Which Franchise to Buy When Financial Numbers Lead and Lie- Part 1 in a 3 Part Series

All Financial reports will give Franchisee’s insight into solid Brands to buy into – or will they?

As Franchise Attorneys, Certified Franchise Executives, and Franchise Strategists, we are constantly asked in our education seminars about which are the “good franchise systems to join”.

We commonly point them to several customized gauges, as each person’s review is different, but one indicator that most Franchisee prospects receive from us in our opinion letters is the financial indicators. Franchisees who are inquiring and analyzing prospective franchise systems can sometimes take hints from the financial world’s lenders in determining which franchise systems are more secure to join. One of the lending giants is the Small Business Administration (SBA).

The Financial Lead

SBA-backed loans remain one of the most popular ways of obtaining financing for franchisees.
Through the SBA, borrowers can obtain SBA 7(a) loans that are guaranteed by the U.S. government, which by far are the SBA’s most popular loan program. It was set up in the mid – 1900’s to help
borrowers, who couldn’t qualify for traditional loans, obtain funding to start or expand franchises and other small businesses.

On September 10th 2014, the Wall Street Journal (“The Journal”) had a story about the franchise systems with the highest default rates for Small Business Administration-backed loans over the past decade. The Journal limited its analysis to chains whose franchisees took out a total of 100 or more SBA 7(a) loans from 2004 through 2013. To give some perspective to these numbers, the Federal Reserve reported an overall charge off rate on loans in all industries of only ½% in the first quarter of 2014.

As reflected in The Journal report, the SBA guaranteed nearly $2 billion in 7(a) loans for franchisees, in the fiscal year ending September 30, 2013. Overall, 13% of all SBA 7(a) loans to franchisees were charged off, based on The Journal’s analysis of the data from 2004 through 2013.

The Journal reports that the 10 brands that make up the list of franchises with the highest default rates represent a total of $121 million in total defaults from 2004 through 2013. The default rates for the top ten brands are reflected in chart 1. The total amount of the $121 million in total defaults from 2004 through 2013 spreads out amongst the top ten defaulting brands pretty evenly except for the top two defaulting brands.

Quiznos and Cold Stone Creamery’s default rates are far above the rest, as you can see in chart 2. The Journal reports that franchisees of Quiznos, Cold Stone Creamery, Planet Beach Franchising, and Huntington Learning Centers were among the “bottom 10” brands with the highest rates of defaults (“more than double the rate for SBA borrowers who invested in all other chains”) during the period from 2004 through 2013. And the top “bottom 10” brands with the highest default rates are Aamco Transmissions, Curves International, Cici’s Pizza, Minuteman
Press, Sylvan Learning, and Cartridge World.

Did you catch the reporting period this covers? Yes, 2004 through 2013 when five of those years saw almost every industry in our country in a financial decline.

There were governmental subsidies, layoffs galore and Americans were reintroduced to company encouraged “early retirement options”. Therefore it should not shock anyone that many of the fastest
growing franchise systems in the country during the same time period would have high loan default rates.

1 Franchise Brands With Higher-Than-Average Default Rates. Last confirmed October 20, 2014. Found online at: http://online.wsj.com/articles/some-franchise-brands-have-higherthan-average-default-rates-1410392545.
2 Overall Federal Reserve Loan Charge offs. Last confirmed October 20, 20914http://www.federalreserve.gov/releases/chargeoff/chgallsa.htm
3 Discussions with Al Wells. Retired GE Aviation employee. March 10, 2012.

Ms. Shelton in a previous life was a franchisor of a large franchise system, and is currently a Senior Partner at Shelton & Power franchise law firm. Shelton & Power Attorneys have 25+ years’ of business consulting, franchise and trademark experience. Our knowledge facilitates an understanding of a large variety of businesses, services and technologies.
We help businesses protect their brands through Trademark, Copyright, and Business contractual transactions. These services allow us to “Expand their Brand” through Franchising. For existing Franchisors, we provide full outsourced in house counsel. Shelton & Power additionally works with entrepreneurs buying franchises by assisting with Business Creation, Industry Evaluations, Franchise Disclosure Document Review, Fairness Factors, Opinion Letters and Negotiations.

For more information or to schedule a customized consultation for your business you can write to franchising@sheltonpower.com or call (866) 99-FRANCHISE

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