| Licensing, Technology Transfers, |
The twenty-first century is witnessing a wave of new franchise offerings. Over eighty-five percent of these offerings are transparently not viably franchisable. They are not franchisable because the fundamental requisites of franchisability are absent. It is a contest of smoke and mirrors, in which opportunists present a misdescribed business model that has the appearance of a real business opportunity to the uninitiated and frustrated jetsam of corporate America. But it is all appearance, lacking absolutely in substance. At another level, there are offerings that have the potential to be economically substantive, but that in the manner of their governance do not provide the potential franchisee investor with the realizations that the investor is promised. Indeed, the worst among them make promises/statements of supposed fact in marketing brochures and then carefully disclaim them in the required disclosure and in the franchise agreements themselves. Franchisees who cannot appreciate that someone who tells you something in the marketing brochure or in the sales process and then denies what was told in the required legal disclosures and in the contract is nothing more than a charlatan are the obvious prey, the ultimate chumps, born to be skinned alive and fed to their creditors in the process.
Part of the blame lies in the fact that potential franchisee investors, and most of the lawyers and financial advisors who represent them, have no idea how to 'read' the materials. The vetting of franchise materials does not, in the main, include sufficient insight into the substance of the offering to sort out what is true and what is untrue about the business. Seminars for franchise lawyers do not teach how to acid test franchise investment materials to discover 'the hook'. Continuing legal education seminars are politically correct panderings to franchisors, and anyone who suggested a really incisive program to school lawyers and financial advisors about how to spot the fraud masquerading as a real franchise investment opportunity would simply be excluded from any of these programs. Face it. There's not nearly as much money representing franchisee interests as there is representing franchisor interests. To be sure, there are franchisee associations, but all of them focus upon the problems after the agreements have been signed and the relationship is finally seen to be other than what it was described to be. No franchisee association or group of franchisee associations presents a curriculum to enable the defective offering to be spotted before the checks are written and the contracts are signed. Lawyers still look to whether the 'documents' reflect the appearance of what the statutes require, and have no powers of discernment to go beyond that. Accountancy has also not provided its practitioners with those insights. The Small Business Administration's resources are of no use whatsoever for this purpose. Their so-called fairness, fast track approval process never comes into contact with the fraud in the inducement issues.
The political reality is that the legal system is skewed to reliance upon 'private enforcement', the bringing of lawsuits by defrauded franchisees to redress the grievances. The economic reality is that these franchisees rarely have resources to seek redress of grievances when they finally come face to face with the reality that they have been fleeced. Contingent fee representation is not available now like it was twenty years ago. And so the dishonest franchisor gets to hide behind legalese so long as the fraud is so completely devastating to the franchisee victim that there is no ability to fight back. Franchise litigation is very expensive. Very few franchisees have the resources to wage that fight. The franchisor can settle with the few who can fight and continue to fleece those who can't.
Even the device of providing a list of existing franchisees to the potential franchise investor does not provide the intended protection. When abused franchisees get a call from someone who says he is thinking of buying one of these franchises and is calling to find out from people who already are franchisees how they are doing, their reactions go more to suspicion that the caller is an apparachik of the franchisor trying to identify trouble maker franchisees who need to be 'dealt with'. And when they aren't afraid of retaliation, their concerns go more to fear that not saying something positive might hurt their ability to sell their franchised business to someone else as the way out of the bad investment.
Very few groups of franchisees have the will to establish an effective franchisee association. Franchisors tell you they have a representative group, but it is usually either a small group of suck up franchisees hand picked by the franchisor for being worthless, or some no dues whiners club that will never accomplish anything. Those few franchisee groups that have seriously underwritten a well managed franchisee association that is for real have made a great difference in the quality of their lives. Maybe one day more groups of franchisees will come around to having that kind of gumption.
There are sufficient success stories of some lineage that keep getting repeated as though every new offering was another fabulous opportunity. 'We are the McDonalds of the widget industry' is the mantra. Nothing could be further from the truth. McDonalds was not the McDonalds to which the reference is made until they had experienced magnificent success. Newcomers cannot possibly be the McDonalds of anything. That is a categorical absolute. But people, including lawyers, can't even apply the simple logic requisite to see through so transparent a falsehood.
