Five alerts about franchise fraud
For the new investor, not having to start a new business from scratch offers a significant advantage, both in the time required to earn a return and in the cost of the initial investment. Marketing costs are expected to be reduced. Of course, it is in the franchisor’s interest that quality franchisees succeed and the support offered by the franchisor is a measurable attraction. How does that investor reduce the risk of fraud in the due diligence process?
The relationship of the franchisee investor with the franchisor will be and must be continuous. As with any contractual arrangement, it goes without saying that both parties to the contract must abide by it. Disputes arise in the best of relationships and some can lead to litigation brought by either party on the basis of fraud. Here are five key areas where the potential for fraud may exist to destroy the franchisee’s plans from the outset of the contract. Some will be familiar to the first time investor as a risk to an entrepreneur; but everyone justifies that second take.
Be sure to only search for quality franchise deals. The new franchise investor should forget the passion for a particular business and try to be more objective. Just as overly popular franchises will be more expensive, may be subject to fads, or have fierce competition in the sales territory defined in the proposed contract, there are some franchisors who are known as “sharp operators.” Each franchise offering could have a number of unsatisfied and unsuccessful franchisees who may claim to be subject to fraud. A thorough internet search should be done and if done on behalf not stop at page one Google. Talk to franchisees. Is there a pattern to the complaints? If the complaints make the investor uncomfortable, it is an alert to move on to another option. The relationship with the franchisor must be based on trust and respect.
Franchise directors should be checked for litigation histories. Disputes about non-compliance can arise from the perspective of either party. Franchising is a very litigious business and most franchise companies will have a history of legal action, but it’s important to separate fact from fiction (as the internet is full of both). Was the franchisor seeking to enforce its agreement to protect the brand and system, or was it taking advantage of the franchisees? It is important for the franchisee to understand the competition. The investor’s attorney can alert the investor to signs of undue competition. But what if the competition represented in several initial marketing discussions does not in fact exist? Are there other signs of fraudulent practice that the investor should be aware of?
Franchisees should go in with their eyes wide open. The use of independent, competent and professional assistance in drafting the franchisee’s own business plan and researching earnings forecasts is an essential step in protecting against fraud by the franchisor, especially internationally where FTC-type protections are nonexistent. Breakeven analyzes and less optimistic scenarios should be included, and the investor should not rely solely on information provided by the franchisor, no matter how well known that particular franchise is. In lesser-known, lower-cost franchise offerings, earnings performance can be related to the strengths and skills of the buyer; on the other hand, an optimistic earnings scenario provided to the potential investor can also be a sign of fraud. The investor must prepare a detailed evaluation of the initial investment costs and compare it with the data that must be requested from the franchisor.
There is a greater risk inherent in considering a start-up franchise. It is in the inexperienced franchisee’s interest to choose a business for due diligence with a minimum 4-5 year history, with a minimum number of franchise units currently in operation. Failure to seek the support and expert advice of a franchise consultant at an early stage will require some basic legwork, such as visiting the franchisor’s head office and viewing the training material for yourself.
To quote an old adage, the devil is in the details, even before the next step is a study of the draft contract. Researching important details early in the due diligence process will make the intended franchisee less concerned about the possibility of fraud. They should be comfortable with the quality of the training and support provided, where it will be provided, and for how long. A promise to send the material later should be regarded as just that, a promise, and should be fulfilled promptly. Delays in the provision of any agreed paperwork should alert potential investors and their advisers and the challenged franchisor early in the process.
MatchPoint Franchise Consulting Network was founded in 2006 with the mission of helping companies expand their franchise networks and improve the profitability of their system. His mission included improving the quality of new franchisees entering a system. From its inception, it has been clear that the free advice offered to franchise buyers on the website and by MatchPoint consultants is vital to the potential franchisee’s ability to make a better and more prudent purchasing decision. The advice offered by our consultants does not make us lawyers, but is there to help bring all the advice offered to the potential franchisee in the due diligence process to a high level of quality.
MatchPoint consultants trained by Nigel Mayne know the red flags of fraud in the industry. The very few franchisors who practice franchise fraud are needed to sully the dream of the franchisee. That is where seeking the independent advice of an expert franchise consultant is prudent and invaluable.