Atlanta Bread Company franchisees among worst-performing SBA borrowers

A dozen years ago, Atlanta Bread Co. was among the nation’s fastest-growing franchises, with plans to double its stores almost as fast as you can munch one of its ABC Special sandwiches.

By 2004, the Smyrna-based deli and bakery chain had tripled in size, to 164 shops spanning much of the nation.

Since then, however, Atlanta Bread has been in retreat. More than half its stores have closed, leaving 74 in 20 states.

Likewise, half of the 66 U.S. Small Business Administration-backed loans made to Atlanta Bread franchisees since 2001 have failed, according to a 2011 study by Blue MauMau, an online publication that tracks the franchise industry. The loans totaled $32.8 million, with the federal government losing $5 million.

By SBA loan failures, Atlanta Bread ranked 11th on the website’s list of the 25 worst-performing large franchises. The list is based on companies whose franchisees received at least 50 SBA-backed loans from 2001-2010, according to Blue MauMau.

Such reversals impact a company that once was one of the nation’s largest and fastest-growing deli/bakery chains, spreading the “Atlanta Bread” name from California to Connecticut.

Atlanta Bread’s owners called the retreat largely strategic. The company, which had system-wide sales of $122 million last year, needed to go through a painful, multi-year retooling in order to shore up its brand and remodel its stores, they said.

The shrinkage has now stopped and Atlanta Bread is rebounding. The privately held company, with about 1,000 employees in metro Atlanta, is hiring again and remains profitable, they said.

“We’ve come back with a tremendous amount of strength,” said Atlanta Bread President Jerry Couvaras, who runs the company with brother, chief operating officer Basil Couvaras. “If we hadn’t gone through this catharsis, we wouldn’t be where we are today,” he said.

But a different picture of Atlanta Bread emerges from the company’s franchise disclosure documents and interviews with industry experts.

While Atlanta Bread embarked on an aggressive expansion plan in the late 1990s, its revenues and store network began shrinking dramatically after 2004. Store closures, due partly to poor locations and problems with franchisees, including mounting legal issues, took their toll.

The sinking economy in 2008 and 2009 worsened the decline. Forty-four stores have closed since 2008.

The competition

Atlanta Bread is now far behind rival Panera Bread Company. The St. Louis chain expects to add about 100 new stores this year to its network of nearly 1,500 outlets.

“I think Atlanta Bread had found some success early on,” said Morgan Keegan restaurant analyst Bob Derrington. But it got derailed and became a “secondary player” in a brutally competitive industry, he said.

“Atlanta Bread needs to figure out a niche that it can serve successfully if it wants to survive long-term,” he said.

Panera has several tough-to-beat advantages over Atlanta Bread, he added, including stronger sales per store, bigger and better-capitalized franchisees, and more cash to advertise, develop products and grab choice locations.

“When you’ve got that much lead, it gives you a lot of latitude,” Derrington said.

Atlanta Bread’s store network peaked in 2004, the same year the Couvaras brothers were hit with criminal charges of securities fraud in their native South Africa for allegedly cheating 2,000 investors out of $6.5 million. Months after Jerry was arrested and Basil surrendered in South Africa to face charges, the brothers pleaded guilty to a reduced banking violation and paid a total of $310,000 in fines.

In another major legal dispute, former Atlanta franchisee Sean Lupton-Smith sued Atlanta Bread in 2006 after it terminated his ownership of five stores, claiming he violated the franchise contract by opening a PJ’s Coffee and Lounge in Atlantic Station. The Georgia Supreme Court ruled in 2009 that Atlanta Bread’s non-compete rules were too broad and “unenforceable.”

The $5.5 million settlement Lupton-Smith won hit Atlanta Bread during the depths of the 2008-2009 recession, when the company was borrowing more money and taking other actions to conserve cash.

“I don’t think that was a big issue for us,” Jerry Couvaras said of the franchisee lawsuit. He said the South African charges also were “benign,” stemming from a 20-year-old investor dispute that had nothing to do with Atlanta Bread.

Still, the legal matters, store closings and other challenges, which must be disclosed to potential investors before they buy a franchise, may have distracted top management, soured relations with current franchise operators and scared off potential new business partners, experts say.

Atlanta Bread’s reduced operations “speak for themselves,” said Don Sniegowski, editor of Blue MauMau. “Obviously something’s fundamentally wrong.”

Indeed, Atlanta Bread’s evolution — whether by catharsis or crisis — has been riddled with heavy losses for scores of its former franchise partners. Many lost their businesses, livelihoods and homes.

