Could franchise bankers also act as gangsters?

Are Canadian franchise bankers capable of engaging in “cartel-style anticompetitive corruption” in their $100-billion sales per year marketplace?

Every current or former Canadian franchisee who has had a Canada Small Business Financing loan may want to ask themselves some questions. My posts at  FranchiseBanker.ca (specifically: Banker “everybody is doing it” corruption admitted in the LIBOR scandal) might help frame your thoughts.

Without the Canada Small Business Financing program, many fewer deadbeat franchises would have been sold in the last 20 years.

Industry Canada asked me to jot down my concerns a few years ago.

Franchising Opportunism, a 20 page non-technical paper,  was the result.

Banks push fraudulent business debt using several financial instruments.

Ideas:

• Yves Smith, Naked Capitalism blog
• Matt Taibbi, The Scam Wall Street Learned From the Mafia

Are franchise bankers running a peep-show, a clip joint?

Franchising is low-grade entrepreneurial pornography.

Read Franchising Opportunism and you judge. The horrendous losses on unregistered guaranteed government loans are self-financed on inflated appraisals.

A clip joint or fleshpot is an establishment, usually a strip club or entertainment bar, typically one claiming to offer adult entertainment or bottle service, in which customers are tricked into paying money and receive poor goods or services, or none, in return.

Typically, clip joints suggest the possibility of sex, charge excessively high prices for watered-down drinks, and then eject customers when they become unwilling or unable to spend more money. The product or service may be illicit, offering the victim no recourse through official or legal channels. Wikipedia

The process by which banks create money is so simple that the mind is repelled. John Kenneth Galbraith

See Canada Small Business Financing Program and U.S. SBA 7a Loans [and UK and France and…]

One day, franchisee families will count

Each franchisor and franchisee with their own unique ISBN-type number.

Assigned by a private company under contract to the national franchise governing council with a corresponding gmail account accessible by both spouses, held confidentially by this corporation that is enabled legislatively to report to all levels of government. Online registration and due diligence portal protocol funded by franchise bankers (required number to get current account) and sponsored by industry and government authorities. Revenue neutral within 5 years (private or public equity funding?). Mediation intake, processing and reporting. Franchise bar credentialing. Pre-sale education. Industry and legislative program evaluation possible (ie. VetFran and others). Register all confidentiality agreements.

A basis for rational industry growth.

Within reach of any smart phone at pennies per entry.

Franchise lenders are swill

Some systems hardly have any franchisee debt.

This is particularly true of ones that converted employees to franchisees.

That changes once franchisors listen to their bankers explain how much they both can make (ie. interest kickbacks) if they leverage as many franchisees to the teats.

The primary control method of newer (maybe more formally educated?) franchisees is debt. Hundreds of thousands of supportable debt, if the franchisor who controls their gross margins, lets them service their debt.

It’s ugly:

1. prime plus 5% (“love to give a better rate but it’s unsecured, don’t you know“),
2. immediately callable (demand loan = short leash),
3. plus personal guarantees up the wazzo (“just need the missus to okay the paperwork…“), but
4. secured by NOTHING but the franchisor”s “good faith” (ok as long as the present management stays put but all deals are off if…).

If you want to unlock the chains, start asking your “preferred” lender some questions (on a public blog, btw) about their lending duty under the Bank Act.

Franchise bankers: a breed apart.

A little more sensitive than you run-of-the-mill doofus franchisor: don’t like being fingered for loan pushing, collusion or predatory franchise lending.

• Franchising Opportunism, Les Stewart

Franchising more than helps flush +$100 million CDN annually down the toilet

A good Canadian Press article called Ottawa’s loan program for small business still troubled: report by Dean Beeby.The revenue paid to Industry Canada was supposed to cover the default claims paid out, but the math has never worked in Ottawa’s favour.

Claims paid out have risen steadily over the decade, and now top $100 million annually, while revenues have consistently lagged, costing taxpayers a net $335 million so far.

Put another way, cost recovery is currently at only about 60 per cent rather than the 100 per cent that was planned, and is in steady decline.

“The gap between claims and fee revenues will continue to exist and most likely expand,” predicts the KPMG report, dated Oct. 30 and obtained by The Canadian Press under the Access to Information Act.

