For MidiCi, 329 units sold but none open
What happens when a franchise’s unit sales get far ahead of openings? MidiCi and Menchie’s are testing the limits.
For years, Amit Kleinberger of Encino, California, has been the wizard of franchise sales. In 2008, he entered the crowded frozen yogurt field with Menchie’s, and grew it to more than 400 units open here and many abroad.
In 2015 he pulled an even more daring move, by starting to sell MidiCi’s Pizza franchises several months before opening a corporate store and selling a single slice of pizza. By this September he’d sold 329 pizza franchises and sold out several U.S. territories—but not a single MidiCi’s franchised store had opened as of press time.
MidiCi’s financial statements for 2015 show $6.24 million in income and broker fees of $5 million. The number of Menchie’s units sold, too, is far ahead of openings.
At the end of 2015, Menchie’s had 506 franchises sold but not open, one of the highest counts in the country.
The numbers suggest an enterprise whose appetite for unit sales is outstripping its ability to execute.
Meanwhile, according to its 2016 franchise disclosure documents, a dozen Menchie’s closed in 2015 and another dozen franchisees walked away before trying to open one at all. Northbrook, Illinois-based attorney Andrew Bleiman said his firm, Marks & Klein, has heard from Menchie’s franchisees, who, he said, complain of the lack of support and their inability to find sites and get them approved.
Eric Riess, a partner with Lathrop & Gage in Clayton, Missouri, said he and other franchise attorneys are hearing from MidiCi franchisees who question the feasibility of building and operating a large pizza restaurant within the parameters laid out in the franchisor’s FDD.
Kleinberger owes his spectacular sales to a three-pronged approach using franchise brokers, high-energy discovery days and his own charisma. In a series of phone interviews, Kleinberger said he felt secure in selling pizza franchises before having a restaurant open because, “MidiCi was not an overnight project; we spent years developing the brand.”
Kleinberger said he had hired Italian chefs “of great renown” to develop recipes for Neapolitan pizza and a high-end architect to design a 4,000-square-foot restaurant with an open kitchen, a bar and large seating area. He added, “I already had the teams, resources and expertise that helped me build Menchie’s into the world’s largest frozen yogurt concept.”
But he had not yet built a single corporate restaurant to test out those recipes when he filed his 2015 FDD and opened for business. His one corporate store—and the country’s only MidiCi’s—in Sherman Oaks, California, opened in June 2015 and now serves as the concept’s training site and the center of its sales efforts.
MidiCi’s filed an Item 19 with its 2016 FDD that parses six months of sales at the corporate entity by the week, month, day of the week and even by the hour and food category. Total gross sales from June 13 to December 15, 2015 were $1,562,691. Because Kleinberger put the corporate store into a separate company, its financial statements are not included in MidiCi’s audited financial statements.
Item 7 of the same FDD estimates the total investment for opening a single MidiCi is $611,616 to $752,948; the FDD does not disclose the cost to build the corporate store.
Kleinberger suggested talking to J.D. Graves, an 18-unit Long John Silver’s franchisee who has a MidiCi in permitting stages in Roswell, Georgia. Graves said construction of his store should start this fall and “should come in under $700,000.” But Graves acknowledged that his case “is a little bit different because we own the real estate.”
A restaurant franchisee from the Midwest, who asked that his name not be used because his current franchisor doesn’t know he’s shopping other brands, said he attended a MidiCi’s Discovery Day last spring. “It was like a celebrity event,” he said. “The sales guys made buying a MidiCi sound so tempting, the amazing adventure of your life. They didn’t compare MidiCi to other pizza companies, but to Apple and Google.”
Discovery Day attendees were treated to meals in the corporate store, “food made from really good ingredients,” the franchisee said, and sent home with a computer link, so they could continue watching how busy the restaurant was via a live video feed.
All the franchisees I talked to praised Kleinberger’s passion, leadership skills and use of motivational mottos. “It’s the whole culture,” said Alan Gardner, a Wendy’s and Menchie’s franchisee who signed on to build a minimum of three MidiCis in Scottsdale, Arizona. Gardner mentioned MidiCi’s motto—‘We bring friends together’—and added, “Amit wants to make the world a better place. How can you argue with that?”
Kleinberger said he has used franchise broker networks for all his sales since his early days with Menchie’s. “l feel comfortable that franchisee candidates have already been vetted and have gone through some qualification process.”
Yogurt not pizza
MidiCi’s franchise disclosure documents contain a problem that points to great haste in starting franchise sales: It uses portions of Menchie’s FDD when writing MidiCi’s 2015 documents, by changing mentions of “yogurt” to “pizza. “After studying both documents side by side, it is obvious some changes were missed.
At MidiCi’s grand openings, for example, new franchisees are told to give away “yogurt” samples instead of slices of pizza. Other discrepancies, some of which carry over to MidiCi’s 2016 FDD, use MidiCi’s numbers for some services, then switch to Menchie’s numbers in other parts of the same document. Is the monthly technology fee for MidiCi’s $80 or $97? You’ll never know, because the MidiCi FDD skips from one number to the other.
Outside counsel Brian Schnell of Faegre Baker Daniels in Minneapolis said if a franchisee made an issue over this, the franchisor would simply charge the lower amount of the two fees mentioned. He said all errors would be corrected in MidiCi’s 2017 documents.
Some changes are being made even earlier. Since no restaurant was open at the end of 2014 when MidiCi’s first FDD was drafted, Kleinberger’s team extrapolated from Menchie’s numbers. If Menchie’s required 14 days of franchisee training costing up to $5,000, MidiCi would require 28 days and cost franchisees a maximum of $6,000.
