Defaults by Franchisees Soar as the Recession Deepens

…franchisees' defaults on loans guaranteed by the U.S. Small Business Administration are piling up in amounts unseen in years. A list of loans at 500 franchises shows the number of defaults by franchisees increased 52% in the fiscal year ended Sept. 30, 2008, from fiscal 2007.

The Wall Street Journal
February 24, 2009

Defaults by Franchisees Soar as the Recession Deepens
List of Small Business Administration-Backed Bad Loans at 500 Brands Increased 52% in Most Recent Fiscal Year
Richard Gibson

The recession is bruising businesses across the franchising industry.

From ice-cream parlors to tanning salons, franchisees' defaults on loans guaranteed by the U.S. Small Business Administration are piling up in amounts unseen in years. A list of loans at 500 franchises shows the number of defaults by franchisees increased 52% in the fiscal year ended Sept. 30, 2008, from fiscal 2007. Loan losses totaled $93.3 million, a 167% jump from $35 million just 12 months earlier.

The figures, a stark barometer of the downturn's severity and scope, could give pause to banks that have loan money about where to lend next. Banks that make SBA-guaranteed loans say they use the annual list as guidance in assessing future commitments.

SBA-guaranteed loans are aimed at providing capital to small businesses that often can't qualify for conventional credit. Those loans, made through commercial banks and other lenders, can total as much as $2 million for as long as 10 years. The SBA essentially insures a significant portion of the loan to encourage lending and small-business entrepreneurship. The recently passed stimulus package raises that guarantee amount to 90% from 75%.

The annual list, which shows the number of loan failures for the year and failure rates over eight years, is compiled by the SBA and published by the Coleman Report, a lending-industry trade publication based in La Canada, Calif.

The franchise brands where at least 11 franchisees defaulted on loans during the 2008 fiscal year were: Aamco Transmissions, Carvel Ice Cream, CiCi's Pizza, Cold Stone Creamery, Curves for Women, Domino's Pizza, Dream Dinners, Planet Beach tanning salons, Quiznos, Subway and Taco Del Mar.

'Overpriced Resales'
Gary Heavin, chief executive of Curves International Inc., says, "These loan problems were a result of the overpriced resales of franchises between third parties."

In an email, a spokesman for Domino's Pizza Inc. says that "while even one store closure or franchise default is sad and disappointing, the vast majority of the Domino's franchise community remains profitable, even in these unprecedented economic conditions."

A spokeswoman for Planet Beach Franchising Corp. says the company "experienced a higher 'failure' percentage particularly in the past two years." She adds that the company recognized the tanning industry faced a downturn and in 2005 "took steps to bring our business model into a completely new industry, the Contempo Spa" concept.

Dream Dinners Inc. CEO Darin Leonard says, "We are not involved in the transaction between an individual franchisee and their bank. As an organization, we are experiencing double-digit same-store sales increases in a very difficult retail climate."

A spokesman for Aamco Transmission Inc. said the company would have no comment. Quiznos franchiser QIP Holder LLC, Carvel Inc., CiCi Enterprises LP, Subway franchiser Doctor's Associates Inc. and Taco Del Mar didn't respond to calls seeking comment.

Loan-Performance Rates
Over time, some businesses have significantly better loan-performance rates than others. Among the worst-performing franchise brands, as measured by the percentage of SBA-guaranteed loans issued to franchisees over the past eight fiscal years that defaulted: Mr. Goodcents Subs & Pastas, 55%; Philly Connection sandwiches, 51%; Cottman Transmission, 49%; All Tune & Lube auto centers, 47%; Cornwell Quality Tools, 42%; and Carvel and Blimpie, both with 41% failure rates. Each had obtained at least 50 SBA-guaranteed loans during that period.

Kahala Corp., the franchiser of both the Cold Stone Creamery and Blimpie brands, says, "Despite the default numbers reflecting an eight-year period, many defaults have occurred in response to the declining economic climate." The company added that Kahala has been "heavily engaged in creating new strategies to address economic issues and increase franchise-owner profitability."

Cornwell Quality Tools Co. President Bill Nobley says, "We feel we are as competitive as other tool companies in our retention." He adds that last year the company provided new-dealer financing to 119 of 127 new franchisees, indicating that relatively few used SBA lending to enter the business.

Mr. Goodcents Franchise Systems Inc., Philly Franchising Co., Cottman Transmission Systems LLC, All Tune & Lube franchiser

ATL International Inc. and Carvel didn't respond to calls seeking comment.

The biggest borrowers of such SBA-backed loans this past year — with 50 loans or more — were: Subway, 174 loans; Quiznos, 94; Massage Envy, 71; Days Inn, 65; Choice Hotels International, 63; UPS Store, 61; Super 8 motels, 55; and Dairy Queen, 50.

Risks: Follow the money: franchising re-distributes (not creates) wealth, U.S. Small Business Administration, Government guaranteed loans, wtf? Comment, Excuse du jour, Refuses to answer journalist's questions, United States, 20090224 Defaults by

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