| Licensing, Technology Transfers, |
This is a follow on article that relates to a
tutorial I presented here 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 very 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 very 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.
Copyright 1997 - 2008 || Richard A. Solomon
|| Site Map
||
||
 | Licensing, Technology Transfers, |