But running a frozen yogurt shop with a couple of machines is far less complicated than running a large fast-casual restaurant that serves appetizers, salads, desserts, specialty coffees and bar drinks as well as an impressive variety of pizzas.
Kleinberger said that the “length and structure of MidiCi’s training keeps evolving. Three months ago we started offering 48-day training programs that can cost franchisees up to $18,000 for transportation and lodging for themselves and their general managers.”
New franchisee Alan Gardner said he and his general manager had just returned from training in MidiCi University (the Sherman Oaks store) when interviewed. “It was pretty intense,” he said, “because we had to work through the whole process. I rented a two-bedroom apartment and it cost me around $10,000, even though we drove there in our own cars.”
Since there were no operations when MidiCi started selling franchises, there was no way to write an operations manual. A pizza version of the table of contents, complete with page numbers, from Menchie’s 2015 FDD shows up in MidiCi’s franchise documents instead.
The biggest challenge to Kleinberger’s sales machine may be numbers beyond his control. Although Menchie’s franchise sales continue, the chain hit its peak for openings in 2012, with 102 stores; in 2013, 2014 and 2015, they opened 74, 72 and 70, respectively. At press time, only 43 Menchie’s had opened in 2016; Kleinberger said another 31 would open before the end of the year.
Despite the list of Coming Soon! pizza restaurants on MidiCi’s website, only five are in construction today and should open by December 31. Kleinberger said that “27 will be open by April 30, 2017” and sent a chart showing 12 in lease negotiations and 10 more in the design and permits stage.
In the years since franchisees signed on to build hundreds of Menchie’s and MidiCis, the frozen yogurt space became more saturated and many commercial landlords increased rents, said Darren Tristano, president of Technomic Inc., a restaurant research firm in Chicago.
“Building a 4,000-square-foot, fast-casual pizza concept becomes inherently risky, because you’re talking about annual rents at $100,000 to $125,000 a year, meaning your revenue target has to be $1.3 million or higher,” he said.
Attorney Riess said, “I’ve seen other chains fall under the weight of their own success. Being the fastest-growing in a category helps promote your concept to unsuspecting franchisees who want to get on the same train before it leaves the station. Franchisors with good intentions then lack the capacity to help them open units in time.”
Behind the brokers’ fees
Sabrina Wall, executive director of the Franchise Brokers Association in Orlando, said many emerging brands pay brokers 40 percent to 60 percent of their initial franchise fees to refer candidates to their concepts. “Brands that want to grow aggressively may pay even higher fees,” she said.
“But MidiCi also offers to pay brokers $750, plus cover their air fares and hotels, to attend one of their discovery days. Sometimes a franchisor might cover a broker’s hotel or flight, but I’ve never heard of anyone else paying them a salary to come out and visit.”
There’s a reason behind the largesse. “I want the brokers to be educated about our model and understand what we’re looking for before they talk to candidates,” CEO Amit Kleinberger said, “although I think we might just pay them $700, plus expenses.”
“If brokers are excited about a brand, they are prone to want to present that one when they work with new clients,” Wall said. And franchise sales tend to drive more franchise sales. Brandon Gawthorp, a multi-unit Wingstop franchisee in Katy, Texas, said, “When I attended Discovery Day, it was a real wow experience. I heard that MidiCis were selling fast and I had to move quickly, so I fell in for five units right away.”
The real payoff to brokers comes when their clients sign on. All franchisors and the accountants that certify their financial statements are expected to abide by the rules of the Financial Accounting Standards Board in Norwalk, Connecticut. Their rule ASC 952 states: “Franchise fee revenue from an individual franchise sale shall be recognized when all material services or conditions relating to the sale have been substantially performed or satisfied by the franchisor.”
CPA Aaron Chaitovsky, of the New York firm Citrin Cooperman & Co., said the rule was created “back in the ‘70s when companies were selling franchises and claiming that the franchise fee was their income. Prospective franchisees need a clear idea that a franchisor is financially stable and not just living off its franchise fees.”
The majority of franchisors keep franchise fees in escrow accounts, recognizing them as revenue when each unit opens. But Menchie’s financial statements show that company takes 62 percent of each $40,000 fee as soon as each franchise agreement is signed. MidiCi takes 68 percent.
“The vast majority of that money is used to cover the cost of recruitment,” Kleinberger said. For MidiCi, 68 percent of that $46,000 fee amounts to $32,280, most of which is paid to the franchise broker who referred the franchisee. “Sometimes,” Kleinberger said, “their fees are higher than that.” MidiCi’s financial statements for 2015 record income of $6,243,292 and franchise development (broker fees) costs of $5,058,460.
Both Kleinberger and his outside counsel, Brian Schnell, chair of the franchise practice at Faegre Baker Daniels in Minneapolis, noted that an accounting firm, Sher Gelb, also of Sherman Oaks, had audited and certified both concepts’ financials, so they stand behind them.
On its website, Sher Gelb lists many areas of expertise, including restaurants, but not franchising. “Unfortunately,” Chaitovsky said, “I’ve seen many financial statements certified by accountants that have no experience with franchise accounting. Paying a broker is not a service included in a franchisor’s list of obligations to its franchisees.”
Since most franchisors spend their franchisees’ fees on training, site selection assistance, grand opening help and support, I asked how Kleinberger would pay for those services now that he’s spent most of the franchise fees he’s collected. “The business is funded with my own private capital,” he said. “We have no outside debt. We are a well-oiled machine and we have sufficient capital to be where we need to be.”