Franchisees of the 10 brands in the ranking defaulted at more than double the rate for Small Business Administration (SBA) borrowers who invested in all other chains, according to a Wall Street Journal analysis of charge-offs of all SBA-backed franchise loans in the past decade. Put another way, franchisees of those 10 brands have left taxpayers on the hook for 21% of all franchise-loan charge-offs in the past decade, collectively failing to pay back $121 million in SBA-guaranteed loans from 2004 through 2013.
That finding comes as franchising is booming in popularity,
in part because many people see it as an easier route to entrepreneurship in an
uncertain economic landscape. For prospective buyers faced with a growing
number of options, it has become more difficult to size up a franchise chain
because of the limited information available. The chains aren't required by law
to disclose their franchisees' first-year average sales and failure rates, for
example, although the Federal Trade Commission does require them to share
recent bankruptcy filings and prior litigation, among other basic information.
The 7(a) loan-guarantee program is the SBA's most popular
loan program by far. It was set up six decades ago to help borrowers who can't
qualify for traditional loans obtain funding to start or expand franchises and
other small businesses. The SBA guaranteed nearly $18 billion in 7(a) loans,
including $2 billion for franchisees, in the fiscal year ended Sept. 30, 2013.
Overall, 18% of all SBA 7(a) loans were charged off, based on The Journal's
analysis of the data from 2004 through 2013.
Most recently, charge-offs on SBA 7(a) loans have been
declining. Simultaneously, the $18 billion loaned in fiscal 2013 was the second
highest year in total amount approved in the past decade, according to the SBA.
Most of the franchise brands with the highest default rates
in the ranking blamed the economic crisis, at least in part, even as some
expressed doubts about the SBA data. In addition, the brands said they have
improved the support they provide franchisees and in some cases tightened the
criteria for franchise buyers.
Quiznos franchisees charged off more money than any other
brand during the 10-year period that the Journal reviewed. Its franchisees
accumulated $38 million in unpaid loans and had a default rate of 30% from 2004
through 2013.
The sandwich chain, which filed for bankruptcy protection in
March, said some of its stores failed due to "slower sales, high rent,
increased competition and economic pressures." It added that it is in the
process of "making long-term changes to our business model to help improve
restaurant profits."
High failure rates aren't necessarily a problem for
franchisers as they can still consistently generate millions of dollars in
revenue every year from sales of new units. Some franchisers also offer
discounts to entice buyers to purchase multiple units at once.
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. Among
the best performers in the ranking were Jimmy John's, Little Caesar's Pizza and
Days Inn, which all had default rates of 2% or less.
Franchisees can struggle to repay SBA or other loans for
myriad reasons, including changes in consumer tastes, costly industry
regulation or a weak overall economic climate, as well as bad decisions on
location or marketing. But some also blame the parent franchise companies for
providing insufficient training or ongoing support and for charging excessive
startup or operational fees.
The SBA collects fees from lenders making the loans it
backs. It sets the fees at levels it hopes will cover projected loan defaults.
When defaults are higher than it expected, it may ask Congress for a subsidy,
as it did in each of its four most recent fiscal years.
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