When Private Equity Came for The Toddler Gyms

A PE firm demanded higher fees and instituted more stringent requirements, which the independent owners thought would threaten their profits.

By Lydia DePillis & Michael Corkery

Tiffany Cianci spends most of her days in socks, padding around the fitness studio she operates in Frederick, Maryland, about an hour outside Washington. Her clients are young: kids ranging from 4 months to 12 years old. They come to learn somersaults, try the monkey bars, sing some songs. (“Little Red Caboose,” complete with a train-whistle accompaniment, is one of her favorites.)

Cianci, 41, spent the first part of her career as a sommelier, specializing in sake. In 2017, wanting to leave the hospitality industry for something that allowed her to spend more time at home, she and her husband bought their facility as part of a franchise chain called The Little Gym. Its slogan: “Serious fun.”

They got what generations of franchise owners have gotten out of similar deals, with brands such as McDonald’s or Jiffy Lube: a known brand name and detailed business plans in exchange for an initial fee and a cut of the revenue. For Cianci, it was more than just a business.

“I love it. I really love it,” said Cianci, a mother of three who studied dance. “I love my students, and I love that it lets me make a difference.”

In the past year and a half, since The Little Gym was acquired by a private equity-backed firm called Unleashed Brands, her work has felt far less idyllic.

According to legal filings, internal documents, and interviews with more than a half-dozen other franchisees — most of whom requested anonymity so as to avoid retaliation — Unleashed began to demand higher fees and institute more stringent requirements, which the independent owners thought would threaten their profits. The day after Cianci organized her fellow franchise owners into an association to push back against the changes, the corporate office told her it was terminating her license on the grounds that she was chronically late in paying her fees. Given the timing, Cianci maintains in the legal filings that it constituted retaliation.

Along the way, Unleashed Brands surveilled Cianci’s business with undercover shoppers, met with her landlord and disparaged her to fellow franchisees. When she tried to salvage her business under a new name — it’s now called Teeter Tots Music n Motion — the company sued, accusing her of violating its trademarks and a noncompete clause in her franchise agreement.

The episode has plunged Cianci about $300,000 into debt and enmeshed Unleashed in a nasty court battle not long after it acquired several new brands. The outcome will be a test of just how much a franchiser can unilaterally change the rules of a business relationship that has served as an on-ramp to entrepreneurship for hundreds of thousands of people.

The legal fight — along with two others Unleashed has faced with franchisees at its other brands — also reveals the challenges of applying the private equity playbook to the unique world of franchises.

Private equity has notched decades of high returns for investors by following a well-worn strategy: acquire distressed or undervalued companies or real estate, increase profits and then sell them. Greatest hits include foreclosed homes, highway rest stops and coal mines bought out of bankruptcy.

Franchising has become one of private equity’s targets du jour. According to the research firm FRANdata, the number of franchise brands acquired by private equity firms and other investors rose from 52 in 2019 to 149 in 2021 and was on track to nearly equal that total in 2022.

Private equity firms tout their ability to bring new ideas, technologies and efficiencies, and franchises, financially weakened by the pandemic, appeared ripe for those kinds of changes.

But the reality is not so straightforward. The nation’s franchisees (237,619, according to FRANdata), like Cianci, think of themselves as independent small businesses, who have often sunk their life savings into the enterprise. That’s why Little Gym owners are resisting Unleashed’s attempts to squeeze their profits to pad its own.

Unlike, say, factory workers, who can be laid off at will, franchisees are supposed to be protected by legal documents that prescribe a certain business model for years at a time. Moreover, Unleashed — and its investors — need franchisees to stay motivated so they can keep generating revenue and recruit others to keep expanding the franchise system.

Cianci, who is now in arbitration with Unleashed Brands, has been working to change state laws to better protect franchisees who might find themselves in her position down the line. The Federal Trade Commission, meanwhile, is reconsidering federal regulations on franchisers, which haven’t changed for more than a decade.

Direct inquiries to Michael Browning Jr., Unleashed’s CEO and founder, and other executives were not returned. Instead, a public relations firm answered detailed questions via email, saying the company’s changes have improved business across the board. “The financial impact and franchisee benefit of these efforts is undeniable,” the spokesperson wrote.

