Nearly 3,000 coffee shops have failed since January 2008 according to Ric Rhinehart, executive director of the Specialty Coffee Association of America. He says the one-in-10 shuttered in the past 18 months are evenly divided between independents and chain operations.

Fortunately daily coffee consumption has remained constant in 2009 according to researchers. Americans may drink more coffee at home and they may have traded down from the most expensive offerings but “consumers still see coffee as an integral part of their everyday life,” says Robert F. Nelson, president and CEO of the National Coffee Association.

The thousands of workers let go during this crisis take little solace in what economists call this segment’s fortunate “lack of elasticity.” Constant demand and fewer shops mean that the death of these businesses boosts revenue available to survivors. More significantly it demonstrates that reputation, resilience, ingenuity and sound financial underpinnings matter.

“To survive and even thrive in this environment, shop owners will re-learn the lessons of specialty coffee pioneers Alfred Peet and the early Starbucks and put serious effort into their bean sales,” observes SCAA General Counsel Marshall Fuss.

“One thing seems certain: the American coffee shop landscape will look very different in a few years,” he says.

The stories that follow document Darwinian evolution under the harshest circumstances. In this series the owners of long-standing shops large and small reflect on what led to their demise. They relate with courage and candor the painful lessons that caused them to abandon once-successful ventures, seek bankruptcy protection and pursue remedies in court. These folks aren’t failures. They poured all they had to give, understanding that if you've never failed, you've never really tried.

Koinonia Café -- Kingsford, Mich.

Owners: Liz Wheeler and spouse

Inspiration
As Liz Wheeler and her husband drove into the small town, Kingsford, Mich., which was to become their home, they noted the empty gravel lots where high school students loitered after dusk, hugging, smoking, playing football.

“My husband was a youth pastor; our hearts went out to the students with too much time on their hands and not enough supervision,” recounts Liz Wheeler. “In this blue-collar town, a lot of parents, many single, worked two or more jobs to pay the bills leaving the kids on their own. We felt compelled to start a coffeehouse that would cater to the youth, and pay for itself—like a non-profit, only without the grants.”

The Wheelers started by partnering with a local chef. After a few months of planning, a corporation was formed, and they applied for a loan guaranteed by the Small Business Administration. “To our amazement, we got it,” says Wheeler. “With $62,500 from the bank and another $12,500 from a revolving loan fund from town, we went to work.”

On opening day, Sept. 15, 2002, Koinonia Café greeted customers with a room for dining and conversation, and a second with two pool tables, a foosball table and two dartboards. A full kitchen serviced the breakfast and lunch menu, ranging in price from $1.25 for a muffin to about $6.99 for a full breakfast or $8.25 for a full lunch.

First Sign of Trouble
Wheeler says the first snag was hiring an electrician who dragged his heels. “After six weeks waiting for the work to be completed, we fired him,” she says. “We were running out of working capital and needed to open in two weeks. So we hired someone a lot more expensive. Our budget for electrical was $1,500. We paid the second company almost $15,000.”

Koinonia Café was only open a few hours on opening day to get friends in and practice. In hindsight, Wheeler admits her staff wasn’t trained nearly as well as they should have been.  “After a story about us broke in the local paper, we were overwhelmed with business. People’s first experience in our store was waiting 20 minutes to get a smoothie,” she says. Even so, sales for those first two weeks topped $9,000. “We needed $15,000 a month to break even. We had high overhead with our lease ($1,890 per month plus about $333 for property taxes we agreed to pay). We also planned on myself and the chef taking paychecks.” 

On Mondays, Wheeler says she would “count up $2,200 from just Friday and Saturday.” That didn’t last long. Immature staff members became more interested in friends and significant others than customers. Many couldn’t self-govern and actually do the closing well. And many of them weren’t comfortable asserting authority over other kids their age.  Looking back, Wheeler says moms were her best employees because they already knew how to multitask. “They saw something that needed to be cleaned and cleaned it and they weren’t timid to call out misbehavior,” she says.

Fatal Flaw
When the nearby cheerleaders began changing from their uniforms into street clothes in the middle of the game room, not one person called them on it. When abrasive kids caused trouble, the staff didn’t ask them to leave or escort them from the property. In time, a majority of the students migrated back to gravel lots, parties and friends’ houses instead of coming to the shop where they knew trouble was brewing. Four years into the business, Wheeler moved to Chicago to be with her husband who was attending graduate school there. So, from 2006 to 2008, the Wheelers were absentee owners and went through three managers. “It sounds cliché, but how many typical mistakes can you make?” she asks. “We made them all. We had lost our focus and were unable to correct the problem and let students know.”

