieto blamed the problem on the cheese sauce, saying it wasn’t good enough to turn first-time visitors into regular customers. “It was worth coming in and paying that kind of money once to try it out,” she said. “It wasn’t something to come back for.”

Giordanella denied the company failed to ship the cheese sauce, saying that “every store was making their own sauce. She knew she was going to have to make the cheese sauce.” Emails shared by Prieto show the freight company failed to deliver the cheese sauce on time for the location’s opening.

“I assumed she was a pretty good franchise operator,” Giordanella said. “She owned four or five Domino’s. Very nice woman. Her sales were doing well. Five months later, she closed.”

In reality, it was eight months. Prieto closed her shop on Dec. 31, 2018. She has since filed for personal bankruptcy.

I Heart Mac and Cheese

Military family

Kim Grotz and her husband were considering the next phase of life after he retired from the military in 2018. The couple have three boys, one of whom is autistic. “It was a period of time [when] all they ate was Kraft Macaroni & Cheese,” she said.

They contacted I Heart in November of that year. They went to Florida. The kids loved the food. By that February, they signed the agreement and sent the company the franchise fee. Ultimately, I Heart sold the couple the rights to a store the company was constructing in Athens, Ga., two hours away.

The purchase price for the location was $415,658.72, according to legal filings, and Grotz’s company, G5 Services, paid just over $200,000. I Heart Mac and Cheese financed the rest.

When asked why the company self-financed the franchisee, Giordanella said he received assurances from Grotz’s father that the rest would get paid. “I spoke to her dad,” he said. “She put money up. We gave her a six-month note. Her dad was going to pay off the note. He was very eager to buy that store.”

But that isn’t the only time I Heart self-financed a restaurant sold to a franchisee. Elizabeth Torres and Cory Attardo acquired two locations on New York’s Long Island. The franchisor financed $231,000 for each location, according to legal filings. Torres and Attardo apparently fell behind on payments on those notes starting in April.

That lawsuit also mentions “defamatory statements” Torres allegedly made “to third parties and other franchisees.” I Heart has also sent a "cease and desist" letter to Prieto over comments made to other franchisees. 

Grotz opened her location in November, though she said in an interview that she received little assistance from trainers during the opening. Meanwhile, according to a lawsuit, she found that I Heart Mac and Cheese owed contractors more than $18,000. By that February, she also discovered the company didn’t pay nearly $71,000 in back rent it owed on the location.

What’s more, as part of the pre-purchase agreement, I Heart sold equipment in the restaurant to a leasing company in two separate deals for $113,000. Grotz then leased that equipment from the leasing company.

On March 17, Grotz closed the restaurant. “Partially because of COVID,” she said. “We closed the restaurant, turned in the keys to the landlord, took all our perishable items.” The family has since declared personal bankruptcy.

I Heart Mac and Cheese later reopened the restaurant—using tenant improvement dollars to pay the back rent, according to a lawsuit. It is also using the equipment in that restaurant, though Grotz’s name is still on the lease.

Giordanella said the company has paid the rent due on that Athens location. “If the lease wasn’t paid, we would not be occupying the store,” he said. “She abandoned the store.”

“To this day I still don’t know why,” he said. “She was not a victim.”

But why is the company using equipment supposedly on a lease to Grotz?

“That’s currently in litigation,” Giordanella said. “I can’t really go into that.”

“It’s a mentality. They sell to anyone that has enough to pay the franchise fee and see where the chips fall.” - Attorney Adam Wasch.

Understating buildout costs

One common thread in some of these cases is the cost of buildout. Both Prieto and Grotz accuse I Heart Mac and Cheese of understating the cost of buildout on their franchise disclosure document. Multiple franchisees we spoke with said buildout cost more than the company estimated.

Indeed, estimated buildout costs have increased multiple times, according to the FDD. I Heart’s most recent franchise disclosure document lists the initial investment of as much as $464,500—71% higher than the company’s 2017 FDD.

Giordanella blamed the issue on differences in costs between states. “In some cases, it cost a lot less,” he said. “And then we can’t say what it’s going to cost in another state. We don’t know if there is a lumber issue. There’s negotiations with your contractors, second-generation stores. There’s many, many variables.”

Still, the company is signing up franchisees at a break-neck pace, with people sending in $35,000 for a franchise fee. I Heart’s FDD says it took in $322,500 in franchise fees in the first three months of this year.

Prospective operators have six months to open their store, and the franchise fee is non-refundable. If a franchise can’t get financed—and some franchisees say financing has been a challenge given the chain’s lack of history—then they could lose their franchise fee.

“Some folks get funding, some don’t,” Wasch said. “Those that don’t, now you’re stuck. You can’t get funded. You’ve got a non-refundable franchise fee. The franchise gets the benefit of a fee for effectively nothing.”

Giordanella said  95% of the company’s franchisees get funded. He also said the company checks the financials of any prospective operator before they send in their franchise fee. And he also denied that the company pushes the sale of franchises onto people who don’t have the financial ability to buy one.

“There’s no pressure,” he said. “We don’t force anybody to buy a franchise. We check everybody’s financial ability to do it. If they’re a little light on financials, they go for (U.S. Small Business Administration) loans. Only when they are pre-approved do we allow them to go forward. We don’t push it on anybody.”

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