Wednesday, December 24, 2008

My story

First of all, let me give you a few details about my background prior to Cold Stone. I started with McDonald’s in 1972. I worked for them in one capacity or another for most of my adult life, including a 10 year stint as a franchisee. I am well acquainted with how to run a successful restaurant….I eventually sold my store, and about five years ago saw my first Cold Stone in Hawaii. I was amazed! What a great idea, I thought. I knew that there wasn’t a Cold Stone in Bellingham, WA where I lived. The size of the store and the number of employees was small, by McDonald’s standards. It should be easy to run and manage one of these. I ask the owner for an application and when I returned home, completed all the paperwork, and sent it in. A few weeks later, I got a call from the area developer. We arraigned a meeting, we talked about my background, she gave me the history of Cold Stone, and then I asked about financials. She told me that in the Pacific Northwest Region, the Average Unit Volume was $425,000 (this was in 2003), and had grown steadily for the previous four years. We were told that franchisees were generating between 15% and 20% profits! That sounded impressive! She was very engaging, and my wife and I were very interested. Just prior to the end of our meeting, I told the area developer, that before we made a decision, we would like to see specific financials from franchisees in the area. She explained that she could not give out that kind of information, because it would violate confidentiality agreements with the current franchisees. I told her that she did not have to give us names, just the supporting documentation. She said that the P & L information from each franchisee was not readily available to the area developers, but what she could supply us with was a generalized P & L, that had Cold Stone recommended expenditures listed. She said that I should be able to complete a pro forma based on that. We agreed to look at the information she would provide us, complete a pro forma, and call her by the next week. She supplied us with a list of franchisees to call (her list).
The P & L information she provided looked reasonable. The generalized P & L indicated that Food Costs (including paper) should run about 23-24%, and that labor costs, around 24%. Seemed reasonable, at least in the McDonalds world. Little did we know that these numbers were far from realistic? But we completed a number of projected P & L’s based on the AUV provided by the area developer, looking at the high side, the average, and the low side. It did look doable. We called a name or two on the list. The franchisee in Vancouver, WA was ecstatic about Cold Stone. His comments were “What are you waiting for? You’ve worked for McDonalds! This will be easy for you!” The second franchisee wasn’t quite as glowing, but wasn’t anywhere as enthusiastic either. We decided to take the chance….we called the area developer and told her we wanted to be a part of the Cold Stone family. We wanted in. We signed the paperwork, gave her a check for the franchise fee…..we had done it! Like most of you, we were excited. We signed an agreement for a second location a few months later, paid a second franchise fee, then, even a third location! Another franchisee fee! We still didn’t have an open location, but we were growing! We went to our first co-op meeting. There seemed to be quite a bit of negativity at that meeting. But I didn’t think too much of it, at first. I had been to co-op meetings with McDonalds, and there was always some dissention…usually over how the advertising dollars were spent. But this was different. I got that uneasy feeling you get when you buy a new car, buyer’s remorse……but I attributed it to not knowing these people. We finally opened our first store. There was a lot of difficulty with financing, however, even though I had put up 20% of the projected costs. First National Bank of Arizona wanted more upfront money! I had to come up with an additional $25,000! And none of this included the first food order, the first payroll, or uniforms! Cold Stone would loan me an additional $75,000 because the bank wanted to only loan 50% of the total costs! That in itself should have been a warning signal; however, we continued to move forward, just trying to open our first location. My store was the first store in the system to have Cold Stone be the primary on the lease, so the lease agreement took some time to complete, and proved to be very hard to understand, at least for me. I immediately had to pay Cold Stone an additional 2% of the projected lease amount over a five year period to Cold Stone as an “administrative fee”. That was a whopping $6,000 I had to pay up front to Cold Stone, so they could collect the rent from me, and pay the landlord their rent.
Now the relationship started to look a little one sided……but we still moved forward, buoyed by the AFM, the following January. It certainly was extremely upbeat, and we heard all these testimonials from some of the successful franchisees, and Cold Stone gave us their vision for the future, and it was glorious…..according to Cold Stone. Doug Ducy stood on stage, telling us all how fast Cold Stone would grow……”There will be 1000 profitable stores open by 2005!” he proclaimed! And, if he had to, it would be with the 500 franchisees in the system already.
During the first year both Patty and I worked in the store. We put in a ton of hours. After all, we invested everything we had in the business, my inheritance, our 401 K, and we even put our house up for collateral! My total financial commitment had reached about $150,000 in cash. Then our first winter hit. Cash flow went negative. We struggled to make payroll. We had fallen behind with Sysco, and they put us on C.O.D. They turned over the outstanding balance (about $8,000) to a collection agency. We agreed to pay them $500 every two weeks. Then in December of 2004, we got a call from Cold Stone……they had made a mistake and failed to withdraw rent for 4 months. We owed them about $16,000, and they wanted to know how soon we could pay them! Cold Stone did defer the back rent until March 2005…….then we had to make payments, about $1000 a week until it was paid off. All the while, I wondered what we were doing wrong. Why couldn’t we make this work? Even Cold Stone convinced many of us that it was our fault. We weren’t doing the local store marketing like we should, or the Co-Op had no viable marketing plan in place. It didn’t matter. It was our fault!
