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Curtain Up

When businesses falter, some act quickly to cut the drama


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Beth Ewen

“You could sell tickets to these things, there’s so much drama to them,” says Andy Selden, franchise attorney at Briggs & Morgan in Minneapolis. He’s talking about bankruptcy cases, like the KFC/Popeyes fiasco last fall when a devastated franchisee sold his restaurants to—wait for it—the lowest bidder, and the judge declared herself disgusted by the whole affair. “It’s one of those cases that give the bankruptcy process a lousy and poor reputation,” she said.

Then Selden expands the discussion to financial distress of all kinds, whether through a federal bankruptcy court proceeding with its complicated rituals, or via the workouts, terminations and extensions that people make to salvage something—anything—when their company goes bad. 

They do so at a staggeringly high rate, reaching a peak in 2009 when Dun & Bradstreet said all business failures topped 97,000. Selden pegs about a third of that number as franchise business failures. “Think about 30,000 human tragedies, from small businesses failing and closing,” Selden says, adding he expects more to come. 

“We’ve just come out of a period of massive, massive closures in this country. And for every one that closed, how many are hanging on by a thread?” he says. He hears from franchisees regularly who are barely getting by. “They’re scared to death of the next cycle of mandatory reinvestment,” when franchisees are contractually bound to renovate their facilities. 

But there are ways to catch warning signs early, to work out deals without heading to court, or to “get naked” with prospects to match each to the right franchise, as FranChoice’s Meg Schmitz puts it. 

Three protagonists

When reached in January, Bob Johnston had been on the job for one week as director of franchise development at Fibrenew. “We repair anything leather, plastic or vinyl that is damaged,” he says. The Canada-based company has 110 units in the United States, and adding to the number is Johnston’s focus.

It’s a return to an industry that collapsed in 2008 on Johnston, who spent the four years in between selling franchises for Comfort Care, the home-care brand. Before that he worked for Nationwide Floor & Window Coverings, a Wisconsin-based franchise that by 2000 was humming. Over 12 years they built the operation to more than 100 units—and then the housing market tanked.

Franchisees couldn’t make their royalty payments. The founder of the company gave them a grace period, even taking out a $600,000 personal loan to cover expenses in the meantime. The company shut down in 2008, and Johnston still remembers its ruined founder sobbing in his office when relaying the news. Established franchisees were encouraged to continue operating on their own, but “newbies” were out of luck. “I felt sorry for them,” he says.

Johnston says he’s learned through his career to reiterate hard truths when he talks with prospective franchisees. “I stress to them, I really drill them almost to scare them, about the networking and marketing,” In past franchises, he says, “the biggest reason why people failed was they got tired of the marketing.” 

He likes Fibrenew because instead of the traditional Discovery Day, they have one- or two-day ride-alongs, in which the prospect visits an established franchisee and shadows them through the workday. Johnston also conducts several calls with prospects, insisting on at least one that includes their spouse. “We all know if you don’t have the support of your family you’re already behind the eight ball,” he adds.

‘We get raw, we get real’

Schmitz, a consultant with FranChoice out of Chicago, is another franchise veteran who’s had a brush with financial failure—like just about everyone who’s been around for a while. A former Great Clips franchisee, at FranChoice she matches prospects with franchise brands. Early in that career one match went very wrong.

“She was a young woman. She lived in the city, and the concept wasn’t proven in an urban area. She was biting off a lot,” Schmitz recalls. Other warning signs were ignored. “She had filed for personal bankruptcy herself previously, and was leveraging money from her family. Because she was young and excited, we let it go,” and she ended up filing for bankruptcy.

“It was pretty life-altering for me. It scared the crap out of me,” Schmitz says. She now digs deep to find out what the prospect is really like. “I use the phrase ‘get naked.’ I have had my own successes and failures, and by telling stories, they will then tell you.

“If you’re naked with them, they’ll get naked with you back. We get raw. We get real,” Schmitz says. The result is that today, she says, the operators she places are “rock stars.”

Ann Power has 18 years in franchise development, and last year joined Zounds (rhymes with sounds) Hearing, a new hearing-aid franchise in Phoenix. She knows from experience she’ll have to tamp down the excitement. 

She insists on working with consultants, because she says they’re skilled in matching the right candidate to the franchise. Beyond that, she emphasizes two things. “No. 1, is your candidate well funded enough for the opportunity they’re looking at,” she says. “I always want to make sure they can cover their debt service, as well as their household expenses, to get them to the ramp-up time without working in fear and desperation.”

No. 2, will the prospect follow the system, which she judges by seeing how well they follow the process before signing on. 

Enter the attorneys

Beata Krakus and Patrick Jones are attorneys at Greensfelder, Hemker & Gale in Chicago, and they’re seeing an uptick in franchise failures heading to court, especially hotels, and the experience can surprise franchisors. “It’s not something where they have complete control. A lack of control for the franchisor is a little unnerving,” Krakus says. “When you enter a bankruptcy or something similar, the court has much more to say than the franchisor.”

Specifically, says Jones, an automatic stay goes into effect “the instant a case is filed” for Chapter 11 or Chapter 7 protection, meaning nothing “can be terminated or modified or taken away from the debtor entity.” That includes the termination provisions that exist in every franchise agreement—they’re null and void.

Andrew Bleiman, an attorney with Marks & Klein in Chicago, says he notices franchisors jumping in earlier these days, after at least three years of economic hard times, and being more willing to negotiate. “You’re seeing more concessions, more of an appetite to try and negotiate amongst the people involved when the franchisee is financially distressed,” he says. 

The goal is to continue the story, and to keep the curtain from crashing down. 

Beth Ewen is managing editor of Franchise Times. Send interesting legal cases to bewen@franchisetimes.com.

 

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