Many of the changes, however, are simply not what franchisees say they had signed up for.

“What this reflects is a conflict between the private equity firm that bought this and what they actually bought,” said Francine Lafontaine, an economist at the University of Michigan who specializes in franchise relationships. “In their due diligence, they didn’t seem to think too much about who they were going to be working with once they owned this chain.”

‘Candy Land Board of Life’

Browning, the son of a real estate developer with a background in health care investing, viewed The Little Gym as a perfect part of his vision: He was building a conveyor belt of activities for kids.

Browning spent the 2010s building a franchise called Urban Air, a chain of trampoline parks where parents could spend $700 on a birthday party to remember for their seventh grader. The venture was staked by Browning and his father, and eventually, Urban Air formed Unleashed. Private equity was also interested in the Brownings’ growing business. Although a company spokesperson did not clarify the company’s relationship with private equity, on the websites of private equity firms AHR Growth Partners, Mantucket Capital and MPK Equity Partners, Unleashed or its brands are listed among their current or recent investments.

In 2021, he decided to scale up, following a hot new trend in private equity: building “platforms” to consolidate several brands in a similar industry that could then cross-sell a variety of services to their customers, as well as sell more franchises to their existing franchisees. Browning would often mention Neighborly, a rollup of home-services offerings that had been bought by private equity giant KKR, as his model.

“If I have five home services brands, I can pitch all those services to the same customer,” said Ritwik Donde, senior research analyst at FRANdata, which helps investors vet potential acquisitions. “Those complementary systems lower the cost of customer acquisition. ”

Browning’s company, Unleashed Brands, began buying other youth-enrichment chains. Parents — always moms, in Browning’s conception — could then spend money at his companies from the birth of their kids through high school graduation.

Cianci was immediately skeptical of Browning’s vision for rapidly collecting children’s services and integrating their sales, operations and marketing.

“That might be OK when you’re cleaning a dryer vent, but it’s not when you’re throwing around a 4-month-old and you need them to be safe,” Cianci said. “He was moving faster than he would need to get to know the business.”

To kick off the new program, Unleashed invited all of its newly acquired franchisees to a conference in Orlando, Florida, in October 2021, including Little Gym’s approximately 175 owners. The company rented out the Wizarding World of Harry Potter and held a fireworks show. And Browning treated attendees to a speech he called “vision casting,” in which he articulated his plans for building a family of children’s brands that families could spend money on from birth to age 18.

The “Candy Land board of life,” he called it. He promised new tech tools that would make their lives easier. “Auto-magic,” he called it.

Changes didn’t take long. Within weeks, long-tenured headquarters employees started leaving. In conversations with franchisees across the country, numerous owners expressed frustration that the support they depended on had evaporated; instead of calling a trusted adviser whenever they wanted, they had to file an online ticket. (Unleashed said that it “never sought to cut access” to its staff and that the ticket system was instituted to make sure they were responding in a timely fashion.)

The company tried to impose a new payroll vendor that caused unending headaches. Certain activities, such as karate, were eliminated as Unleashed acquired businesses with similar programming; the company said it trimmed services with low enrollment to “streamline” the offerings. The company also outlined a process by which franchisees could lose their licenses if they failed to meet brand standards, which set a sour tone among some of the operators. To people who’d just made it through a pandemic and operated on thin margins even in good times, the changes felt unnecessary and destabilizing.

In the fall of 2021, the company required all franchisees to sign a new agreement allowing Unleashed to automatically debit their bank accounts. Cianci noticed that it also contained broad language allowing the company to extract any other fees that might be owed, which she believed went beyond her franchise agreement.

Under the advice of a lawyer, she refused to sign it and started to send her royalty payments via paper check. But she worried that most franchisees would simply accept the new arrangement, along with another requiring them to use — and pay for — a shared call center.

To sound the alarm to others, Cianci held conference calls, often with a lawyer present. As concerns spread, a group of Little Gym franchisees in May formed the Happy Handstands Franchisee Association, which ultimately reached more than 90% participation from across the system. Cianci was elected president. The company started sending warning notices to franchisees who hadn’t signed the new agreements.

