Post-sale, cupcake wars hit Gigi’s
The cupcake business is hard work, but it’s not incredibly complex. Mix flour, butter and sugar and sell the treats. That simple but effective model was the foundation for Gigi’s Cupcakes, the cupcake chain started in 2008. But a group of franchisees say that simple model became unsustainable.
Former Gigi’s Cupcakes operator Bruce Speidel is helping organize a group of 18 owners that control more than 20 current and former locations in a legal battle with the parent organization. He said at the core of their dispute are the basics: flour, butter and sugar.
Speidel said the owners’ group alleges KeyCorp subsidiary Cupcakes LLC, which acquired the brand from the original ownership group in July 2016, raised prices on key ingredients to an unsustainable level.
Speidel said he purchased his Murfreesboro, Tennessee, location in June 2015, a year before the new owners acquired the brand. His daughter was in charge of operations, and according to Speidel, she did well, increasing profits by about 40 percent in the year after she took control.
When the new owners came in, he and other operators said they were intoxicated by the opportunity to grow under a well-capitalized ownership group. “The things they proposed were things lacking in the previous ownership,” said Speidel. “I’m not knocking anyone, but when you get big, it’s hard to keep that structure.”
But then Speidel said there was little communication until a notice that the brand was changing suppliers.
“In June of 2017, my daughter came to me and said that they had gotten word that they were switching food suppliers,” said Speidel. “The next Monday, she came in and said, ‘Look at these prices, we cannot afford this.’”
He said the new ingredient prices were a patchwork of fees and obligations, including large minimum order sizes, fees for low or no orders and an across-the-board price increase that added 30 percent to the cost of goods.
He added there were strict rules around buying only from Gigi’s Cupcakes unless the franchisee was given written approval to do otherwise. Speidel said they went from break-even to unprofitable immediately.
“I think we reported a $30,000 loss the first year (2015),” said Speidel, noting there were some renovations, but he was No. 48 out of the about 100 locations by revenue.
“We were an average store, we were smack dab in the middle and we had to close within months of the supply change.”
Some operators adjust
KeyCorp and Cupcakes LLC were contacted but said they would not comment on litigation. Gigi Butler, the founder and public face of the brand, was contacted and did not reply.
Amanda Duncan, president of a Gigi’s Cupcakes franchisee council created by the company, said it’s unfortunate that the group of franchise owners chose to be “part of the problem, not the solution.” She said she also saw a 20 to 30 percent increase in supply costs, but opted to change how she operated the business.
“Did I see it? Absolutely I saw it. I could focus on it and I could focus on the things I can control and incentivize my staff to focus on those things, too, to make it still a profitable model. That’s what I chose to do,” said Duncan. “We all knew that when we purchased this franchise, the success or lack thereof lies 100 percent in our hands, it really does.”
Duncan also said the owner of two of the locations involved in the dispute wasn’t executing the system.
“I live in an area where there are two stores I was very familiar with. Walking in, they weren’t being an owner there and the cupcakes weren’t on par,” said Duncan. “If you’re not in the store running it or putting out a quality product, you’re going to see a decrease in sales.”
Issues date back
The financial issues didn’t start with the acquisition, according to documents and legal filings. Looking at the financial disclosure documents through the years, profitability as measured in earnings before interest, taxes, depreciation, and amortization (EBITDA) had sagged from 22 percent in 2011 to 7 or 8 percent in the 2017 FDD.
In that FDD an item also notes that “82 percent of the franchisor’s assets are intangible. This means that the franchisor may not have the financial resources to provide services or support to you.”
In a court case filed against the former owners after the sale in October 2016, KeyCorp and Cupcakes LLC brought up finances. They alleged the prior owners (Gigi’s Holdings, Gigi’s Franchising and A&G Franchising) had “made several material misrepresentations” including location transfers and franchisees threatening to close their locations and obligations to other vendors and investors.
The new owners sued for breach of contract, fraud and negligent misrepresentation. That lawsuit was dismissed in November 2016.
Those financial misrepresentation claims are muddied by the fact that the business was sold and now resides in a holding company, which claims its purchase of the brand came free of any lien.
The company argues that any financial misrepresentations from before the sale are not the fault of the new owners. In legal filings, they write, “Gigi’s is in no way responsible for the alleged misrepresentations of the previous franchisor, if any.”
For operators, Speidel said the increased supply costs sapped whatever profits still existed. So they took to Facebook to discuss in an owners’ group. Those discussions prompted the new owners to file legal complaints against franchisees in November 2017, again in the Northern District of Texas.
In one filing, the company alleged “unauthorized use of the Gigi’s Cupcakes trademarked name within this social media page” and use of this forum “to make disparaging statements about Gigi’s business judgment.”
Speidel said he heard more and more stories like his and saw more claims targeting his franchise peers. Eventually the group coalesced and contacted Jeffrey Cohen of Cohen LLC based in Denver, and the lawyer who represented franchisees in a similar legal dispute in the Quizno’s system.
‘Surprised’ by attacks
Cohen said KeyCorp’s moves are not typical. “I was surprised by their attacks,” said Cohen. “I don’t remember seeing this, and I’ve been involved in franchise cases since the mid-2000s.”
Cohen, the franchisees and Gigi’s Cupcakes did attempt mediation, but it was unsuccessful.
Since then, there has been a court appearance to determine whether or not the trademark violation cases should be heard in federal court where they were filed. The verdict hadn’t been reached by press time, but if the process stayed in federal court, Cohen said he would also argue for the inclusion of umbrella organization KeyCorp in any legal damages.
The firm owns Cupcakes LLC but is “otherwise uninvolved” with the brand, according to a company representative. KeyCorp is an affiliate and investment vehicle for FundCorp, also the private equity owner of Gatti’s Pizza and investor in franchise operations.
The legal battle will continue, but the franchisee group members said they would continue to support Gigi’s operators and attempt to fix what they see at the corporate level and help get compensation for those who have been significantly affected.
“We want the franchisees to be able to operate without the threat of failure constantly hanging over their heads,” said Speidel.