The Next Step: Burgerim, Franchising and Fraud

The Next Step with Anjali Purkayastha is a LinkedIn interview series for the franchising industry. Anjali has worked with franchisees since 2014 and is Senior Business Development Representative at Efficient Hire, where she helps businesses simplify hiring and maximize tax credits.

Jonathan Pace is President of On Pace Franchise & Biz Hub. He helps successful professionals who are tired of the corporate grind and want to now own a franchise business to explore options they might not have considered.

This is an edited version of the interview: the link to the original recording is in the comments.

Anjali: Hi, I'm Anjali Purkayastha and welcome to The Next Step, where we talk about the franchising industry. Today I've got with me Jon Pace from On Pace Franchise Consulting. Jon, could you please introduce yourself?

Jonathan: Hi everyone. Pleasure to be here. My name is Jonathan Pace. I'm a franchise consultant and I help business owners who want to get into franchising.

Anjali: That's awesome. I even considered buying a franchise with you, so pretty good advertisement for that. Today we're going to be talking about the Burgerim disaster that Jonathan Maze did some amazing reporting on in January.

For those of you who aren't familiar, Burgerim was one of the hottest emerging brands. They were selling new contracts like crazy but it did not turn out well. The company briefly went dark last year and there were rumors of bankruptcy.

The founder fled the country and they've now been barred from selling franchises in several states, including California and Maryland. Dianne Feinstein has asked the FTC to investigate. I'm going to link Jonathan's articles below and I encourage you to check it out.

So, Jon, crazy story. I know you've got some thoughts about how franchisees can protect themselves. So we'll talk about that today.

Jonathan: Absolutely. It is important to do your research before getting into any franchise concept.

Anjali: Having come from a bookkeeping background, I would say the first thing that stood out to me was selling franchises without an item 19. These franchisees were getting their numbers about profitability and margins from the salespeople. It wasn't audited financials.

Jonathan: Yes, a franchise should not have their sales team is make earnings claims. That's something the FTC specifically prohibits. It's something that has to be in the franchise disclosure document. When they're looking to grow, you want to find the ones you can trust.

Anjali: It makes you think twice about lists that hype new brands and aren't necessarily digging into every aspect of it. What should we be thinking about as we start to dig into some of the media hype?

Jonathan: I would start validating with existing owners. With new concepts it can be difficult when they don't have a lot of franchisees. Take your time to talk to as many of their current owners about their experience and understand the support, training, marketing and how operations are going.

Anjali: There's sometimes this idea that franchising is a way to get rich quick and that you can take your $80,000 that you have saved and turned it into six figures in income every year by leveraging. But if you don't do your due diligence, you can really get burned.

Jonathan: It’s a system that's set up for investors who don't necessarily have that background or that experience. You’ll see a lot of franchisors that say no experience necessary. When you're looking at these different concepts or you think it's going to be fun running this hot new burger concept, you want to try to take the emotions out of it and put yourself in the place of a franchisee, understanding the day in the life, the overall investment and everything that goes along with that.

Anjali: I really feel for these Burgerim franchisees because of the money back guarantee. When you get into this situation, that money back guarantee sounds pretty good. I know when I looked at franchising in the past, I probably would have found that appealing. So what's your advice about that type of promise?

Jonathan: What I'd tell anybody when looking at any franchise system or investment opportunity, when it sounds a little too good to be true, it's time to really throw the red flag down. Don't be shy to bring in an attorney and have them take a second look when it comes to contracts. Especially when it comes to that franchise agreement. It’s a lengthy document but there's just a lot of different pieces to it. Make sure you have a good quality franchise attorney and somebody that's familiar with the franchising industry, you want to make sure that you're getting in to a system that's going to be fair with you.

Anjali: I've definitely seen over the years even the successful franchisors and franchisees have a bit of tension. It does seem like the really successful franchises often prefer to work with sophisticated multi-unit operators. Do you think we should naturally be skeptical of franchisors that want to work with people who don't have experience and who've never franchised before?

Jonathan: It’s worth really taking that step back to understand yourself and your skill set. Your background, your financial situation, your experience, how is that going to play into this business that you're going to be operating?

Sometimes it's difficult for everybody to identify their own strengths and weaknesses. You want to match that up with the franchise system and every franchise runs a little bit differently. So, you're going to want to take what you're strong at and match that up with the franchises. You don't necessarily have to have come from that industry, but knowing what the operations look like and being able to see yourself taking over those functions of the business is critical.

Anjali: That makes a lot of sense. I know when I looked at franchising, I typically was looking for franchises where I could use my sales and marketing skill set.

I think there is this common theme with the Burgerim story that the authorities kind of failed the franchisees. This brand was affiliated with all the major associations. You could get an SBA loan for one. I just shudder that you could get a Small Business Administration loan for a brand that isn't doing well and is lying about its financials. So if all of those safeguards fail and the brand is affiliated with all the major associations, it really does seem to come back to what you were saying about talking to the other franchisees.

Jonathan: I would say, a combination of that validation process and making sure that you had experience with the concept. You know, there are some investors out there that will only invest in a product or service that they use personally. Whenever you're getting into a franchise, you really want to have that strong belief. We want this to be a partnership that works because the franchisor provides the system, the training, the operations, and then you as the franchisee go out and be the operator and they make money as you grow.