On May 19, 2022, Happy Handstands’ lawyers sent Unleashed a cease-and-desist letter on behalf of the membership. The next evening, an email popped up saying Cianci’s franchise had been terminated. When she tried to check it, her email account was gone, too. Unleashed said the company didn’t know she was the association’s president when they decided to terminate her. Cianci said it was widely known across the system and mentioned in a Facebook group visible to lower-level corporate executives.

To save her business, Cianci went before an arbitrator and filed for a preliminary injunction decrying the termination as retaliatory; the arbitrator ruled that she hadn’t cleared the high legal bar necessary to stop the process. After that, she started tearing down all her Little Gym branding and adapting her curriculum so as not to violate the company’s trademarks. She paused when Unleashed’s lawyers wanted to discuss a settlement, which she said she rejected over its harsh terms. When they demanded she finish the process of “de-identifying” as a Little Gym immediately, she had difficulty getting started again because she had surgery on a broken foot.

In June and July, the company sent undercover shoppers — including one who was a licensed private investigator — who posed as parents and asked Cianci’s employees what kinds of lessons they offered and whether they overlapped with The Little Gym’s programming. In early July, Unleashed, with the help of outside counsel DLA Piper, sued her in the superior court of Arizona for Maricopa County, where The Little Gym is based. The company accused her of failing to eliminate all branding fast enough, offering declarations from the investigators as evidence — the color scheme looked the same, for example, and a Wi-Fi network was still “TheLittleGym,” password “SeriousFun.”

Soon after, the company’s lawyers also visited her landlord in Frederick, which Unleashed said was “part of a standard process to inquire as to the status of the lease.” According to Cianci’s notes from her subsequent conversation with the landlord, the lawyers told him that she was in legal trouble and wouldn’t be able to keep paying rent.

Her landlord then sent her a letter, which was filed as evidence in court, declining to renew her lease and demanding more than $275,000 in back rent, including real estate taxes, most of which Cianci thought had been forgiven during the pandemic. Unleashed then exercised its option to take over the lease, although the building remains empty. (Her landlord declined to comment.)

In mid-July, Unleashed Brands’ chief legal officer, Stephen Polozola, sent all Little Gym franchisees an email titled “Friendly Reminder on Confidentiality.” In it, without naming Cianci, he warned them not to share any information with a certain former franchisee, who he said had been terminated for not paying royalty fees on time.

Further, he wrote that the company had received reports from “no less than seven” former employees who said that the unnamed franchisee had underpaid them and created a hostile work environment. The email finished with a grainy screenshot of a Facebook post containing a vulgar message that Polozola said had come from that same franchisee but didn’t have her name attached.

Cianci, who had taken her son to a water park for his birthday, immediately started getting messages from other franchisees. None of it was true, she told them. As she would detail in court documents, the company allowed late payments for nearly all franchisees during the pandemic, and her gym had been closed by local ordinance for longer than most. She had continued to send her royalties in the mail, even after she refused to sign Unleashed’s new payment form, she said, and she was current on all her accounts when she was terminated. And the inappropriate Facebook post? She said she hadn’t written it.

The allegations by Cianci’s former employees that Polozola referred to in his “friendly reminder” email sprang from messages that were sent by the workers in April 2021, before The Little Gym changed hands. After an investigation, no action was taken. The Unleashed spokesperson said the company had relied on Cianci’s assurance that she would resolve the matter with the Maryland Department of Labor. Cianci said she made no such assurance.

In response to an inquiry from The New York Times, the Department of Labor provided records showing a total of five complaints against Cianci for unpaid wages since 2017, two of which she resolved by paying her former employees; two were dropped; and one is pending.

But the emails from the former employees, which Unleashed supplied to the Times in unredacted form, detail complaints other than unpaid wages — such as dealing pills and mistreating children — that would seem to merit more immediate action by corporate headquarters, and which Cianci strongly denies.

