WE’VE POSTED TWO NEW ARTICLES TO OUR WEBSITE DESIGNED TO WARN FRANCHISE INVESTORS OF THE RISK OF BUYING AN MTY FRANCHISE. THE FIRST IS TITLED “UNPROFITABLE FRANCHISES”. IT DISCUSSES MTY CEO ERIC LEFEBVRE’S RECENT ADMISSION THAT, NEARLY TWO YEARS AFTER HE COMMITTED TO ADDRESSING THE COMPANY’S CLOSURE AND FRANCHISEE PROFITABILITY ISSUES, BOTH RAGE ON. HE ALSO ADMITS THE COMPANY STRUGGLES TO CONVINCE FRANCHISEES TO RENEW DUE TO THE FRANCHISEE PROFITABILITY ISSUE. IT ALSO DISCUSSES THE DEVASTATING AND LASTING IMPACT THAT 2,594 CLOSURES IN FIVE YEARS CAN HAVE ON THE FRANCHISE FAMILIES THAT INVESTED AS MUCH AS $1M+ TO START THEIR BUSINESSES. THE ARTICLE IS AVAILABLE HERE.
THE SECOND ARTICLE IS TITLED “SUBSTANTIAL RISK OF FAILURE”. IT LISTS SEVERAL WARNINGS CONTAINED IN MTY’S FEDERAL DISCLOSURES. THIS INCLUDES A WARNING REQUIRED BY THE STATE OF MARYLAND APPARENTLY DUE TO THE COMPANY’S “FINANCIAL CONDITION”. GIVEN MTY’S KICKBACKS, CLOSURES AND STANLEY MA’S ELABORATE $214M MONEY-MAKING SCHEME, THESE WARNINGS SHOULD BE GIVEN CAREFUL CONSIDERATION BY POTENTIAL FRANCHISE INVESTORS. THE ARTICLE IS AVAILABLE HERE.
MTY Discloses Kickback Scheme
Updated January 13, 2022
Kickbacks or “commercial bribes” can cause franchises to close in masse. Franchisors require franchisees to buy products from their approved distribution network. If the franchisor requires the distributor to pay a kickback to the franchisor, the distributor adds the amount of the kickback to the franchisee’s cost. Thus, kickbacks can be viewed as a corporate line of credit that is not repaid in cash, but in store closures. They can also be viewed in the context of a bigger stronger kid taking lunch money from his classmates simply because the victims can’t fight back.
For example, a pizza franchisor may negotiate a 60¢ per bottle kickback with a soda distributor for the exclusive right to sell to its franchisees. If the distributor normally sells soda for 50¢ a bottle, it will now sell to the franchisees at the “artificially high” price of $1.10 to cover the kickback to the franchisor. (The same arrangement occurs with the franchisee’s other food, paper and supply products.) Because the pizza shop must compete with the sub shop next door that sells the same brand of soda at a cost of only 50¢ and with other pizza shops in the area, the franchisee becomes less profitable until it eventually goes out of business.
Franchisors use kickbacks to increase revenues. They create a “windfall to the franchisor at the franchisees’ expense”. Unbelievably, kickbacks, not restaurant services, accounted for an extraordinary 82% of MTY’s 2020 earnings. The U.S. Inspector General’s Office has acknowledged the financial devastation suffered by Cold Stone and Quiznos franchisees—two franchise companies that perhaps rank as the most criticized for excessive kickbacks linked to store closures.
Kickbacks can cause even large franchise networks to collapse in a short period of time as was the case for Quiznos. The company’s franchise network shrank from 4,700 locations to fewer than 400 locations in just ten years. Because franchisees are largely family operations investing their life savings, these failures can cause lifelong financial challenges such as protracted litigation, bankruptcy and home foreclosure. They can also result in relationship and emotional issues such as divorce and, even in the case of one Quiznos owner, suicide. Franchise investors must heed the warning of those who have experienced the devastating effects of abusive kickbacks preferably BEFORE signing on with the franchisor, but certainly before the build-out. After the build-out, the franchisor has the upper hand and can begin to plug their finances using the franchisee’s savings.
MTY admits it uses kickbacks to hike up its revenues, albeit in cloaked and sanitized language. Its 2020 Annual Report discloses that kickbacks “are recognized as revenue… and are recorded in other franchising revenue” (PDF pg. 66). For example, MTY’s federal disclosure for its flagship brand, Cold Stone Creamery, reveals that MTY charged franchisees more than $24M (“approximately 12.5%… of revenue”) in kickbacks during the year. That money may be used in MTY’s “sole and absolute discretion” (PDF pg. 54). MTY’s kickbacks have led to an exceptionally high franchise failure rate of 9.3% through 2019 and a store closure rate of 11.1% through 2020. Thus, a larger dollar amount of kickbacks is forced onto a shrinking number of franchise owners each year.
For example, MTY’s largest two brands are Cold Stone and Papa Murphy’s. MTY disclosed an average increase of $1.4 million each year in kickbacks totaling $87.5 million from 2017–2020 (PDF pgs. 62, 66, 59 and 54) on a declining number of U.S. franchisees. MTY reported kickbacks in other brands as well. For example, MTY more than doubled Papa Murphy’s 2019 kickbacks from $781,545 (PDF pg. 48) to more than $1.6 million in 2020 (PDF pg. 44). The company also increased Taco Time’s 2019 kickbacks from $23 million (PDF pg. 59) to more than $24 million in 2020 (PDF pg. 52).
MTY has a dependency on kickbacks that it cannot seem to give up. This is underscored by some of the events of the pandemic. In early 2020, COVID began to severely impact restaurants. The industry was reporting restaurant revenue had “tanked”, losing $220B in GDP and 6M restaurant jobs were lost in March and April alone.
MTY had its own struggles. In March 2020, MTY announced it was taking measures to “support its franchisees” including deferring up to $18M in royalties. In April, MTY issued a material impact statement reporting 2,100 locations were temporarily closed, the company had laid off more than half its staff and some spending was reduced to a minimum. Franchisees were clearly struggling to remain open, reopen and to just put food on their own family table. Despite this, MTY took more than $25.5M in kickbacks from franchisees in the first six months of the year alone (see “Other franchising revenue”, PDF pg. 22).
MTY has taken $239M in kickbacks from franchisees and closed 2,594 locations in the following five years through 2020. That includes an increasing annual closure rate of averaging 442 during the four years before the pandemic and 619 in the five years through 2020.