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Licensing, Technology Transfers,
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This is a follow on article that relates to a tutorial I presented in 1998 entitled "Why New Franchisors Fail" . Things have not improved, but the documentation of the transactions has tried to move some of the risk of failure onto the failed franchisee when the damage has been done. The government will not come to their aid. They are left at start over, frequently past age 40 when they are less employable and besmirched their resumes with the franchise business failure and the ensuing bankruptcy. The sad track record of 69% of the franchisors listed in Entrepreneur Magazine's Franchise 500 in 1987 no longer being in existence in 1992, usually taking the fruits of the investments by their franchisees with them to the entrepreneurial grave, according to the American Association of Franchisees and Dealers, has probably not abated.
No business attorney would ever advise a successful business owner to become a franchisor without placing the franchising operations into a separate entity, looking to protect the heretofore successfully achieved state of wealth from the high risk associated with the decision to try to franchise that business. Hedging that risk is the contract language calculated to leave the victimized franchisees without resources to enable redress should the venture go bust.
Perusal of any industry trade journal that is addressed to small businesses, like the Nations Restaurant News, for example, will show that there are always adverts by "franchise consultants" offering to show you how to franchise your business. The nature of that business is such that one eats only what one kills. Accordingly, there is practically never a negative or conditional response to the question "Can my business be franchised successfully?" To such people all businesses can be franchised, and if it doesn't work out, why that's the owner's failure to execute the plan, and certainly not the product of the decision having been encouraged by a charlatan.
One comes to the inescapable conclusion that new franchisors don't do competent due diligence any more than their franchisees when the decision to franchise their businesses is made. What then is the financial result difference between being a failed new franchisor and the franchisee of such a company? The answer is that the franchisor at least has better asset protection protocols in place. While that new franchisor may not have succeeded, at least what was achieved prior to franchising has a higher likelihood of still being intact. The exception is that poor chap who has made the terrible mistake of having one or more of its franchisee victims find a way to get competent representation by counsel despite the franchise failure. As there is personal liability by the principals of a franchise company if fraud or material misrepresentation can be shown, the asset protection protocols do not always work to insulate against the consequences of what has been done. Inasmuch as the owner of the franchisor company is listed in the UFOC roster of responsible persons, it is not practicable to evade the exposure.
And it's not for want of trying that the exposure lingers on. Franchisor counsel place non-reliance clauses in agreements to reinforce merger clauses, plus acknowledgements that no representations have been made that are not included in the UFOC and its exhibits. Franchisees still sign these agreements, some not realizing that they have been lied to. The intended result of this construct is that the franchisor is to be given a license to lie. In many/most instances, at the time the agreements are signed, it is not possible for many representations to be recognized as false. The obviousness of falsity cannot always be recognized until after the fact.
Many courts now have before them the question of whether these contract clauses will be allowed to become a charter to exonerate what in reality is patent fraud in the inducement. Thankfully, most courts still hold to the traditional law that fraud and misrepresentation trump merger clauses and their companion contract provisions. A lawyer who omits such clauses in the documentation would be exposed to malpractice liability, for those clauses are standard practice in the preparation of franchise documents. People thinking of franchising their businesses do not think of themselves as dishonest. By and large, that would/should be a reliable assumption. Where things go awry is in their entrusting the franchise sales materials preparation and the presentation of the sales process to people who are not as forthright as they are. The result is that they are painted with the same brush.
What mesmerized prospective franchisors see is only a string of "success" stories told by the "Consultants". What the lawyers provide is an apparent shield from legal risk - not always reliable. In the event of disaster, "Consultants" are usually not collectible. Consulting is not a capital intensive business. A rented office and a few thousand dollars worth of office furniture and equipment is all it takes. Suing the charlatan consultant is not likely to have much prospect for effective redress. Just as the government won't go after the fraudulent franchisor, there will be no community resources available to deal with the charlatan consultant. Only competent due diligence on the consultant and its proposal to assist you to franchise your business will suffice here to stem this tide of failures. Just as no where is there training to do competent due diligence on new franchise offerings, there is none available to enable attorneys representing prospective new franchisors to assist in competent due diligence on the consultant and the proposal to franchise.