In total, the Wheelers limped along six years, continually getting further in debt. “We tended to not pay Uncle Sam withholding and didn’t separate our sales tax money from our regular checking account,” says Wheeler.  “As a result, the money we owed our state would be gone by the time it came to pay. The penalty is 25 percent of what is owed: stiff so people don’t slight them. We did it anyway.”

When it came to playing music and featuring bands, Wheeler tried to be ethical, but says, “Getting three licenses from ASCAP, BMI and SESAC was more than $2,000 a year. So we stopped the live music and just played the radio. Our original intent—building community and establishing a safe and fun haven—was whittled down. “

Aftermath
Koinonia Café closed on Dec. 24, 2008, under the owners’ own volition, but Wheeler says she’s not sure how much longer the government or the bank would have let them go on. “Although we were incorporated, trust taxes like sales tax and withholding don’t go away even if we had decided to go personal bankruptcy,” she says. “We turned the equipment over to the bank, paid off our smaller creditors, and are now working to do an ‘Offer in Compromise’ with the Internal Revenue Service. We’ll be paying for this education for a very long time.”

FACTS

Location: Kingsford/Iron Mountain, Mich., in the Upper Peninsula

Shop: 2,378 square feet in two units of a four-unit strip mall

Seating: 125 (fire code seating number)

Initial investment: $75,000 (bank and town loans) plus another $25,000 to cover electrical and other unexpected start-up expenses

Lease: $1,890 per month plus landlord’s property taxes, which, in 2008, were about $4,400

Staff: one full-time manager, one full-time chef (part owner), up to 13 part-time staff

Bluehouse -- Baltimore, Md.

Owners: Rob Hartmann and David Buscher

By Amy Reinink

The coffee shop inside Baltimore’s Bluehouse furniture and home decorating store aimed to breathe vitality into the business, luring foot traffic and creating a comfortable vibe for shoppers.

Three years later, the café, also named Bluehouse, had done just that. Neighborhood residents, medical students at Johns Hopkins University and professionals from nearby offices made the café—a converted warehouse with high ceilings and exposed-brick walls—their second home, lingering for hours with lattes and laptops. But even as the café thrived, a series of unfortunate events were leading toward its demise.

First Signs of Trouble

In early 2008, Bluehouse owners Rob Hartmann and David Buscher decided to open a second Baltimore Bluehouse store. By the time the store opened that fall, the economy had headed south, and Hartmann says it was immediately clear that one of the two locations would have to go.

Hartmann says the high rent at the original location in Baltimore’s Harbor East neighborhood made it the natural choice, café notwithstanding. The store closed Feb. 13, and the café closed with it. “It was sort of a paradox, because the coffee shop was actually doing really well,” Hartmann says. “We really hated to close it.”

Manager Amy LaPerle says inspiration for the coffee shop came from the furniture store’s clean, modern design, and says she strived to serve the best organic, Fair Trade coffee she could find. LaPerle says she also worked to create the coveted “third space,” a place where customers could relax in a setting that wasn’t work or home.

“I still run into old customers who say, ‘We haven’t gone anywhere else since you closed,’” LaPerle says.  

Fatal Flaw

Though the coffee shop’s demise was tied to the unique circumstances surrounding the furniture stores, Hartmann says he, Buscher and LaPerle learned a myriad of lessons from the experience. While the shop enjoyed a stable flow of regular customers, the up-and-coming Harbor East neighborhood lacked the foot traffic to net lucrative to-go business. Also, Hartmann says, the café didn’t have much room for food preparation, leaving the shop dependent upon outside sources for sandwiches and baked goods.

“The profit margins there were so, so, so slim,” Hartmann says. “Two unsold sandwiches could start to put a dent in the thing.”

Aftermath

Hartmann says the same group will apply those lessons and others to a coffee shop they hope to open elsewhere in Baltimore under a new name later this year. The new shop will have plenty of space for in-house food preparation and also for community events, like the tango class Bluehouse started to host before it closed. The new shop will also be employee-owned, meaning “people’s time will go toward being vested in a partnership,” Hartmann says.