I became involved in the Co-Op. I wanted to be a team player. I was the Co-Op president for 2 years. Throughout that time, I supported the initiatives Cold Stone was pushing. Like many of you, I looked to Cold Stone as the expert. They were, after all looking out for our best interests………or so I thought. One franchisee in our Co-Op always seemed to be the complainer. Always telling us what the real cost of couponing would be. How Cold Stone was making a ton of money through FMP dollars (money paid to Cold Stone by vendors like Sysco or Sygma for increasing case count), or how the rapid expansion of the number of franchises would hurt asset value for most of us. Little did we realize that he knew what he was talking about! I remember a conference call that I was part of with Bruce Burnham, who was then Vice President of Purchasing. During that call, I asked Bruce this question….”Bruce, why would I make a business decision to purchase candy from Sysco, when the cost per box (as an example) for Snickers was $32.00. The same box of Snickers at Costco was $16.00!” Bruce told me and everyone on that conference call that if I did not purchase it through Sysco that I would be considered out of compliance and that Cold Stone could take legal action against me. There were more incidents similar to these that occurred over my four years as a franchisee. We continued to struggle financially. It seemed that we were always “robbing Peter to pay Paul”. My wife finally had to get another job. We had personal bills to pay! We had actually come within hours of our house being foreclosed on. She got a job as a flight attendant, something she had always wanted to do. The job had benefits! The only problem, she was based in Fresno, California! I saw her only about four days a month. But at least one of us was out of the pressure cooker called Cold Stone! In 2006, I lost $56,000. I kind of had a priority established of who got paid first. First were the employees. Actually, I guess that Sysco got paid first, because now Sysco wanted their money up front, before they even shipped the order. After Sysco and the employees, the various utility companies got paid (the electric company, the phone company…..), then, if there was any money left, the taxes got paid…..this became more and more difficult. As of today, I am currently in arrears for federal and state taxes in excess of $100,000. There was usually no money left for Cold Stone to debit, and certainly not anything for me. This financial difficulty was not unknown to my area developers. I had been constantly updating them about my situation. Then in late December, 2006, I got the phone call. It was Josh Becker, assistant general counsel for Cold Stone. Cold Stone had decided to terminate my franchises. I had fallen way behind in rent and royalty payments. Josh said I would have to sign termination paperwork immediately. And he advised me not to seek legal counsel, because in his words, “it would make things messy.” I did sign the paperwork. Cold Stone did agree to let me market my stores for two months. If I did not have a signed purchase and sales agreement in hand by the end of those two months, then the termination process would begin. The two months I had to sell the stores was January and February of 2007. Not exactly prime time to sell ice cream, let alone two Cold Stones!
But, I began to market both stores. I had gotten my real estate license, and used a local broker to help me try to sell them. I actually got some interest, and in fact, received a number of purchase and sales agreements. But, when the prospective buyers reviewed my financials, they quickly lost interest. There was no way they could even begin to pay a fair price for the stores, and make the numbers work! With rapidly declining sales, not just in our region, but across the country, it would only get worse. My first year, one of my stores was on track to do $425,000, the other, which opened nine months later, about $475,000. In fact, after the Cake Batter disaster, neither store broke $375,000. Year ending 2007, in fact, my combined total sales for both stores was $601,000! I would be lucky if someone would pay $200,000 for each store. Remember, as first generation franchisees, we had to shell out about $300,000 per location. And, besides what I owed to the government, I had leased equipment in one store for which I owed about $140,000, and I still owed my lenders about $300,000. And both of them had liens on my house. At this point, I realized that I was in deep financial trouble. I contacted a bankruptcy attorney. Our strategy was simple. The odds of me finding a willing buyer was almost nil, especially by the end of February. We would delay Cold Stones attempts to force termination of the franchises with the threat of a chapter 13 filing. Then, we would try to negotiate with them. Hopefully, they would want to avoid a lengthy chapter 13 ruling. And it would give me time to find buyers for my two locations. After about a month, Cold Stone decided not to negotiate, and we filed for Chapter 13 protection. I did locate a willing buyer, who wanted both stores, and submitted a purchase and sale agreement for $400,000 for both stores! They interviewed with our area developers, and were approved! However, after meeting with the area developers, and their lender, they decided to amend their offer for only one of the stores for $200,000. Their lender had said that the deal was risky and would not be able to fund both stores. They had decided to forgo any lender, and would buy the one store for cash. They did their 40 hours of local training, and then went for the week of training in Scottsdale. However, after the training in Scottsdale, on the way back from the airport, I got a call from them. They had decided to rescind the purchase and sale agreement! They mentioned indirectly, that after a conversation with Cold Stone and the area developers, they decided that it was too risky to move forward. I now have credible evidence that my buyers had conspired with Cold Stone and had agreed to rescind their purchase and sale agreement, let Cold Stone take over my store(s), and would purchase my store directly from Cold Stone at a greatly reduced price! Cold Stone would pocket the total proceeds on the sale, netting themselves a tidy profit, while leaving me with all my outstanding debt. After much discussion with my attorney who said at one point, “you can put lipstick on a pig, but it’s still a pig!” he called the buyers back, and asked them to bring a reasonable offer to the table and we would consider it.
Our strategy had to change. Based on what my attorney felt we would get as an offer, now our strategy would revolve around how we would avoid paying anything to Cold Stone, and instead paying the lenders as much as we could. There would be nothing going to pay any taxes. “Ed,” he said, “it’s like you’ve fallen off the back of a truck. You’re going to get hurt. We just want to minimize the pain!” So, this is how I spent my inheritance, and mortgaged our future! But, I had to think about what would have happened if I had just rolled over, and let Cold Stone come in and taken the assets. Nothing and no one would have gotten paid off, except Cold Stone! Then, they would turn around and sell the asset to someone else. That is a winning strategy for them! I couldn’t let that happen.
After much negotiating, we settled on a price of $120,000! We found a buyer for the second store, a franchisee in our Co-Op, who wanted a store along the I-5 corridor. During the negotiations, he told us about a conversation he had with the area developers. They told him to “avoid the Bellingham store, that Ed and Patty were in a legal dispute with Cold Stone.” That they, in fact, were selling a store they owned. By the way, they had purchased this store from a distressed franchisee a year earlier for $118,000. Does this sound like either a conflict of interest at the very least, or interference with the sale of my store? He decided to pass on their store, and offered me $75,000 for my store. At this time I received another offer for $175,000! We accepted this offer, but after being interviewed by the area developers, they amended their offer to $110,000. The franchisee who offered me $75,000 increased his offer to $100,000 plus a note for $10,000. The second offeree raised his offer finally to $135,000. We accepted this offer, only to have the area developers reject them as potential franchisees, because his wife did not pass the English profitenciy test. This potential franchisee was a tenured professor of economics at Western Washington University! The franchisee did raise his offer to $120,000, and we finally accepted this offer.
Filing a Chapter 13 bankruptcy action may not be the best strategy, but it was better than doing nothing. We were able to provide a clear title to both purchasers, free of any liens or encumbrances (cleared by the judge), and the judge did allow for one of my lien holders to get paid off. The money I owed to Cold Stone (somewhere in the $300,000 range, including unpaid rent, royalties, the remaining balance on a note they carried, and the leased equipment for $140,000) was discharged. They were able to collect some of the post petition rent that I owed them through the sale of the second store. I am still on the hook for the second lien holder, and the taxes owed. I am still going to have to sell my house to satisfy the lien at some point, and will have to do something about the taxes owed, but I am much better off than I would have been, letting Cold Stone take over my stores.
This was my strategy, and I’m sure there are others out there that might be better. Don’t be afraid to seek out answers. The worst action you can take is to do nothing!


  1. Hi Ed,

    We feel your pain. We also went through/are going through the Cold Stone hell. We wish something like this would have been available when we were looking at buying our store--if we would have had half of the information available on your blog or in Wall Street Journal's article (and resulting comments) we could have missed out on a lot of pain! Keep up the good work, and thanks for sharing your story.

  2. Yes, I definately feel your pain.
    After the fact, it appears to me that franchising, in general, is extremely risky for the franchisee. Do 10 times the due diligence you think necessary.

    My experiences with Sport Clips are very similiar, and the end financial results will be the same, even though I had better than average stores.

  3. Thanks, Ed, for telling your story. Thanks also for pointing out that regulation and the UFOC/FDD really protects the franchisor and not the franchisee.

    I sincerly hope that things are getting better for you now. When the federal government took franchisors out from under state securities laws and state common law fraud laws, they enabled the franchisors to commit fraud with apparent immunity under our laws.

    Hopefully, your experience will help others.

  4. Wow. My wife and I were pioneer franchisees. Our story is simular, but after purchasing rights to three stores ( we opened only two) we are now in bankrupcy court. Cold Stone robbed us of over $700,000.00 invested. We lost everything and almost devorced over Cold Stone. We closed our last store last November 2009 and our lives have begun again. Mike Williamson