If you are a prospective franchisor, you are your own last resort in avoiding a franchising disaster for you and your prospective franchisees. What I can absolutely promise you is that if franchising does not succeed for you, you will endure a living hell of relationship failure, and you will pour enormous resources, financial and personal, into the experience. You never thought of yourself as a crook. But you will be vilified as a crook. And when all is said and done, you will appear to be a crook. You will absolutely wish that you had never been gulled into franchising your business. You will, though you will not admit it, have to deal with having been ripped of, and appearing to yourself to have been a stupid person despite a pre - franchising history of solid and honest success.
How does one go about effective due diligence on the advice from a franchise consultant that you should definitely franchise your business and retain that person/company to show you how to do it? This article is intended to provide you with some insight into how to get that done.
There are a few obvious alarm bells. If what you intend to franchise is essentially a scheme to have people buy what would in normal circumstances be no more than a menial job, you are not being reasonable in your assumptions that this is a vehicle to success. Yet today you will find people offering and, sadly investing in, proposals to use their name to identify a small business that provides the service of mowing and/or fertilizing residential lawns. Anyone who can't get people to hire them to mow their lawn/maintain their yard without investing in a franchise in which they pay thousands in initial fees; obligate themselves in addition to pay periodic royalties for five to ten years; agree that if they leave the franchise system they will abstain from the lawn mowing business for two years in the entire county (or worse) where they had their "business"; and pay liquidated damages to their franchisor for the "irreparable harm" they caused to the franchisor's business and reputation by their failure to succeed, is simply an idiot - even if he had theretofore been a financial manager in a publicly held large corporation where he made over $ 50,000 a year base compensation. The exact same thing may be said of those who buy franchises in which the business is that of getting people to hire you to clean out their garage. And there is even my Bozo Of The Year franchise in which the business of the franchise is that you are supposed to get people to hire you to clean the dog/cat poop off their lawns. If you are looking for people that stupid to invest in your business proposition, then, my friend, you deserve everything that will happen to you. Sheep were made to be sheared, right?
A sure sign of a crooked franchise consultant is the person who tells you that you don't have to invest in compliance with laws regulating franchise sales if you just call what you are selling by another name than a franchise. You can, so they say, call it a license, a joint venture, a limited partnership, and hocus pocus save yourself tons of money by not having to prepare disclosure documents and register the offering in states that require franchise registration and, in many instances, require that initial fees be placed in escrow until the franchisee will sign off on an affidavit that he has received all the franchisor assistance that he was promised to get him up and running in his new business. Some of these bozos will tell you that you have a free bites opportunity - sell your first several franchises in one state only and if they succeed, you can convert to a franchise after that. If your lawyer doesn't know that these ploys are per se unlawful, you need to get better legal help.
There are some crooked consultants who tell you that they have franchise lawyers on retainer who will prepare all your deal documentation, and include that work in the retainer. If you allow yourself to be dealt with in this manner, you will be fleeced. The lawyers who work for these crooks are bottom of the barrel starvelings who will write anything - no matter what - for a few dollars. They have law degrees and law licenses, but they are worthless. You have to have your own counsel who knows how this works to tell you what is and is not proper.
You have to do more in checking of references than just calling people whose names they give you and asking if they think the consultant is OK. First of all, the consultant is only going to give you names of people who he knows will say good things about him. And even those people need to be looked at closely to see how their franchise systems have performed. And that is more than just getting a copy of their blurbs, publications and disclosure statements for review. If you really have guts, you will insist that the consultant you are considering provide to you in writing the identities of every franchise deal he represented in the last five years in a letter that specifically states that the list is complete and accurate. You will then assume that he is still not telling the whole truth, and have to dig deeper after you have vetted those on the list. You have to go to outside resources - beyond what the consultant is providing. That is what you would do if you were thinking of investing in any other business proposition, unless you are incompetent.
You then need to obtain the marketing/sales brochures and UFOC disclosure materials of the franchisors the consultant has represented in the last five years and vet those materials. You will notice that they are extremely similar from company to company, no matter what the business of any of those franchise systems may have been. That tells you that you are only getting a cut and paste job, not anything that involves original or creative thinking about the franchise system you are thinking of creating. To be sure, there are great similarities in franchise deals, as well as in the legal work that pertains to them. But if you look at the things said about these other businesses that you would not have thought to be applicable to what your business is about, you will start to see some light in that long dark tunnel.
