Franchise Law
Investigating Franchise Offerings
Before investing in any franchise system, be sure to get a copy of the
franchisor's disclosure document. This document is now called a Franchise
Disclosure Document. Under the FTC's Franchise Rule, you must receive the
document at least 10 business days before you are asked to sign any contract or
pay any money to the franchisor. You should read the entire disclosure document
and try to ensure you understand it. The following overview may help you to
understand key provisions of typical disclosure but you should consider
consulting with an experienced franchise attorney to assist you.
Business Background
The disclosure document identifies the executives of the franchise system and
describes their prior experience. Consider not only their general business
background, but their experience in managing franchise systems. Investing with
an inexperienced franchisor may be riskier than investing with an experienced
one.
Litigation History
The disclosure document helps you assess the background of the franchisor and
its executives by requiring the disclosure of certain prior and pending
lawsuits. The disclosure document must tell you if the franchisor or any of its
executive officers have been convicted of felonies involving, for example,
fraud, any violation of franchise law, unfair or deceptive practices law, or are
subject to any state or federal injunctions involving similar misconduct. A
number of claims against the franchisor may indicate that it has not performed
according to its agreements, or, at the very least, that franchisees have been
dissatisfied with the franchisor's performance.
Bankruptcy
The disclosure document tells you if the franchisor or any of its executives
have recently been involved in a bankruptcy. This information can help you to
assess the franchisor's financial stability and general business acumen of the
management team.
Costs
The disclosure document tells you the costs involved to start one of the
company's franchises. It will describe any initial deposit or franchise fee,
which may be nonrefundable, and costs for initial inventory, signs, equipment,
leases, or rentals. Be aware that there may be other undisclosed costs. An
accountant can help you to evaluate this information.
Restrictions
Your franchisor may restrict how you operate your outlet. The disclosure
document tells you if the franchisor limits:
- The supplier of goods from whom you may purchase.
- The goods or services you
may offer for sale.
- The customers to whom you can offer goods or services.
- The territory in which you can sell goods or services.
Understand that restrictions such as these may significantly limit your ability
to exercise your own business judgment in operating your outlet.
Terminations
The disclosure document tells you the conditions under which the franchisor may
terminate your franchise and your obligations to the franchisor after
termination. It also tells you the conditions under which you can renew, sell,
or assign your franchise to other parties.
Training and Other Assistance
The
disclosure document will explain the franchisor's training and assistance
program. Make sure you understand the level of training and assistance offered.
Keep in mind that a primary reason for investing in the franchise, as opposed to
starting your own business, is training and assistance.
Advertising
You often
must contribute a percentage of your income to an advertising fund even if you
disagree with how these funds are used. The disclosure document provides
information on advertising costs. Some things to consider:
- How much of the
advertising fund is spent on administrative costs?
- Are there other expenses
paid from the advertising fund?
- Do franchisees have any control over how the
advertising dollars are spent?
- How much of the fund is spent on national
advertising?
- How much of the fund is spent on advertising in your area?
- How
much of the fund is spent on selling more franchises?
- Do all franchisees
contribute equally to the advertising fund?
Current and Former Franchisees
The
disclosure document provides important information about current and former
franchisees. Pay attention to the number of terminated franchisees. A large
number of terminated, canceled, or non-renewed franchises may indicate problems.
Also be aware that some companies may try to conceal the number of failed
franchisees by repurchasing failed outlets and then listing them as
company-owned outlets. If you buy an existing outlet, ask the franchisor how
many owners operated that outlet and over what period of time. A number of
different owners over a short period of time may indicate that the location is
not a profitable one or that the franchisor has not supported that outlet with
promised services. Also, determine how many franchises are currently operating.
A large number of franchisees in your area may mean increased competition and an
attempt to saturate the market with franchises.
The disclosure document gives
you the names and addresses of current franchisees that have left the system
within the last year. Speaking with current and former franchisees is a good way
to gather information about the franchise and validate the franchisor's claims.
By visiting franchises you can see for yourself the volume and type of business
being done.
Be aware that some franchisors may give you a separate reference
list of selected franchisees to contact. Be careful as those on the list may be
individuals who are paid or otherwise incentivized by the franchisor to give a
good opinion of the company. Finally, ask if there is a truly independent
franchisee association or a just a franchisor controlled advisory council or
board. If an independent association exists, contact its board members and learn
their views.
Earnings Potential
You may want to know how much money you can make
if you invest in a particular franchise system. Franchisors are not required to
make earnings claims, but if they do, the FTC's Franchise Rule requires
franchisors to have a reasonable basis for these claims and to provide you with
a document that substantiates them. This substantiation includes the basis and
assumptions upon which these claims are made. Some things to consider:
- Average
figures tell you little about how individual franchises perform. A few very
successful franchisees can inflate the average.
- Some franchisors provide
figures for the gross sales revenues of their franchisees. These figures,
however, do not tell you anything about the franchise's profits. An outlet with
high gross sales revenue on paper actually may be losing money because of high
overhead, rent, and other expenses.
- Earnings may vary in different parts of
the country. An ice cream store franchise in a southern state, such as Florida,
may expect to earn more income than a similar franchise in a northern state,
such as Minnesota. If you hear that a franchisee earned a particular income, ask
where that franchisee is located.
Make sure you get and closely review the
earnings claims document and consider consulting with an experienced franchise
attorney or accountant to assist you in evaluating any earnings claims.
Financial History
The disclosure document provides you with important
information about the company's financial status, including audited financial
statements. Be aware that investing in a financially unstable franchisor is
risky; the company may go out of business or into bankruptcy after you have
invested your money. Consider hiring an experienced franchise attorney or an
accountant to help you review the franchisor's financial statements.
Lawyer and
Accountant
An accountant can help you understand the company's financial
statements, develop a business plan, and assess any earnings projections and the
assumptions upon which they are based. An experienced franchise attorney can
help you to understand your obligations under the contract. It is best to rely
upon your own lawyer or accountant rather than those of the franchisor.
Better
Business Bureau
Check with the local Better Business Bureau (BBB) in the cities
where the franchisor has its headquarters. Ask if any consumers have complained
about the company's products, services, or personnel.
Government Departments
Several states regulate the sale of franchises. Check with your state Division
of Securities or Office of Attorney General for more information about your
rights as a franchise owner in your state. In California, franchises are
regulated by the Department of Corporations, visit:
http://www.corp.ca.gov/srd/franchise.htm
Federal Trade Commission (FTC)
The FTC
publishes information that may be of interest to you. To get free information on
franchise issues, visit
http://www.ftc.gov or call toll-free, 1-877-FTC-HELP
(1-877-382-4357), TTY: 1-866-653-4261.