LaPerle says closing the first store was heart-wrenching. Still, she says the group is looking forward to a fresh start. “I don’t think any of us walked away without some sense of relief,” she says.

FACTS

Location: 1407 Fleet St., Harbor East, Baltimore, Md. 21231
Shop: 7,000 square feet (1,500 cafe; 5,500 retail)
Seating: 30 to 35
Lease: $11,000 per month
Staff: Amy LaPerle  manager; 3 full-time; up to 5 part-time staff

Antigua Cultural Coffeehouse -- El Sereno, Calif.

Owners: Yancy Quiñones and Cuauhtli Roura-Villegas

By Mina Williams 

Fostering social consciousness and artistic creativity is a corner stone for coffeehouses across the country. However one business, located east of Los Angeles in a not-so-tony neighborhood, found that good intentions and brisk business alone will not keep an operation serving its community.

It was here in blue-collar El Sereno, between Los Angeles and the San Gabriel Valley, that Yancy Quiñones and his business partner Cuauhtli Roura-Villegas opened Antigua Cultural Coffeehouse. The recently graduated duo from California State Los Angeles wanted to create a community gathering place for activities and artists, students and writers. The gateway into the coffeehouse business was Quiñones’ own coffee roasting operation, featuring beans originating from his family’s Guatemalan farm.

First Sign of Trouble

They honed in on a virtually abandoned store front along El Sereno’s main drag and opened their coffee shop. “It was a horrible location,” recalls Quiñones. “In the middle of the block, there was no parking.”

Serving coffee drinks, soups, salads and sandwiches plus bulk beans, the shop opened early to catch commuters and stayed open past midnight in this hardscrabble area hemmed in by the railroad tracks and two freeways. The coffeehouse immediately began giving artists an outlet, writers a forum and young people a place to hang-out in a neighborhood where most businesses buttoned up by 8 p.m. The free Wi-Fi service became a hit with local Cal State students. Weekend live entertainment and film screenings at the café urged upscale Westside residents to venture into the homey barrio. “We were able to bring positive change to the neighborhood,” claims Quiñones.

Fatal Flaw

What came next was the inevitable, gentrification eked into El Sereno. Dry cleaners and a library came to the low-brow area dotted with small markets and medical clinics. Construction was initiated on a two-story commercial building. Three years after Antigua Cultural Coffeehouse opened, the lease expired and Quiñones and Roura-Villegas found themselves up against a rent increase that they could not swallow. Unable to find an affordable replacement location in the same strip, they closed their neighborhood oasis.

A year later and out on his own, Quiñones is in the process of re-opening Antigua Cultural Coffeehouse in nearby Cypress Park, a semi-neglected area just north of the 110 freeway from El Sereno.

Another window opened for Quiñones with his alma mater. Cal State LA Federal Credit Union executives, aware of his situation in El Sereno, have suggested he install a coffeehouse outpost in a building the bank will be opening. Plans are to create a community lounge where artistic creativity will be showcased. He is also working with the university to barter coffee for tutoring. 

Aftermath

The hard lesson of a changing world has made Quiñones a savvy businessman. In seeking the new Cypress Park location he opted for a corner location on a busy street that serves as an entrance to Dodger Stadium and national retailers including Home Depot. He also negotiated a five-year lease with an option for first priority to renew the lease.

“To develop a strong community base of support a coffeehouse owner must look to the customers as part of your family,” he explains. “You have to create a space as if it were your customers second home and get to know them so that they feel comfortable. The days of ‘build it and they will come’ are over. You have to build the coffeehouse and then go get your customers.”

Keeping with his dedication to community, the first action he took with the new location was to remove the security bars on the store’s windows. “I want to let the community see the change,” he says.

FACTS

Location: 4836 Huntington Dr., Los Angeles

Shop: 1,250 square feet

Seating: 60

Initial investment: $70,000

Lease: Triple net lease, three years $3,100 a month

Staff: 6 to 8

Coffee Beanery -- Annapolis, Md.

Owners of franchise: Deborah Williams and Richard Welshans

When Annapolis, Md., couple Deborah Williams and Richard Welshans invested more than $1 million in 2004 in the startup their Coffee Beanery franchise, they had no idea the costly legal battles they would soon be waging.

