This is the first of a three articles intended to raise investment care sensitivities. They are offered as a gesture of concern about what I see happening to people who invest in new and in old/over the hill franchise opportunities.
The purpose of the deceits practiced by these two groups of franchisor companies is, in the first instance, to portray itself as the investment quality equivalent of an already proven franchise concept/model, and, in the second instance, to portray itself as still being as good an investment vehicle as it once may have been but no longer is.
Is it possible for franchisors to say to prospective franchisees that profitability information is not provided when they do they provide profitability information?
It is also a very logical question to ask whether a franchisor can provide false or misleading profitability information so long as a warning is also given that there is no guaranty that you will achieve profitability and that you assume the risk of profit or loss and that there are risks.
Since risk is inherent in any investment, warnings about risks do not include or excuse risks that are produced by false statements made to induce the investor to part with his money in the first place.
How does someone who is thinking of investing in a franchise go about vetting the numbers?
This is the hottest button issue in disclosure, because assurances of potential profit are the most effective way to sell a franchise. Only an imbecile buys a franchise because of the bullshit. Real people want to know whether they will make a profit and how much, and how long it will take to reach profitability, and how much it will cost to get there.
Many years ago I published a suggestion in the ABA Franchise Newsletter that, since every franchise agreement empowers the franchisor to receive copies of periodic financial information and tax returns generated by its franchisees, compiling that information ought to be made mandatory, and that information ought to have to be disclosed in a way that displays how the franchisees are really doing.
This would include grouping franchisee performance information by levels of profitability (top third, middle third, bottom third), by region of the country, and by showing seasonality if seasonality is a significant factor. I also suggested that the information could be handled in such a way as to eliminate the impact of different franchisees treating various expenses differently for accounting or tax purposes.
If that were to happen, people might be able to appreciate at a higher level of quality just what the performance expectancies might be.
Franchisors, of course, howled at the thought. Why, if that were done, people might be able to see whether your franchise system was more profitable for its franchisees than someone else's franchise system, and the lower performing franchise systems would have a harder time selling franchises. DUH! That's one of the best reasons for doing it!
Since a potential franchisee will not receive that quality of prospective financial performance information, it remains necessary to have access to a fairly high level of sophistication in dealing with what is provided.
This article is intended to help to deal with the garbage that is thrown at you now.
Reading this article does not make you my client, and there are many other things that must be accounted for than just the questions raised here. But you can take this to your lawyer or accountant/financial planner, and maybe it will help you both better understand what you are being handed.
Are there Franchise Consultants? No.
Let's get started. Start by first asking yourself who it is that you are dealing with -- who is behind the face you are looking at when you are dealing with the person who is providing you with initial information about a franchise opportunity? If that person identifies himself/herself as a 'FRANCHISE CONSULTANT', you know you are dealing with a liar.
There is no such thing as a franchise consultant who sells franchises. While many people do that, they are not consultants in any functional meaning.
The reason for that is that they only get paid for selling franchises -- usually by a commission. That's a salesperson, not a consultant. And even if they were consultants, they aren't working for you to help you.
If you aren't the only one paying them for assistance, they are salespeople. When they tell you that they are there to help you get the right deal for your circumstances, that is total bullshit. They are there to sell you a franchise -- any franchise that will pay them a commission. You have to be extremely cynical about everything you are told.
Doubt everything until it is proven -- and you need to know what proof looks like.
What they call proof usually isn't. In once case in my office, the franchisor sales person claimed to be a vice president when he wasn't even an employee of the company. He was an outside salesman. You have to doubt EVERYTHING.
Item 19 Traps
a) - No Item 19 earnings claim is a Lie
Liar Number One tells you in Item 19 of the UFOC that the company does not give out earnings claims and that no one is authorized to provide earnings information in connection with the sale of its franchises.
This is an obvious lie for several reasons. The first reason is that the only reason to make an investment is to make a profitable return on that investment. If there is no representation of profitability potential/earnings potential, then there cannot be any reason on earth to make an investment in their franchise.
The second reason is that every one of these franchise companies does make earnings claim information to every potential franchise purchaser. The earnings claims information isn't in Item 19 of their UFOC, but it is provided by other means.