In late summer of 2021, when one of the former employees contacted Unleashed again, Polozola told Cianci to ignore it, according to an email exchange she provided — until he brought the complaints back up to discredit her nearly a year later.

Arguing that such tactics seemed far outside the norms of legal practice, Cianci’s team in September filed a defense of so-called unclean hands, making the case that Unleashed Brands’ conduct had so tainted the proceedings that the judge should rule in their favor.

But their motion never went anywhere. Before the judge could rule on it, Unleashed filed to dismiss its own case, arguing that its complaint that Cianci was essentially operating an unauthorized Little Gym was moot because her landlord had evicted her.

The upshot of all this legal wrangling is that the fight between Cianci and Unleashed continues in arbitration in Arizona. In arbitration, potential damages are more limited, proceedings are sealed, and no precedent is created for other cases.

Unleashed is fighting to stop Cianci from running what it says is a competing gym. Cianci is fighting for the chance to keep her new business and recoup the hundreds of thousands of dollars she has now spent on lawyers.

One of them, Peter Lagarias, began his career at the FTC, enforcing the agency’s then-new franchise rule in the late 1970s, and spent most of his career advocating for franchisees both in the courtroom and the California statehouse. He took her case for a low rate, but arbitrators, whose cost must be split by both parties, can run tens of thousands of dollars, too.

“They don’t want money,” Cianci said of Unleashed. “They want to destroy my life.”

A Cash-Flow Crunch

Bill Walenda, 55, also got into running Little Gyms as a second career. After years as a financial planner, he wanted to buy a franchise — maybe a McDonald’s or a Dunkin’ Donuts — and his wife suggested The Little Gym, since he loved working with children. He opened a gym in New Jersey in 2002 and bought another in Illinois in 2009.

After Cianci’s franchise was terminated, the Happy Handstands Franchisee Association fractured over strategy. Another group of owners started an association with a different approach: working “collaboratively” with the corporate office to provide feedback on changes. Walenda was elected president, and he has had limited success.

He has been fighting a new point-of-sale system with a credit card processor controlled by Unleashed, which franchisees say is keeping customer payments for more than a week before sending them to gym owners, creating a cash-flow crunch for owners. (Unleashed said the system keeps money for only two or three days.)

The company also continues to try to make everyone use its new shared call center, which Walenda said would “take us out of the equation of dealing with our customers” — something that might work for a business such as Urban Air, which processes thousands of people a week, but not the familial relationships on which The Little Gym operated for decades.

“You can’t treat every business the same,” Walenda said. “And that’s really what’s causing all of this strife.”

In November, Unleashed introduced a revised operations manual that lays out new rules and fees. It specifies the hours the businesses must be open, how quickly they must return customer calls, which architect they must use and what company meetings they must attend. Staff salaries were only supposed to make up 30% of revenue. The technology fee can rise to $399 from $119.

The national advertising fee can rise to 5% of gross sales from 1%; part of that will go to a fund that supports other Unleashed properties. New fees appeared, including a $30,000 fee to renew the franchise agreement, and a fee of about $15,000 to relocate the facility. For some owners, the changes seem to mean that they can no longer operate profitably and will have to sell rather than renew.

Unleashed said the changes apply only to new franchisees, and Walenda said his group has been able to negotiate away some of the fees even for them. But other fees remain, including a $100,000 payment if the franchise is terminated, and Walenda said the company continues to try to force everyone to use its call center and point-of-sale system. As much as he believes in the collaborative approach, he is willing to litigate to stop the attempts to extract more money.

“That’s all private equity cares about, as far as I’m concerned,” Walenda said. His business is doing well, which he credits to the post-pandemic desperation for children’s activities; he said Unleashed’s new systems have mostly just taken more time for his managers to deal with.

“We’re not people, we’re not businesses, we’re just numbers to them,” Walenda said. “And that’s a problem. Because ‘Let’s just keep squeezing everything we can out of them until we can’t squeeze anymore’ — it’s a good way of making money. It’s not a very good way to run a business.”