In 2003 when Williams and Welshans were scouting for a coffee business, they were looking for a small, franchised coffee bar concept, since neither had related experience. After traveling to Coffee Beanery headquarters in Flushing, Mich., they got talked into Coffee Beanery’s new “café store” concept offering a menu of sandwiches, salads and pastries in addition to selling coffee-related products. This café store model was a full-scale operation, requiring lots of food prep, equipment and capital … and was already failing for existing café store franchisees. 

First Signs of Trouble  

What happens next is well-documented in a fascinating expose appearing in Mother Jones' March-April 2009 issue: “The couple hadn’t fully appreciated that Coffee Beanery, like many franchise operators, makes money selling franchises and gear, not coffee. They started getting bills far in excess of what they believed they’d signed up for. There was surveillance equipment, a music system, an obsolete, $14,000 lighting system. The ice machine the company sent was big enough to supply several restaurants, Williams says. Then there was the faulty $8,000 pastry display case, and a cash register so buggy that it sometimes forced them to close for days. In Coffee Beanery’s initial documentation, Welshans and Williams allege, it also failed to disclose a gift-card program and a Pepsi® contract that were later imposed.”

In the same story, Williams admits, “We were losing money hand over fist.” If the couple refused any of the required purchases or fees, the company could have sued them for franchise violation.

Fatal Flaw

After encountering problems with the company-designed layout of the store, the requisite cash register system, the mandatory advertising program plus other certain pieces required in the equipment package, Williams and Welshans discovered something else. Buried deep within their franchise agreement was a clause that all disputes would be settled by “Binding Mandatory Arbitration” a non-judicial but legally binding process that robs individuals of their Seventh Amendment right to settle disputes in a court of law. It was a clause that would come back to haunt them.

In September 2006, the Maryland Attorney General found that the Coffee Beanery had violated the state’s franchise law by “making material misrepresentations” regarding its franchise offering. It was little satisfaction for the couple, whose franchise floundered due to the company’s misrepresentations. Williams and Welshans next turned to recoup operating loses, lost wages and other damages they’d suffered because of the Coffee Beanery’s misrepresentations. However, they were denied their right to bring suit in the Maryland court before a jury of peers. Instead, because of the binding mandatory arbitration clause, they were required to travel to Michigan to have their case heard by an arbitrator chosen by the Coffee Beanery. Small wonder what happened next: not only did they not win the case, but they spent more than $100,000 in arbitration costs and were ordered to pay the Coffee Beanery $150,000. The judgment has sent the couple into bankruptcy and the franchise has been shuttered.

Aftermath

Pushing the envelope, Williams and Welshans sought to reverse the arbitrator’s decision in Federal Court. The three judge panel agreed that the arbitrator had shown “disregard of the law,” and that the Coffee Beanery had violated Maryland’s Franchise Registration and Disclosure Law. Still the legal battle continues. Williams and Welshans are now embroiled in an appeals case. Due to their most recent court battle and at the recommendation of their attorney, Harry F. Rifkin, Cohan, West, Rifkin & Cohen, P.C., refused to offer their comment for this story. Rifkin has stated that it is his clients’ intent to pursue their case to a jury trial. “We believe that we will be able to obtain a substantial judgment, and that after we get the pending case reopened we can move for summary judgment on liability and get a jury trial on damages.”

It is too easy to say, in hindsight, that deeper due diligence might have saved Williams and Welshans from financial ruin. Perhaps hiring an accountant and a franchise lawyer, as opposed to a contract attorney, might have spared them from even becoming entangled with the Coffee Beanery. However no due diligence could have spared the couple from being duped into buying a failed business concept implying earnings claims of $125,000 per year with unwritten strings attached. When the couple sought to recoup losses created by hidden fees and the knowledge of undisclosed café failures they were forced, by their franchise agreement’s arbitration clause, to give up their rights to sue and agree to seek resolution through arbitration not the courts.

Their story is not so unique. With only 15 states having franchisee-protection laws on the books, Congress is considering a ban on arbitration clauses in employment, franchise and medical contracts. Part of this legislation reads, “Mandatory Arbitration is a poor system for protecting civil rights and consumer rights because it is not transparent.” As would be expected, the International Franchise Association has spent more than $2 million since 2005 lobbying lawmakers in Washington, D.C.