There are other patent falsehoods that should be as transparent. For example, there is no such thing as buying power that is a function of the purchasing clout of a few dozen stores. If you are only buying from other small businesses who will deal on price to get an order from a small group of stores, there could be some truth about buying power. But in the main you are buying from large vendor companies who are selling to many large group customers and who have established pricing systems that address sales volume per delivery to one location. There is some 'give' in situations where major customers are being courted by another major company vendor, but that is rare and that is not the situation with any small group of new company franchisees. There could possibly be some 'buying power' way off in the future if the franchise system you are looking at does succeed in becoming a powerhouse. But that is a very long shot and not relevant to your decision to buy this recently begun franchise. Franchise investors and their lawyers and accountants lack the insight to see this very obvious scenario for what it really is. Ultimately, if you have to buy from your franchisor or a vendor affiliated with your franchisor, it is the franchisor that is getting the benefit of the buying power of the group, not the franchisee. The franchise agreement never provides that there will be a pass through of favorable pricing to the franchisees. And the investor, his lawyers and accountants can't figure out that someone who sells you buying power and then has you contract away any buying power benefits is simply a crook.
Being associated with a national name or brand means nothing if the name and brand has not yet become truly established on a national basis. And it means very little, if anything, in a business that is primarily service based, unless interstate referrals throughout the franchise system is a major element of income generation, as in the case of real estate agency franchises. Furthermore, if the business is old and there are many names and brands out there, as in the case of any food franchise, the business has become overcrowded and price competition has become more of a factor than name recognition. Simple arithmetic will tell you that you would be better off to take a year and work in someone's similar business and learn it that way than to spend large initial franchise fees and commit yourself to ten or twenty years of a franchise relationship in which you have to pay a set royalty and advertising fee based upon gross sales while profits constantly decline. Its just arithmetic, but no one advising new franchise investors seems capable of doing analysis at that level.
Presentations to franchise investors are made in a format similar to what they worked with when they were in their former incarnation. The corporate report format and the business plan are usually fiction from start to finish, but nowadays everyone does it. The only thing that can be said truthfully about a business plan is that it will not tell you what will happen or even be a reliable predictor of that. There are too many dependent variables associated with market changes and the speed of market changes for anyone ever to be able to make a financial projection on a franchise being offered by a newer franchisor with few years of experience. All this exercise is fairy tale fantasy and not reality at any level. And the information that goes into the business plan always comes from the franchisor that has cherry picked positive facts that have absolutely no relevance to the viability of the franchise being purchased. For example, the facts that, according to the bureau of the census, billions of dollars are spent every year on home remodeling, and that you would be a participant in a multi billion dollar industry cannot possibly be positive indicators for the future prospects of your floor covering store or similar home remodeling business retail operation in your town. Even if the statement is true, it does not change the fact that thousands of small businesses in that industry go bankrupt every year. It's bloody nonsense.
New franchisors always tout site location assistance as part of the sales process. The reality is otherwise. The assistance consists of telling you to find a commercial real estate leasing agent and let that person tell you where to put your store. If you don't already know that is how to go about it, you aren't ready to be a business owner. You have never asked yourself what do people do who establish new businesses who don't have a franchisor's help in deciding where to put the store in the first place. The answer is that anyone with any snap at all simply goes to a commercial real estate agent for help. DUH! And when you read the contract that the franchisor hands you, you would see, if you weren't blind, that what the franchisor does is 'approve' a location that you have chosen, the selection of which is entirely your responsibility. This is, of course, always accompanied by a disclaimer that if store turns out to have been placed in a bozo location, tough luck. It's your risk entirely. Once again, when the sales pitch and marketing materials differ from the contract, no one seems to be awake enough to understand what that fact is telling you. When you have to agree that what was told to you was not told to you -- and that's what this really is -- you are dealing with a crook.