“We took quite a beating,” said Nino Russo, who had hoped to someday own several Atlanta Bread outlets. He bought an existing store in downtown Decatur from Atlanta Bread in 2004 for $500,000, plus a $40,000 franchise fee.

Instead, the store failed in 2009. Russo and his wife lost their savings and the SBA foreclosed on their Acworth home. Now in their 50s and 60s, both are still working.

Russo said the restaurant struggled from the beginning with an unfavorable location that only grew worse when it lost access to customer parking as the result of a neighborhood redevelopment. The recent recession was the final straw, he said.

“Those last three years were a blur,” said Russo, who had been working “massive hours” to keep the restaurant going. When he finally closed the doors, he was shocked to hear that Atlanta Bread had about half as many restaurants as when he first bought in.

“I’ve had other restaurants,” Russo said. “I don’t know if I would ever open another one again. It was frightening.”

Growing pains

Franchise networks operate many of the familiar outlets where consumers do business, such as McDonald’s restaurants, Exxon service stations and Chevrolet dealerships.

Typically, would-be small business owners who don’t want to launch a business on their own become franchisees. They pay companies like Atlanta Bread an up-front franchise fee to use the franchise company’s trademarks and expertise, and borrow or invest their own money to open an outlet. They must run the outlet according to the franchise company’s specifications and pay an ongoing percentage of their sales to operate, or risk being “terminated,” or forced to close or give up the business to the franchise company.

Some corporations rely on franchising as a way to ramp up their growth without having to use their own capital.

That’s what Jerry Couvaras had in mind when he moved to Atlanta in 1994 and came upon a crowded Sandy Springs sandwich shop. The Couvaras brothers bought into the business, Atlanta Bread, and by 1995 they were selling franchises to open more shops.

Soon, they gained control and ownership of the business — unfairly, according to a 1998 lawsuit by Atlanta Bread’s founders, Robert and Richard Auffenberg. The company settled the lawsuit with the Auffenbergs in 1999 by agreeing to pay millions of dollars in royalties over a 15-year period.

That same year, under the Couvaras’ leadership, Atlanta Bread hit the afterburners. In an interview at the time, Jerry Couvaras said he had embarked on an aggressive franchising effort to double Atlanta Bread’s size in a year, adding 60 new stores and boosting the chain’s sales to $131 million in 2000.

By 2006, the company had sold franchise agreements for 232 stores.

But franchise operations are complex businesses that have extra challenges that can trip them up, industry experts say.

“The problem with franchising is it creates problems,” said Robert Wagner, a longtime Atlanta accountant for restaurant businesses. Franchise firms not only have to woo customers, but “maintaining good relations with franchisees is incredibly difficult,” he said.

Top management sometimes can’t keep up with a rapidly growing network, resulting in mistakes such as poor location choices for new outlets.

Worse, franchise firms may concentrate too much on selling franchises rather than making sure the underlying businesses are healthy.

Sniegowski, with Blue MauMau, said Atlanta Bread appears to have suffered most of those growing pains, as evidenced by its rapid rise and contraction, several lawsuits with franchisees, and the fact it usually had only one or two corporate-owned stores.

“They grew very quickly,” Sniegowski said. “The more stores [in the network], the better their revenues, whether the stores work or not,” he said.

Scores of stores ran into trouble. Since 2008, 27 stores closed and Atlanta Bread terminated franchisees’ rights to run 17 others. The firm has sued franchisees or been sued by them eight times since 2001.

Company: Plan working

Jerry Couvaras concedes that Atlanta Bread made mistakes. The company may have grown too fast, causing it to pick franchisees “who culturally were not a good fit,” he said.

Also, “a couple of years ago we realized we do need a bigger core of corporate stores,” he added. Atlanta Bread now has 13 company-owned stores, which “has made us a much better franchisor,” he said. The company may open three or four more next year, he said.

“There’s no question that the economy played a role” in the company’s retrenchment, he added.

But he stands by Atlanta Bread’s decision to push franchisees starting in 2006 to re-tool their stores to offer more private and inviting spaces where customers would linger. The remodelings, which are due every five years under the franchise contracts, cost $80,000 to $250,000.

“The better thing to do sometimes is to pull back from the market” and fix things, he said. “We needed a group of people — franchisees — who understand where we are going.”

“I know we closed a lot of stores,” he added, but it has paid off with rising sales at the stores that have remodeled.

“The plan has worked,” he said.

Atlanta Bread hired 30 employees this year at its headquarters and central bakery, and expects to open up to nine new company and franchisee-owned stores next year, officials said.

Same-store sales — revenues at stores open at least a year — have been up almost two years, Couvaras said.

“This is probably one of our most profitable years,” he added. He would not disclose same-store sales or profit figures.

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