The way that royalties are set up is if the franchise is not helping you to grow a good business then they're not going to make money. A franchisor should never be making a majority of their revenue off of the franchise fees. That's sort of the entrance fee to get in and be a part of the system. The success of the franchise is built on the success of the franchisees.

Anjali: Right. I know we've talked about Burgerim not collecting royalties because the founder wanted the franchisees to be profitable before he collected royalties. And that is just so crazy to me.

Jonathan: Yeah. That's something that was unique, I believe, to this situation. And it seems like there were a series of issues going on inside of the company that needed to be resolved. They sold over 1200 licenses and when you're growing at such a rapid pace, it's hard to manage all of these people that are looking to come on board. I'm not sure what the company's intentions were. But all in all, it's not a system. The money wouldn't last in that sense, as franchisors make money from collecting those royalty fees. So did they ever plan on being a successful franchise? Hard to say in this situation.

Anjali: Absolutely. You mentioned how many licenses they sold. I do think one of the red flags here was that they'd sold to over 1200 franchisees, but the only had 200 locations open. One of the red flags they had was that the build-out was much more expensive than they had projected. And their numbers didn't seem to be based in reality and people were actually having to take on additional personal loans to open their locations.

Jonathan: Yeah. Really, they needed to slow things down. They need to get those franchisees that have already bought in open. You don't want to have so many licenses sold and only see a small majority of them open. It's something that you have to think about it from a different perspective. If they can't get the stores open, how am I going to open my store? So you always want to watch out for franchisors that are growing at too rapid of a pace. They should have a goal in mind for how many stores they can open at a time. And know how far out they are ready and making sure that existing franchisees are successful at what they're selling them on.

Anjali: Absolutely. Such good points. You mentioned that sense of urgency. It does seem like when something is this hyped, it feels like if you don't hop on Burgerim immediately, you're going to be left behind forever. Especially when they're doing this money back guarantee that no other restaurant franchise is, it can be very easy to get carried away with your emotions.

Jonathan: Yeah. It’s one of those things that should be planned and you should be talking to your trusted advisors - your accountant, your CPA or other financial advisors. Even though you're getting into a franchise, it's never a bad idea to draw out that business plan and really understand the numbers and figure out what your projections look like. You can find somebody that can help you with that. At the end of the day you should believe in those numbers and understand what that all entails. It’s a marathon. It's not a sprint. You're usually signing up for 10 years and you'll probably even want to renew that a couple of times. And so you're probably talking 20 or 30 years of business. And so taking that extra time in the beginning to be able to understand that and to write a business plan, it's well worth it. There shouldn't be that, that big of a rush. When the concept is growing, there's alternate territories you can look at and usually other brands within the same industry you can look at. You should take that time and make sure you plan everything the best you can.

Anjali: That’s such a good point. I think it is so emotional to decide to pursue your dreams and go into business for yourself that having that team of trusted advisors to rein you in is really important.

I also hope that as an industry we can be a little more skeptical of brands that are growing too fast, don't have enough locations open and not hype that brand. So people who are vulnerable and who don't necessarily know the industry, maybe they can’t afford a lawyer. Like if you saved $50,000 and that's your annual salary, you really can't afford to do your due diligence, unfortunately. I do think that is part of the segment that Burgerim was targeting, as sad as that is. I do want to say that if there's anything I can do to help any of the Burgerim operators out there, reach out to me, especially if you need bookkeeping. My dad’s company is Indevia Accounting.

Jonathan: Yes. Anytime you're thinking of an investment, it's something that you really want to seriously consider because undercapitalization is probably the number one issue for businesses that fail out there. So always trying to make sure that the concept and your financial situation match up. You want to make sure that you're thinking logically about what you're getting into. Does that financial picture match up with what they're telling you? You want to make sure that the one you choose is the right opportunity.

Anjali: That's really good advice. On the topic of undercapitalization, I know quite a few people lost their homes because they put up their house for the SBA loan. Would you consider somebody who has to put up their house to open a franchise to be undercapitalized?

Jonathan: I would say yes. I's not something that I would want any of my clients getting into. We want to have that budget in mind and there's investment opportunities across a wide range. If it's not something that's brick and mortar, maybe they consider something that's more of a service business or other lower cost investments. But if it takes another mortgage on your house or refinancing, it probably is a little bit beyond their means.

Again, you want to make sure that you’ve really done your research. And again, validating that with the existing franchisees. You know, how much did it cost you to get started in this business? Because if you stretch yourself too thin, you might not going to have a place to live.

Anjali: Yeah, that's a very good point. Part of the reason I haven't opened a franchise is because I am pretty risk averse and I just don't want to put too much of my savings at risk.

So I think this is a great place to leave it. Do you have any last thoughts on this whole tragedy?

Jonathan: Okay. It’s just one of those things where you always want to find people out there that can help you, like myself. Knowing these different franchise opportunities and really understanding all the various opportunities that are available. I always encourage people to reach out, look for opportunities to find experts that can help them and really understand what their options are.

Anjali: Absolutely. And it definitely is like a marriage and you've got to be careful what you choose. So Jon, I really want to thank you for joining me today and thank you to everybody who tuned in.

Jonathan: Thank you.