The program’s portfolio of loans has become ever more risky over the decade, now catering especially to newly established small firms with weak credit scores and little collateral, many in the food-and-beverage sector.

These loans are used extensively in franchising although the franchise bankers frequently don’t even bother to try to register or make a claim on the phantom loans. The difference between new and used equipment nicely covers the money split between the mob (see here for details).

I’ve kept a close eye on the Canada Small Business Financing program and how the franchise industry misuses it (see my 2005 paper called Franchising Opportunism)

Program results from 1999 to 2008 using Industry Canada’s own Annual Reports (franchised v. non-franchised loans):

• Franchise Loan Claim Rate was 26.5% higher (than for Non-franchised loans).
• Franchise Loan Default Rates resulted in over $22.9-million more Claims (Non-franchised rate).
• The mean Franchised loan was 43.4% higher than Non-Franchised.
• The mean Franchised claim was 11.9% higher than Non-Franchised.

Comparing the years 2008 to 1999:

• The Claim Rate increased 858.2 times for Franchised (245.1  times for Non-franchised loans).
• The Franchised Claim Rate accelerated 3.5 times more than Non-franchised loans.

I’d be happy to send anyone the spreadsheet.

The U.S. Small Business Administration’s 7a. loan program seems to be sticking their citizens with a $70-83-billion public debt, too.

If we forget, We will continue to repeat our mistakes

We created WikiFranchise.org to house the documents that I have collected and to start a dialogue.

A wiki‘s strength is in its volunteer editors.

Time will tell whether other people find this franchise industry-only indexed archive useful.

It has some merit for teaching and learning about the business risks that sometimes run counter to the overwhelming advertising message to say “yes” to every half-baked concept.

The latest, saddest example I added to WikidFranchise today is from the Washington Times’s Elise Anderson, entitled: Jobless seek future in franchising.

As Elizabeth Winterhalter and her husband, Monte, packed up their house in Glastonbury, Conn., for their move to McLean, they were eager and anxious about trading the pain of unemployment for the promise and peril of something they had never tried before — running a franchise.

Good grief.

I wish the Winterhalter, Dillen, and Prioleau families all the very best as a personal and financial outcome but I hope Ms. Anderson follows up with them in 6 or 12 months. As for the expert that Anderson solely relies on?: Alisa Harrison has been with the franchise industry for a total of 1 1/2 years.

Banks won’t do Franchise loans: It is true that there are no normal or even government-subsidized (SBA) loans to be had now.

The reason: an emerging crisis that implicates the 7(a) Loan program of the U.S. Small Business Administration which has a long and consistently scandalous history.

Predatory franchise loans are becoming visible to everyone: loan brokers, banks, re-packagers and politicians. The public bailout of the franchise industry’s greed is what is freezing everyone in their tracks: not a recession. Pending fraud indictments tend to chill even the shadiest franchising financing scam.

Estimates of a public bailout of $70 to 80-billion will seem quaint if an accurate, non-biased accounting were to ever take place.

Don’t expect to see any breaking news stories about this on Franchise-Chat.com or BlueMauMau.org either: these off-message stories are skimmed off before they hit any franchise RSS feed. Keep the kids busy talking about the evil empires (MBE, Quiznos) or arbitration reform or how franchisees are to blame.

What I do: I took the article, coded it and saved it in WikidFranchise. Here are the business risks I assigned to it:

1. Cannon fodder,
2. Desperation causes bad decision making,
3. False hope,
4. Financing with 401k money is totally reckless,
5. International Franchise Association, IFA,
6. Only one side presented,
7. Loss Aversion: people dislike losing much more than winning (the same $),
8. Professional journalistic standards,
9. Retirement savings gone,
10. Severance package financing dream,
11. Sold during time of psychological vulnerability, especially unemployment,
12. Sold only to people with no small business experience (very naïve),
13. Success or failure is within the direct control of the individual franchisee,
14. Unproven business model,
15. Unskilled and unaware of risks, and
16. Who pays for the research?

Many families are going through very desperate times and are searching for help.

• This article is just plain cruel.

I collected the already-published documents to give a sense of history for new investors.