“We didn’t know about the 73 failed Coffee Beanery franchisees,” Williams told the House Judiciary Committee’s subcommittee of Commercial and Administrative Law in 2007. “The average café lifespan is only three years, with an average $375,000 investment. I am 54, bankrupt and on the verge of being homeless, all because of a binding mandatory arbitration clause." 

Franchising certainly has its benefits, however neophytes are not best poised to judge a business model before handing over their nest egg. During these downsizing days it is all too common for people to seek putting severance packages to work as the springboard into self employment. Buyer beware. Fraud is running rampant, claims Texas franchise lawyer Richard Solomon. 

FACT S

Location: Annapolis, Md.

Shop: office park

Seating: count N/A

Initial investment: $90,000 owner investment, $300,000 SBA loan, plus $40,000 home equity loan

Lease: N/A

Staff: 8 to 14 

Coffee Beanery*

Location:  Flushing, Mich.

Total Capital Investment:  $68,375 - $545,000

Cash Required:  $150,000

Net Worth:  $500,000

Franchise Fee:  $27,500

Marketing Fund Contribution:  2 percent gross sales

Royalty Contribution:  6% paid weekly

Start up cost:  $125,000 - $150,000

Total investment:  $338,500 - $501,500

* figures claimed by company in franchise prospectus and through business brokers

U.S. Franchises**

2006    137

2007    120

2008    88

** Entrepreneur.com

Wired @ The Copper Cup -- Stratton Mountain, Vt.

Owners: Amy & Wayne Herman

By Amanda Baltazar

Tradition has ended for Wired @ The Copper Cup, a shop that unduly depended on seasonal business cycles to stay afloat.

Located in the Village at Stratton Mountain Resort in southern Vermont, this three-year-old coffee shop shut its doors in April 2009 when the seasonal trends it was relying on for its business were disrupted.

Amy and Wayne Herman opened Wired @ The Copper Cup in January 2006. Both had worked at the resort for several years during which they constantly heard clients longing for a good cup of coffee and Internet access.

Winter business was always strong but the warm months had something to offer as well.

First sign of trouble

Unfortunately summer activities at the resort dwindled due to shrinking finances, and naturally, so did the number of guests. In previous years the Hermans made enough in the winter to tide them through the summer months, but business slid so much last summer they decided it might no longer be possible to continue.

A big problem, explained Amy Herman, was the lease, which mandated that the shop remain open seven days a week, year-round. The second problem was the rent that remained the same every month, irrespective of the reduced summer traffic.

But of course it’s not just the lease; the recession meant resort regulars were visiting less or not at all; and those who came were cutting back.

“People were downsizing their latte or just getting a drip coffee; they were finding ways to pinch pennies,” Wayne says.

Fatal Flaw

Was there anything the Hermans could have done? “The mistake was that we didn’t do much advertising because we didn’t have the budget,” he says. Instead, they relied on the resort to do their marketing.

“Perhaps we didn’t advertise enough but we obviously don’t have the pull to draw hordes of people up the mountain,” he says. “But we should maybe have advertised to the people who were already there.”

What the Hermans did instead was rely on their relationships at the resort. The could always count on the people who ran the information desk to send them customers.

The resort’s summer schedule wasn’t much help. Wayne says they should have paid more attention to the dwindling number of activities. “I hate to point a finger to the mountain itself but in the three summer months it has almost nothing going on,” he says.

The business had insufficient cash reserves going in, Amy says. “One of the major lessons we’ve learned is that if you think you have enough startup capital, you should probably double or triple it, no matter how well you think you’ve budgeted because things come up and there are so many unforeseeables,” she says.

Aftermath

The rule of thumb is to have money sitting in a savings account so you can weather storms like that, she adds, but the Hermans were not in that position.

They did try to conserve some money by not hiring more winter employees and putting in extra hours themselves “because any additional payroll expenses we’d preferred to have in the bank,” she says.

But the big lesson, she says, is to steer clear of seasonal businesses. “Unless you are an established business with an income to fall back on and the pieces will fall into place,” she says. 

FACTS

Location: Stratton Mountain Resort, Stratton, Vt.

Shop: Just under 1,000 square feet, including a small outdoor patio

Seating: 23

Initial investment: $15,000 loan, plus another $20,000 in owner investments

Lease: $2,500 per month, plus a portion of the community oil bill, usually around $100 (regardless of what we actually use)

Staff: One full-time (Wayne) one three-quarter time (Amy), one part-time (winter only) weekend help