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Free market economics assumes that there will be tough people doing tough
things. It assumes that these will include crooks who will do anything to
separate folks from their money, regardless of the theoretical consequences. It
also assumes that markets can only remain free if there is a minimalist approach
to government interference. It is axiomatic to free markets that they govern
best who govern least.
It is for that reason that there are rules so organized that government can step
in when things get really way out of hand, but restrain the governing hand where
there are adequate resources for people operating in the market to take
effective steps to protect their own interests.
In the context of franchising, it has been necessary that regulations be created
not only to prohibit dishonesty, but to affirmatively require certain protocols
of disclosure to be observed in order to lessen fraud. As an adjunct to the
regulations themselves, agencies were empowered to take enforcement action in
instances where non compliance is sufficiently pervasive to require government
intervention to deal with widespread risk of criminal or hard core civil
wrongdoing. This regimen has been established in overlapping jurisdictional
configuration with cumulative responsibility at federal and state levels.
It has always been the case that the main enforcement of these regulations was
to be private action. Government action was always intended to be reserved for
situations where private action was incapable of dealing with active threats.
Accordingly, appropriations were never made available for pervasive government
enforcement. Whenever you see the availability of a private right of action, the
intention is that the private right to take action is intended to be the
mechanism to deal with all problems that may arise in that business.
In franchising, it was never intended or contemplated that people should rely
upon government enforcement to protect their private interests. In addition to
the regulations themselves, there remained available all the common law and
other statutory remedies that were designed to facilitate addressing the
grievances at issue.
Self defense was and is intended to take three forms. The first is, of course,
that you cannot simply take what sellers of business investment opportunities
say without thorough investigation. Individual small business investment is
unlike investing in securities in that the buyer will actually be operating the
business rather than relying upon others to operate the business as in the
instance of securities. That puts the buyer up close and personal with the hands
on day to day realities of managing the risks.
This first line of defense has been the most lacking in quality up until now.
Franchise buyers do not know how to vet franchise offerings, and no one in the
legal or accounting professions knew a lot about how to go about that either.
Consequently, potential franchise investors would go to business lawyers who
could do no more than explain what the franchise contract said and who are
unable to opine regarding the degree of business risk. When asked if they think
a proposition is a good investment, the only competent answer that any lawyer or
accountant could give has been that it could be a good investment if what the
sellers are telling you is true. The techniques to ascertain whether what is
being said to the prospect is true remained arcane until now.
Now there are some, but not many, who can do due diligence on franchise
investments that is at a very high level of quality. It still isn’t perfect and
it never will be fool proof, because the mind of the crook is ever fertile. But
so many more risk management questions can now be answered effectively that
there is less and less of an excuse for an investor not availing himself of this
resource.
The cost of this assistance is higher than the small fee for just reading
contracts. Instead of a few hundred dollars, the investor must now plan for
upwards of $ 3,000 to $ 5,000 for effective franchise due diligence. On the
other hand, if you are going to risk anywhere from $ 250,000 to over $
1,000,000, including loan and lease liability in addition to the initial cash
outlay, assumption of that risk calls for the higher quality of due diligence
assistance. Between the sheer size of the financial risk and the risks inherent
in very unfavorable contract terms, failure to budget for adequate due diligence
could now be said to represent negligence on the part of the franchise investor.
Simply put, if you go off the high dive without assuring that there is enough
water in the pool, it’s your own fault if you break your neck by hitting the
bottom of the pool.
Post closing risk management can also be facilitated by franchisees having the
temerity to form an effective franchisee association early on. It is possible to
observe direct relationships between the profit potential of a franchise system
for the franchisees according to whether the franchisees are competently
defending their own turf. Many times, collective self defense can overcome the
terms of the contract, as in the case of purchasing management. There is no
buying power benefit for a franchisee unless the franchisees control purchasing.
Where that is not done, it is the franchisor who gets the benefit of the
collective franchisee buying power. With a strong franchisee association,
expensive modifications to “new look” store appearance and other similarly large
capital outlays get sorted out before the franchisees have to undertake the
cost. Without strong franchisee association influence, “new look” capital
expenditures can be and are mandated without any sorting out operationally of
whether the modification/upgrade has any potential to improve sales and profits,
and new looks get abandoned/changed without prior proper market testing by the
franchisor. Renewal terms and new contract terms are also matters that can be
influenced by a strong franchisee association.
There are so many benefits to a strong franchisee association being established
and competently managed that one could reasonably posit that failure to do so
constitutes franchisee negligence. They simply shot themselves in the foot and
are nothing more than a group of cowardly, cheapskate whiners who get what
whiners always get.
The third leg of franchisee self defense is litigation. Litigation, however, is
too expensive and risky. It is the worst possible way to resolve business
issues. But it is available when all else has failed.
The important point is that formal dispute resolution in court or arbitration is
far less likely to be necessary if the franchisees have done what they should do
in the first two categories of self protection, due diligence and group action.
There has been a great deal of pain in franchising because of the failure to
address the heart of the problems of the franchising industry. It is now no
longer acceptable to throw yourself into a meat grinder in order to invest in a
franchised business relationship. Accordingly, if you do throw yourself into a
meat grinder, you will simply be out of luck. The system of market regulation is
not going to change to accommodate those who will not help themselves. A perfect
example of that is the impotent whining for rules of “good faith and fair
dealing” that has been heard in the halls of Congress for so many years.
Franchisees have been told that they now have what they need to survive in the
world of franchising. If they fail to avail themselves of the proper resources
that are there for them, they will simply suffer dire consequences.
Copyright 1997 - 2008 || Richard A. Solomon
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