WikiFranchise.org is a revolutionary tool for those willing to use it.

Eat the bankers

Now this is serious business.

Using humor to relieve anxiety and doing so shows how capitalism is impotent to continue to control peoples’ lives.

Brilliant, as they so often say over on the other side of the pond. And in English instead of those French panty wastes.

FranchiseFool of the Week: Chris Knight, suspended English anthropology professor.

Watch the clip.

Abolish the SBA: $70-83B reasons why it should happen

Private gain, Public loss.

Banks, like all buisnesses, just love it when governments underwrite their risks.

It’s only a bonus when Joe Q. Public gets to pay for the drunkard’s binge of “aggressive” to predatory to outright fraudulent loan practices.

Canada, the United Kingdom and the U.S. all have small business loan programs which guarantees defaults.

The North American franchise industry relies very heavily on this debt program to fuel franchise sales. In Canada, the Canada Small Business Financing program is almost the only debt that Schedule 1 banks will offer for franchises (last time I checked).

The U.K. industry discernment is still embryonic. Their Small Firm Loan Guarantee scheme, SFLG is run by the Department of Business, Enterprise & Regulatory Reform, BERR. By the looks of  The Royal Bank of Scotland site, SFLG loans are a big part of the U.K. franchise industry also.

• Blue MauMau is the most active centre for franchise investor concerns in the world. Tellingly, SBA Loans Free Fall is a current headline.

Dr. Veronique de Rugy, adjunct scholar at the CATO Institute in 2007 (and now senior research fellow at the Mercatus Center at George Mason University) presents some very important facts from a CATO Daily Podcast [see below].

Specifically the U.S. Small Business Act, SBA loan program:

1. may end up costing citizens $70-billion (maybe $83-B?, if defaults climb faster than projected; unfunded debt that will be added to future taxpayers),
2. with less than only 1% of small businesses taking out a SBA loan per year, it’s irrelevant economically,
3. was created 53 years ago when credit information was much harder to determine (program has not evolved as information sharing has improved),
4. of the loans that are currently on the books, they are “defaulting massively” (SBA loans disproportionally finance doomed business ventures), and
5. only has 3% of women or minority-controlled firms take take out a SBA loan per year (as a social program it is a bust: 97% of these “discriminated against” groups get their debt elsewhere).

All of this begs the question: If the 7a Loans are defaulting like mad who exactly are benefiting from this program?

To her credit, Dr. de Rugy points directly to the banks and their capacity to sell off the 75% government guaranteed portion on the secondary market and stick the massive debt to the taxpayers if their own default projections are understated (ie. d/recession).

The banks love SBA loans (in a technical sense) because:

1. 60% of all loans are underwritten by the 10 largest banks can exert market influence even within a very decentalized banking system, comparatively, (in Canada it’s worse: 82.5% all guaranteed loans with Top 5 bankers, 2000-05: FOI author) and
2. the return on equity for is a minimum of over 3.8 times higher than for regular loans (SBA: 70% v. Regular loans 15-18%).

Listen to the 9:06 podcast and see how $70-billion could be added on top of the current +$700-billion banking bailout. I can’t help but note how fuzzy the banks are so far on accounting for the first bailout installment. [click here]

According to Dr. de Rugy, the SBA loan program serves two very powerful masters:

1. “lawmakers who have successfully sold the SBA as a program to help the so popular small businesses and
2. the banking industry, which profits by issuing and selling the low-risk, government-guaranteed small-business loans.”

As of the end of 2006, the SBA had nearly $83 billion in outstanding guaranteed loans that the taxpayers – not the banks – would have to pay if the economy experienced a serious downturn.

BANKING ON THE SBA: Big Banks, not small businesses, benefit the most from SBA loans programs, Veronique de Rugy, August 2007, 4 pages

The Mob: A Working group of Professional Thieves

Thieves steal to live.

Professionals in thievery and business behave in a very similar manner.

Only a tiny percentage of thieves are recognized and view themselves as being professional: full time, rational and consistent planning.

The most prestigious of theft rackets is The Grift or Con games. The Grift requires cooperation among specialists.