After a year of owning The Little Gym, Unleashed Brands says that average gym revenue rose 36.8% in 2022 over 2019. And its franchisee recruitment has focused on people who want to open multiple units, such as Cody Herndon, whom Unleashed provided as an example of a Little Gym owner with a more positive view of management.

An Urban Air operator who sold one of his two parks to another private equity investor, Herndon bought the rights to open three Little Gyms in Texas last year. He said he was drawn by the opportunity to have longer-term relationships with families and thought the new systems that Unleashed was pushing would work out in the end.

“There are going to be so many massive benefits to any change that’s been asked,” Herndon said.

While disclosing few other metrics, the company told Axios in May that it expected to generate $160 million in revenue in 2022 and was shopping for a buyer. It appears to have found one.

Unleashed’s current private equity investors are selling their stakes in the company imminently, according to a company spokesperson. But the company declined to disclose the buyer or the terms of the deal.

Whoever the buyer may be, the’ve got significant franchisee rancor on their hands — even beyond The Little Gym.

At Browning’s original chain, Urban Air, a franchisee association representing more than 50 owners tried to bring a lawsuit in 2020 over what it viewed as unfair changes that had revealed the “terms and provisions of the franchise agreements upon which investment decisions were made to be illusory and meaningless.” But a Texas court threw out the case on technical grounds, and with individual arbitration the only path forward, the effort fell apart.

In late 2022, Unleashed was also sued by 54 franchisees of its Premier Martial Arts brand who said in legal filings that the franchiser gave them an unrealistic impression of the cost of running a martial arts studio, leaving them with dead-end businesses and debt.

Michelle and Peter Silberman depleted their retirement savings, maxed out their credit cards and took out a home-equity loan to acquire three Premier Martial Arts territories in March 2020, before Unleashed owned the franchiser. The first opened near their home in the Pittsburgh area in May. Peter Silberman said Premier Martial Arts told them that they could expect profit margins as high as 48%, while running the studios as “semi-absentee” owners who had to run the business as little as 10 hours a week.

The couple were charging parents $138 a month, which included two classes a week. The Silbermans, who had no experience with martial arts, said they relied on the company’s assurances that it would help them manage the business.

But when attendance began to decline and expenses were piling up — the couple spent $370,000 acquiring the territories and operating the one facility — Peter Silberman said Premier Martial Arts offered little additional help. Their studio closed this past fall.

Although the trouble began long before Unleashed announced that it had bought Premier Martial Arts in early 2022, the lawsuit states that after the acquisition, “the same false statements were still made and the same bogus model was pitched.”

In response, the Unleashed spokesperson said the company is “not a party to any contract” with a Premier Martial Arts franchisee.

As for the Silbermans, they have been trying to pay down their debts.

“We are, hopefully, going to avoid bankruptcy by the skin of our teeth,” said Silberman.

New Rules for Franchises

Cianci’s case is winding its way through arbitration. Her new gym in a suburban mall next to Macy’s has only about 74 members, compared with the 275 she had before her termination by Unleashed. She said her husband, a federal trademark attorney, is working long hours to support them.

In the meantime, she’s trying to prevent future franchisees from being put in the situation she found herself in.

As the FTC reviews the rules governing franchising, advocates have urged the commission to add stronger protections, such as more disclosure of how the average franchise location performs. The International Franchise Association — whose board Browning recently joined — has lobbied hard to avert those changes.

In Congress, Sen. Catherine Cortez Masto, D-Nev., has done extensive research on problems with the franchise system and introduced two bills seeking to give franchisees more leverage. But their fate is uncertain.

That’s why Cianci is focused on the states — specifically Arizona, where The Little Gym headquarters is based. Lawmakers have introduced a bill that would protect franchisees’ right to form associations, require changes to their agreements to be presented in contractual form and limit the circumstances under which their licenses could be terminated.

At the very least, she hopes her case will ultimately prove that it’s possible to resist a franchiser’s efforts to impose its will outside what are supposed to be legally binding agreements, whether it’s how many birthday parties to offer or which insurance company to use.

“That’s exactly what went wrong here,” Cianci said. “He’s buying companies where people had rights.”

c.2023 The New York Times Company. This article originally appeared in The New York Times.

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