Restaurant chain franchises are under scrutiny by the FTC

Making It Work is a series about small business owners going through tough times.

When Kenneth Laskin flew to California to meet with executives at Burgerim, a newly formed restaurant chain, he felt like not just another potential franchisee, but like part of a family.

The company executives, he said, made a point of emphasizing their shared Jewish faith one evening by praying with him in Hebrew.

Back in 2017, Mr. Laskin believed he was being offered a prime deal. He paid $50,000 for the right to open as many Burgerim franchises as he wanted in Oregon. “I have a whole state,” recalls Mr. Laskin.

Today, Burgerim is in trouble, leaving a trail of financial troubles, a Federal Trade Commission lawsuit and a wider regulatory scrutiny as to whether protections are appropriate for franchisees like Mr. Laskin.

The challenges highlighted by Burgerim arise as franchising is increasingly becoming a way of starting small businesses.

There is growing concern that franchisees need more protection in their contracts with franchisors. These concerns caught the ear of the Biden administration and several state legislatures, leading to several proposals to limit the powers of franchisors.

Mr. Laskin ended up opening just one Burgerim restaurant in Eugene, Oregon, which closed in 2020 during the pandemic. Since then, Mr. Laskin has used his life savings to pay the bills.

Burgerim, which boasted imaginative, high-quality burgers, was criticized by former franchisees for making big promises and under-disclosing business risks. Of the more than 1,500 franchises that Burgerim sold, most never opened, the commission said in a lawsuit the agency filed against the company and its founder in US District Court in California last year.

Peter Bronstein, an attorney for Oren Loni, the company’s chief executive officer in the United States, said Burgerim made some business mistakes but often tried to help its franchisees succeed. According to court documents, both sides were engaged in mediation.

Even with the pandemic still ongoing, the number of franchises in the country grew 2.8 percent in 2021 and 2 percent in 2022. That number is expected to grow another 2 percent this year, bringing the total to 805,436 franchises, according to the latest data from the International Franchise Association, an industry group.

As the franchising network expands, so does its contribution to the overall economy. Franchises employed 8.4 million people last year, a 3 percent increase from 2021.

According to the International Franchise Association, there is historical evidence that the first US franchise dates back to Ben Franklin, who established a network of printing partnerships.

Today, the business model is one of fundamental symbiosis: franchisees pay an upfront fee to a franchisor like Dunkin’ Donuts or Applebee’s, giving them access to all of that brand’s suppliers, advertising and technology. The franchisee can lean on these established systems to get their business up and running quickly, rather than having to start from scratch. And the franchisor, in turn, receives the franchise fee, which is typically in the tens of thousands of dollars, on top of a regular license fee from the franchisee.

“Franchising has always been a way for the middle class to start their own business,” said Charlie Chase, general manager of FirstService Brands, a home improvement and painting services franchisor.

Mr. Chase, who has served on the board of directors of the International Franchise Association, said he has helped hundreds of successful franchisees get started over the years. “We created many millionaires,” he said.

Still, Mr. Chase said he was concerned at how some franchisees were being pushed into businesses without understanding all the risks.

He blames some of this on aggressive internet advertising (for example, Mr Laskin learned about Burgerim through a Facebook ad), but also on a network of third-party brokers who often urge potential franchisees to buy multiple franchises at once.

The Federal Trade Commission, led by Lina Khan, conducts extensive investigations into industry practices, including disclosure and issues such as franchisors unilaterally changing the terms of an agreement with a franchisee.

“Franchising can be a good business model, but it can also do a lot of damage,” said Elizabeth Wilkins, director of the Commission’s Office for Policy and Planning. “We are concerned about instances where the promise does not match reality. We believe there is a significant gap worth investigating.”

In Burgerim’s case, federal officials said the company’s executives told franchisees they would refund their franchise fees if their business didn’t open, but many people never got their money back. Mr Bronstein, Mr Loni’s lawyer, said offering refunds was “not the best way to run a business”.

In the years since the 2008 financial crisis and mortgage crisis, regulators have strengthened consumer protections by improving disclosures by banks and banning certain fees they may charge. But small businesses, including franchisees, haven’t benefited from the same extensive regulatory scrutiny.

“The dominant view in the consumer protection world is that small businesses do not get the same level of protection as other consumers,” said Samuel Levine, director of the FTC’s Consumer Protection Bureau. “Yet, consumers and small businesses, including franchisees, face many of the same challenges. That’s something we want to address.”

As part of this effort, the Federal Trade Commission is investigating the application of laws such as the Robinson-Patman Act, an antitrust law that prevents large companies from taking advantage of small businesses through discriminatory pricing. The Agency has also proposed a rule banning non-compete clauses in employment contracts and may consider restricting the use of non-compete clauses in franchise agreements.

When Mr. Laskin bought a franchise, his goal was not to become a millionaire but to build a stable, middle-class life for himself.

In September 2019, he opened his only Burgerim store in Oregon.

But problems began soon after it opened, Mr Laskin said. Burgerim has not established a reliable food distribution system in Oregon, he said, forcing Mr. Laskin to supply his restaurant himself. In trying to launch new locations, the company has never collected royalties from franchisees, which has limited its ability to support its restaurant network over the long term, Mr. Bronstein said. Still, he added, there are many burgerim restaurants that are operating successfully.

Mr Laskin kept the business afloat during the pandemic by offering takeaway food. But during the lockdown, he was unable to find workers, meaning he and his wife ran the entire operation themselves.

Mr. Laskin, who suffers from severe back pain from years of restaurant work, hoped a franchise would give him the opportunity to delegate work to employees and save his back.

But some days, Mr. Laskin came back from the burger joint at night and wasn’t able to walk the last few yards up the driveway because he was in pain from standing on his feet all day.

The Burgerim leadership, Mr Laskin said, has not provided any support during the pandemic.

In May 2020 he closed his restaurant and moved to Florida. Mr Laskin, 57, said his back problems limited the nature of his work and that after his burger business closed, it had been difficult to find work.

The struggles of the former Burgerim franchisees were brought to light in a 2020 series of articles by the publication Restaurant Business, which focuses on the hospitality industry.

Some franchisees believe that improved disclosure or stricter regulation of fee structures will not be a panacea for weeding out troubled players in the industry.

“Transparency is a great thing, but I’m not sure more disclosure will change anything about the results,” said Greg Flynn, founder and chief executive officer of Flynn Restaurant Group, the country’s largest franchisee with 2,400 locations and 73,000 employees. Brands like Taco Bell, Pizza Hut and Panera.

“There are a lot of stories of franchisees who buy into a system and then go bad,” he added. “I would only speculate that they may have had a similar experience outside of a franchise system.”

Mr Laskin says it’s not just bad timing or circumstances to blame. “The system is fundamentally paralyzed,” he said. “There’s too much secrecy. It shouldn’t be that difficult.”

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