Earnings claims, the stuff of Item 19 of every UFOC disclosure document, are another area in which what is done is simply never understood by the franchise investor, his lawyers or his accountants. The claims that are made in Item 19 of the UFOC contain hedges in the footnotes. No one ever does the 'new math'. The new math is to redo the projections/pro formas taking into account the adjustments that are spelt out in the footnotes. When you do this, the results of operations in the Item 19 claims go south by a rather substantial percentage. And this is true for Item 19 information that is well prepared. Most Item 19 disclosures are poorly prepared or are simply outright lies. A constant location of misleading information is the working capital requirement. It is always understated, and very frequently by orders of magnitude. Even the most blatant falsehoods don't get spotted. Many Item 19 disclosures simply state that the franchisor does not make earnings claims and does not authorize earnings claims to be made in its sales process. BULLSHIT! In almost every case there are oral earnings claims, statements made to the franchise investor in meetings and on the phone about how much sales to expect; where you hit break even; how long it takes to hit break even. Often the franchise investor is steered to selected other franchisees who have done well to get the financial performance information from only the very luckiest in the system. In many cases there are meetings in motel conference rooms, staged by franchise sales people, brokers and sometimes even corporate officers of the franchisor. They don't make earnings claims, but they 'invite' an existing franchisee in to 'discuss his business'. And this franchisee makes the earnings claims in terms of his performance financially. That's an earnings claim too, and it's certainly not one that epitomizes the potential financial performance of the franchise opportunity being offered. It's just the top of the heap. Most often, the franchisee who is 'invited' to speak to you receives a commission on every new franchise that is sold to attendees at that meeting. Why don't the new prospects spot the scam here? What is the scam here? OK. Here it is. The scam is that someone who tells you in Item 19 that they do not make earnings claims, and then makes earnings claims by giving out financial performance information, by any means, directly or indirectly, has lied to you. DUH! Wake up!
The representations about the wonderful support that you can expect to receive as a franchisee are always overstatements. 'You are in business for yourself, but not by yourself' is the mantra. Read the bloody contract to see what you are really being promised. The contract always says -- in some form of legalistic sounding language -- that you get whatever support the franchisor feels like providing from time to time. That's it. There is never a contract covenant to provide competent and competitively effective support. But nobody ever figures this out before the franchise investment is made. It is always discovered after the fact, when it is too late and you have bought nothing but the right to sue, if you can afford to sue. Buying the right to sue is always a bad investment!
The list goes on and on. This article could be a book. The last item I will touch upon here is the franchise in which your expectation of payment is that you will be paid by a third party, but you won't be paid directly. Your franchisor will be paid, and then you have to depend upon your franchisor to pay you what you are entitled to receive. This occurs when vendors are expected to pay you commissions on what you sell for them and then they pay your franchisor, who is supposed to pay you -- after certain deductions that seem innocent enough when they are described in the contracts. It also occurs when your income goes into an account that your franchisor can draw from, a lock box account. In this scenario, the franchisor draws the money out of the account, does you a favor by handling certain 'administrative functions' and then crediting or remitting to you what you are 'entitled' to receive. FORGETABOUTIT! The truth is always that if you let anyone come between you and your revenue, you will be robbed. You never get an honest count. Trying to get even honest mistakes corrected is an ordeal that is never handled correctly. EVERY FRANCHISE THAT PUTS THE FRANCHISOR BETWEEN YOU AND YOUR MONEY IS A CROOKED FRANCHISE! You will always be robbed in any such relationship. But your lawyers and accountants can't seem to figure that out. Never buy a franchise in which others touch your money while it is on its way to you!
These are but a few, but very frequently occurring examples of the pitfalls of franchise opportunity vetting issues. There are many more.
Remember that you are about to sign an agreement that will cost you 40 % to 50 % of your potential net profit for a very long period of time, and that's just what you will have to pay to your franchisor for royalties and advert fund 'contributions'. The franchisor has other revenue stream expectations in this deal that you haven't even thought of yet, and that, if disclosed, have been artfully disclosed in language that does not inform you of the realities. The most important vetting exercise is really to find out how you can be in this business that you think you like without signing a franchise contract. If you can do that effectively, your return on investment over what would have been the franchise period will be at least double. And, no matter what they tell you, franchisees never have a better chance of success than independent, unaffiliated new business start-ups. The likelihood for success is exactly the same either way. That claim is based upon an old department of commerce 'study' that was utterly incompetent. Every study that has questioned that claim has found that it was false. Being someone's franchisee makes absolutely no difference whatsoever. There are usually many ways to obtain equivalent start-up and continuing support assistance without having to sign a franchise agreement. You just have to take the trouble to find out where they are.
Copyright 1997 - 2010 || Richard A. Solomon
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 | Licensing, Technology Transfers, |