Among these other means you will see one or several of the following:
The franchise sales person provides the information either orally, on a blackboard, on a random piece of scrap paper/cocktail napkin/table cloth (and if you hang on to that piece of paper you may have a great exhibit when things later don't go as you thought they should).
b) Franchisee Verifications cannot be relied upon
The franchise sales person invites other franchisees to come appear at a meeting of franchisee prospects to tell of their experience as a franchisee. These folks always tell about their own wonderful financial performance. The presentation is intended to tell you that this is what you can expect if you buy the franchise.
The selected franchisee spokespeople are either all very successful or just shills lying through their teeth. In some instances these shills also receive a 'commission' on every franchise fee taken from each person attending that meeting who buys a franchise.
There are probably some successful franchisees in the system, but the point is that you are being provided with information that the franchisor denies providing to you, and that the information -- since it is denied it was ever given anyway -- is never reliable.
If you do buy the franchise, you will see in the franchise agreement an Acknowledgement clause that says that you agree that you were never given any earnings claims information.
If you sign that agreement knowing that you were in fact given earnings claim information, you may be out of luck even getting it admitted into evidence in court or in arbitration of any fraud claim you may later seek to assert.
Some courts are allowing the Acknowledgement clause to exonerate misrepresentation, making the defrauded franchisee seek reversal of those rulings in courts of appeal. That adds time and expense to obtaining relief.
You are provided, as is required, a list of the names, addresses and telephone numbers of all the franchisees of that franchisor so that you can contact them as part of your investigation/due diligence before you buy the franchise, to see what kind of experience they are having with the franchise.
But the franchise sales person steers you to certain franchisees. These will always say they are making tons of money and are just thrilled with the franchisor who provides great training and support. If you do buy the franchise, the sales person usually gives them a percentage of the sales commission, or they receive some other form of consideration for their assistance.
The franchisor's position is that, notwithstanding the steering, they have no part in providing you with earnings claims information. If you buy that you are too stupid for words. While it may in some strict sense be true that someone else, not the franchisor, provided you with the information, the fact is that the information was provided to you through the efforts of someone affiliated with the franchisor.
c) Financial Assistance for SBA Loans, but no Item 19
The franchisor who claims not to provide earnings claims information to persuade you to buy the franchise, does offer to assist you in seeking an SBA loan. The loan requires that you prepare a 'business plan' (another work of sheer fiction). The business plan requires a pro forma operating statement and balance sheet statement to show the lender what you expect by way of financial performance of the business for which you are borrowing the money.
The franchisor either provides you with information to use in preparing the business plan, including the financial pro forma, or steers you to a 'consultant' to assist you and the consultant provides financial pro forma information that the consultant obtained from the franchisor.
Then of course, you take your business plan to the franchisor for review, before submitting it to the SBA lender, and the franchisor tells you that you 'did a good job' or that 'your numbers are reasonable', vouching for the numbers/earnings claims information.
The lying franchisor's position is that they provided nothing and that you got that only from some third party, not from the franchisor. The franchisor's back up position is that they didn't provide you with the information in order to get you to buy the franchise. They just provided information to help you get a loan.
DUH! And -- I actually heard a franchisor person testify to this once -- the ultimate fall back position if the information is false is that the false information wasn't provided to you, but was provided to the lender.
There are other ploys by which franchisors who state in Item 19 of their UFOC that they don't give out earnings claims financial information actually do in some fashion provide it.
The fact is that it is almost never true that they don't provide earnings claim information, and if they provide it while insisting that they are not providing it, they are lying to you and you need to run like hell, not buy the franchise.
As always, you can call me, RIchard Solomon, at 281-584-0519.
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This should be a standard request by every prospective & current franchise owner.
"Many years ago I published a suggestion in the ABA Franchise Newsletter that, since every franchise agreement empowers the franchisor to receive copies of periodic financial information and tax returns generated by its franchisees, compiling that information ought to be made mandatory, and that information ought to have to be disclosed in a way that displays how the franchisees are really doing."
Great idea.