The working group of professional thieves is known as a mob, troop, or outfit. The number of members in a mob is determined in part by the racket which is being hustled, in part by the angles which are being played, and in part by the circumstances and situations…Sometimes a large number of thieves work together in a loose organization in the more elaborate confidence games, using a common pay-off joint or big store (fake gambling club or brokerage office.) p. 27

For any group to function productively, certain rules need to be known and obeyed. This discipline is generally higher than in straight business because of the extralegal nature of some of their work.

The mob has many codes, rules, and understandings, most of which are so general that they apply to the whole profession as well as to a particular mob. p. 35

I understand (from books alone) that they are:

1. gains are divided equally (although, different for different roles),
2. all payouts must be paid from the net take (expenses [or nut] first deducted from gross take),
3. all loans must be repaid from the group’s first fruits (rigidly enforced),
4. everyone shares in the profit or loss (good or bad),
5. the fall-dough (shared cash) is used to protect any member of the mob,
6. each member must deal honestly with each other (burning someone is a almost unthinkable, lying is considered more serious than in straight business),
7. if someone leaves the mob, he must ask to be taken back (type of social norm or professional consideration),
8. a member of the mob is not responsible for things outside of his control (appreciation for the role of randomness and luck),
9. a mob member should not cut in on another member’s area of responsibility (reflects negatively on the competence of the “helped” member), and
10. it’s “the responsibility of every member of the mob to do everything  possible to fix a case for any member of the mob if the pinch [arrest, exposure] occurred in connection with mob activities.” p. 38

In addition to their specialized skills, a professional thief must have a more general capability called larceny sense.

Larceny Sense: This term is applied to the thief just as the term “business sense” is applied to the business man. It is an ability to deal with unusual situations in the best possible manner and is acquired in the course of experience. Every thief with good larceny sense will try to figure out every eventuality in taking off a touch. Some thieves are considered to have no larceny sense, while others have plenty of it.

Quotations Source: The Professional Thief, Chapter 2: The Mob, The University of Chicago, 1937 [my emphasis]

Franchise marketing, for some systems, has evolved into a specialized, highly secretive applied fraud. Each trademark system has a number of 3 or 4 professionals working to sell and resell franchises that are designed to fail for the investor.

There is no boss per se within the group. Because the work is underground, there is little documentation available.

If there is a boss in the traditional sense, it would be the banker in head office who are within the small business lending division. These Franchise Bankers (one bank per franchise system) work very closely with the franchisor for their direct lending needs as well as setting up extremely lucrative service contracts for their franchisees (current accounts, merchant accounts, etc.).

In 2000, I interviewed Dan Farmer of the Royal Bank of Canada. He stated that franchise lending was “the most lucrative form of commercial lending there is”.

Roles & Functions

• mark (potential franchisee),
• sales agent (initial contact with mark, as the outsideman he steers marks to the mob’s preferred trademark; they are sometimes nominally independent, sometimes internal; also-known-as: consultants, franchise brokers),
• franchisor contact (initially charming, aura of success, kept at arm’s-length until the loan proceeds are advanced and removed from mark’s current account), and
• lender (specific bank official, specific bank branch: a high-risk, 24-hour turnaround on government guaranteed loans).

In their function as lenders, bank officers owe their borrowers a legal duty to perform lender’s due diligence. They are prohibited by law from creating debt instruments that they knew or should be reasonably be expected to know would be unsustainable or result in the borrower’s financial ruin. In Canada, the relevant statutes are the Bank Act and the Canada Small Business Financing Act and Regulations.

• Banks and bank officers are not being held accountable because these arrangements, although highly exploitable, provide substantial profits to the franchise bar, franchisors, etc. Canada has a well-known reputation for harbouring white-collar criminals.
• This, however,  is very, very fertile litigation soil for outside law firms that can know what questions to ask.

That I am a 1/3 partner in only one active lawsuit, speaks not to the rarity of the fraud but to my restraint and patience for the cleanup to happen. In 2005, we had identified over 12 potential lawsuits involving  just one franchise system, bank pairing.

Additional information on Predatory Franchise Lending and my recommendations to stop such abuse, can be found by in a paper I wrote to Industry Canada in 2005 called Franchising Opportunism: Deceit to secrsy confind. [Predatory Lending, IC Feb 2005]