Then you have to pretext that you are a person looking to buy one of those franchises, and do a proper job of due diligence on a few of those deals. How to go about doing that is discussed in the Franchise Fraud Symposium Tutorials that you can access on this web site. While you are vetting what is said in the marketing and sales brochures of the consultant's other franchisor clients, start asking yourself whether you could truthfully say these things about what you will be bringing to folks who might be investing in your franchise - and remember that although you may intend eventually to be able to provide the stated benefits, you may not be able to provide them to your first few dozen franchisees. Later is not the same as now. Do you begin to get a sense that if you use this consultant, the truth about your franchise offering is probably going to be stretched very thin, and maybe even beyond bursting? Would you want everything you own in the world to have to ride on the quality of this kind of representation? Would you want the responsibility of having others rely to their detriment upon mischaracterizations that will be attributed to you even if made by your franchise selling facility?
Remember that the greater the stretch between what is said and reality, the more likely it is that the franchisees will fail. Pretext yourself to be a prospect of franchisors represented by this consultant in the past, and experience what their sales facility is telling prospects about the benefits of being a franchisee in that system. Then go talk to their franchisees and ask about the extent to which what was told them was unreliable and whether they would invest in that franchise again knowing what they know now. Don't go to franchisees recommended to you. Go to a random sample from the list of all franchisee that is required to be included in the disclosure package. Go also to the former franchisees who were involved in lawsuits and arbitrations in which they claimed they were lied to. Those disputes are also required to be disclosed.
This is only the part of due diligence that consists of scoping materials provided by the consultant and his franchisor clients. There is also a wealth of important information that is not included in that body of data, and that extraneous information is even more insightful than the "packaged" information. Due diligence includes scoping out that information and evaluating its impact on deal quality. Your lawyer and financial advisor need to be able to guide you through that exercise.
There is much more to considering whether to franchise your business than what you are told by the franchise consultants. The list is extremely long. Just a few items ought to show you where this is going.
Are these deals describing what they offer as unique or different even though hundreds of other brands have proliferated over the time since they started (or maybe even a long time before they started), and the products/services are everywhere available. If you are coming late to the franchising of this product/service group, just what is it that would cause anyone to buy from you rather than the many others, many of whom are independents who don't have to cover the carrying costs of a franchise relationship; and doesn't that give the competitors a lot of room to compete in price points with profit room to spare compared to anyone who might invest in your franchise. Just the ability to buy ingredients/inventory anywhere they choose would make a big operating cost difference compared to your franchisees having to buy from you or your designated vendors. Those vendors will pay you for making your franchisees buy from them, and that cost gets passed along to the franchisees in the form of higher than competitive prices. When a lot of your franchisees' competitors aren't saddled with that burden, how can you truthfully tell them in your selling materials that you bring them the benefits of group buying power? Every new franchisor says that in its sales/marketing brochure. Every consultant puts that in the brochure no matter what. It's almost never true. Where the business model is in its life cycle is a good indicator of your likelihood of success. You may make a bloody fortune operating your own stores that you are an expert at running. No one just coming into the business is going to match your performance with just the training that goes on in any normal franchise setting. And they have to cover franchise carrying costs on top of the cost of their inexperience. What can you really deliver? What are these companies you are looking at delivering - ask their franchisees and you will get a better feeling of how much they have been given stretched to the limit versions of the truth. Do you want to be in that kind of business?
I know - this is starting to sound preachy. OK But let's cut to the chase here. If you let some hyper glandular franchise consultant convince you to try to franchise a business model that isn't "ripe" for it, you will be amongst the almost eighty percent that fall apart and go bust. While some few do make a ton of money doing this, most don't. It's a long shot at best, and you don't want to put yourself through the agony of that kind of awful nightmare. Make the effort to doubt, challenge and investigate every statement and hypothesis. If you aren't equipped to do it, get some hyper cynical sonofabitch to do it for you. You'll spend a lot of time hating him, but he will probably save your ass. Good luck.
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