Franchisees catch pneumonia when a franchisor gets a cold

Sometimes franchisees inherit problems that they had nothing at all to do with. Sometimes those complex, uncontrollable issues are toxic enough to kill their already weakened business.

A couple of articles from South Africa caught my eye this week.

And as usual, the immediate issue was not the the full story. You have to know what questions to ask to find out where the bodies are buried.

The problem was initially defined in a June 13th article as a dispute between the franchisor and a DVD distributor: DVD stores face legal action after ruling

Video and DVD rental stores across South Africa may face legal action if they are found contravening copyright laws, after the Cape High Court barred Mr Video and 22 of its franchises from renting DVDs not acquired through local authorised licensee Nu Metro.

It seems the franchisor made business decisions that other companies disagree with. In this case the adversaries (that the franchisees have inherited) are fairly substantial: Twentieth Century Fox Film Corporation, Disney Enterprises, and Warner Bros Entertainment.

These other companies have filed suit against the franchisor and the franchisees.

Attorney Anthony Norton, representing the studios and the distributor, said the rental outlets now face claims of damages by the major studios.

He said in some instances, the titles were released for rental by Mr Video before their theatrical release here.

As a franchisee you rely heavily on your franchisor. If a franchisor acts in a controversial way, you often suffer much more than they do.

A June 18th follow-up story paints that picture: Mr Video faces another legal wrangle

…some of its former franchisees who have accused the DVD rental company of “grossly unfair business practices”.

At least four former franchisees in KwaZulu-Natal have confirmed they were forced to close their shops because they could not pay their debts. Some have lost everything because their assets were attached to settle outstanding debts that ran up to R500 000 for each franchisee. The debts include bank loans and royalty fees.

Churning is a term that has been used in North America that describes a specific franchisor business behavior. The signs are:

  • New stores are opened with little regard for where, when or who (if they can “fog a mirror” and sign the loan papers — they’re in!).
  • Existing stores are sold, and then sold again, and then resold (often as quickly as every 12 months, sometimes less time).
  • The “promiscuous” (I’m being generous here) financing is largely through one lender and one loan officer. Potential owners are steered to them for almost instant approval which breaches the lender’s due diligence duty).
  • If the loans are underwritten by a government guarantee, this really acts to fuel the predatory fire.

Bank loans used to finance a franchise system that is alleged to be churning?

  1. Does South Africa have a small business loan program (ie. a high percentage of any defaulted small business loan is paid back to the lender)?
  2. Were any of these specific defaulted loans written under the program?
  3. Were the “bad” loans all with the same lender?

If the answer is “yes” to two of these questions or some similar red flags, then the likelihood of Predatory Franchise Lending should be looked into.

Some franchise systems operate like a Pyramid or Ponzi scheme. They were created to fail from Day 1:

  • the franchisor collects and hides as much cash as possible from the most unsophisticated investors available (sound familiar?) and then declares an intentional insolvency which leaves everyone with a claim against that specific company holding an empty bag.

One Response to Franchisees catch pneumonia when a franchisor gets a cold

  1. Carol Cross says:

    Obviously, when franchisors get into trouble, their franchisees die from pneumonia and the franchisors, the banks and the lenders, and the landlords and the government are there to collect burial fees as provided under contract. Recently, I have been reading about franchises being closed and the assets being sold to pay past-due sales taxes to government. .

    When franchisors get into trouble with their so called proven plans, they don’t pull back and stop selling franchises. There goal is to always grow visibility and gross sales and to never show a reduction of system gross sales or system units in their financial reports. If they can sell NEW franchises out the front door and highly discounted franchised businesses out the back door, they can, perhaps, hang on for a long time even if they can’t control the black swans in the economy. Franchisors have a better chance of surviving recessions than their franchisees and governments support the franchisors who feed the local economies.

    While we realize that all franchisors would prefer their franchisees to be successful and to even earn profits, it appears the very nature of franchising under the status quo of the law permits the franchisor to survive with profits even when substantial numbedrs of their franchisees have no profits and don’t survive at all.

    This “free lunch” for franchisors results in greed and churning and turning and pumping and dumping of franchisees becomes a management tool for survival and the maximization of the system’s profits. Franchisees are a premeditated sacrifice to the greater good of the franchisors, the banks and the lenders, the landlords, the developers, and local, state, and federal governments.

    This is representative government – huh!


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