December 2015 Archives

How can a really sweet deal turn into a really bad nightmare?

That is perhaps what two franchise founders are saying to each other about now. Michael and Kathy Butler (collectively the "Butlers") are seasoned public relations folks. Michael Butler has had his own PR firm for 30 years.

The Butlers came up with the idea to open a retail store that offered PR and marketing services to small businesses. They liked the concept so much, they decided to franchise it. They called the franchise the PR Shop. They contracted with a franchise broker to sell PR Shop franchises. The broker did a good job.

A franchise prospect in New York wound up buying 20 franchise outlets.

Then the nightmare began. New York requires franchisors to complete a franchise registration prior to the offering or selling of franchises in the state of New York. PR Shop filed a franchise registration. But, it was not complete or effective at the time that the PR Shop franchises were sold to the prospect in New York. This was uncovered by the prospect turned franchisee. He called the state of New York wanting to complain about 20 PR Shop franchises.

Go no further. The franchise registration was not effective when the franchisee bought the franchises. The franchisor must offer the franchisee rescission. Rescission means, pretend like the franchise agreement was never signed and the franchisee gets all his money back.

One problem, by this time the franchise has dissolved. The franchise's founders (the Butlers) have filed personal bankruptcy. This whole thing cannot be written off that easy. Can it? Really? No. The case is In re Michael L. Butler and Kathy H. Butler v. John Mangione. The bankruptcy court did not look fondly upon the Bulters' conduct.

The court found that Michael and Kathy Butler were personally liable to John Mangione, the New York franchisee. And, the Butler's liability to Mr. Mangione was not dischargeable in bankruptcy. The Butlers must repay Mr. Mangione his initial franchise fees, for all 20 franchises + interest + Mr. Mangione's attorney's fees totally $714,000.

The Butlers broke state law by not completing the franchise registration prior to selling the franchises in New York. The Butlers did not hold the initial franchise fees in escrow as instructed by the state. Failure to put the initial franchise fees in escrow, in the court's opinion, was akin to stealing. The Butlers committed fraud by misrepresenting to the franchisee that PR Shop was registered in New York. The court did not take a soft approach in this case.

Lesson from the Court: Register it before you sell it or the deal may be unraveled post facto.

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More often than not, I get phone calls like this from prospective franchisees. (If you want you can skip directly to my free advice at the bottom.)

Prospect: Mr. Solomon, I am looking at a franchise to buy and I would like you to advise me about it.

Me: What franchise are you looking at?

Prospect: I am looking at an ice cream franchise called Tombstone Creamery.

Me: That's just about the worst franchise on the planet. If you invest in that you will only end up with years of misery and poverty.

Prospect: They tell me it is a wonderful investment for a good small business, and everybody eats ice cream. How can that possibly go wrong? I spoke to several franchisees and they all say they are happy.

Me: They told you that because they think you are working for the franchisor and looking for anyone saying negative things so that the franchisor can retaliate against them.

The truth is that this franchise is a one way street to misery and you need to run like hell.

No one trusts franchisee interviews anymore. Most of them are scared to say anything real.

Prospect: I don't understand how you can say that. Can you be more specific? And if not that, what about a sandwich shop franchise?

Me: Sandwich shops are almost as bad as ice cream franchises. Don't buy one of those either.

Prospect: What don't you like about those? Do you have a good thing to say about anything? I'm getting sorry that I called you.

Me: To answer your questions one at a time, there are too many sandwich shops and price competition is eating them alive. There is oversaturation everywhere.

Moreover, the prices franchisees have to pay to vendors to enable the vendors to pay rebates to the franchisors takes away all value of group purchasing from the franchisees and transfers that value to the franchisor like an added royalty.

The cost of being a franchisee in a sandwich shop franchise system is over 20 % of gross sales when you add up all the extraneous costs associated with being their franchisee, not what the disclosure documents tell you.

I like very few franchises because so few are revenue credible in the sense that when you go home at night you have made any money. There are a very few good ones in net revenue terms and you may not be qualified, for all I know about you, to buy one of those.

But you haven't hired me yet, so you have lost nothing by this phone call. If you can find a lawyer who will give you this much insight into the business risks of buying a franchise, hire him immediately.

Prospect: What would you have me do?

Me: You are apparently inexperienced at small business investment due diligence. You are listening to anecdotes and not demanding any corroboration of the sales pitch. You need to revise how you go about doing your homework.

I have something to share with you that may save you from bankruptcy.

Prospect: How much do you charge for that?

Me: This is something I give away so that you can prove to yourself that I know what I am talking about. Follow these 8 magical steps.

1. Go onto the Internet and do a Google Search using the words business broker in (name of your home town).

2. Contact business brokers telling them that you are looking for a business to buy and you do not want a start up. Tell them you want a business that has been open and operating for at least five years. You can give them the name of a few franchises that you think you are interested in. Tombstone Creameries and any sandwich shop franchise would be good areas to look at.

3. The business brokers will have dozens or hundreds of these that are up for resale.

4. Tell them that you need to see copies of the actual signed federal tax returns, including all the exhibits, for the last three years (five would be better).

5. All you have to do is sign a confidentiality agreement that says you will not disclose the information to others. You can disclose it to your attorney and your accountant.

6. Now you will see the financial realities of these franchises you think you are interested in.

7. You or your accountant/lawyer will be able to do realistic financial analysis based on the information in the tax returns.

8. This is the way you start looking seriously at small business ownership investment, franchised or independent. You will be amazed at the difference between what you see in the tax returns and what these franchise salespeople are telling you.

When you think you have found something you are interested in after looking at the real financial results of ownership, if you want me to be your lawyer, you can call me back.

You are welcome. But, do call me back.

Author Richard Solomon is a Franchise Lawyer with 50 years of experience in business development, antitrust and franchise law, management counseling and dispute resolution including trials and crisis management. Give him a call at 281-584-0519.

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For the past five years I've had the privilege of being the President of the Capital Area Franchise Association (CAFA).

For CAFA's January 2015 lunch & learn program schedule we were honored to hear from Robert Cresanti, then Executive Vice President of Government Relations & Public Policy of the International Franchise Association (IFA).

Robert had a full house and shared his perspective on the state of franchising. He spoke candidly about what the IFA was forecasting for 2015, the priorities for the year: credit access, taxes, health care, veterans in franchising and the continued importance and impact of franchising in our economy.

Now, I am pleased to announce that Robert Cresanti, as the new IFA President & CEO, will be back to CAFA to launch our 2016 lunch & learn program schedule on Tuesday, January 19, 2016 at The Tower Club in Tysons Corners, VA.

Start the year by hearing from someone who clearly understands the issues and opportunities for franchising in 2016.

At this year's event we will have an "Actor's Studio" style exchange between Robert and Warren Lee Lewis of Akerman LLP with ample opportunity for audience participation and questions.

For over 20 years, CAFA, 6 times a year on the 3rd Tuesday of alternating months, brought together some of the best, brightest and most innovative franchisors, franchisees and franchising professionals in the Mid-Atlantic region to share their franchising knowledge and insights.

CAFA is member organization dedicated to the best in franchising and franchise education that encourages guest attendance at all meetings.