The Coming Franchise Investment Bloodbath

A tuning fork is an acoustic resonator in the form of a two-pronged fork with the tines formed from a U-shaped bar of elastic metal (usually steel). It resonates at a specific constant pitch when set vibrating by striking it against a surface or with an object… Wikipedia

If what Richard Solomon is saying over at Blue MauMau is NOT resonating with you, you’re a potential individual in…

…a sea of dead franchise fish stinking up the franchise world for many years to come in the near future.

Why?

Tens of thousands are exiting companies due to tough economic conditions. They have poor job prospects. They have access to half a million dollars and more in liquidity. They are considering small business ownership as their next move.

Whatever their prior experience, none has ever done pre investment due diligence on any small business investment, and none has ever done pre investment due diligence on franchise investment. Despite their education and experience, they are fish out of water.

You should read every word Solomon has to say. And then make sure your spouse does the same. Then give the article to any family member or friend you’d hit up to save your sorry future ass by throwing good  money after bad.

• This advice goes double for those poor pathetic souls stuck in franchising now.

There are three types of franchisees and all of them are in a certain % of denial:

1. the smug profitable ones (so the future is the same as the past? okay…),
2. the ones just scraping by (can’t make ROI in good times but in bad times…?) and
3. the ones bleed internally and anally.

No sane individual should invest or renew in any franchise heading into these worldwide recessionary times.

Richard’s advice stands on its own.

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Accidental franchises: Sue franchisor and their lawyer

When a franchisor and their lawyers pretends that a franchise is a license or distributorship, sometimes they end up shooting themselves in the foot.

An interesting article on FranchiseChat.com this week demonstrates how an Accidental franchise happens. And the consequences can be very profound.

Kevin Tampone of The Central New York Business Journal (Make & Take, franchisees battle in court) starts off pretty hum-drum [Gosh, not another franchise misrepresentation case?]

It warms up substantially when Michael Einbinder’s name is dropped as he is a very heavy-duty lawyer.

Okay…These guys are very good. What next? So it seems the allegations are that the franchisor lied and failed to make a legal franchise offering: No disclosure documents were given and…

State law, he says, forbids companies from making such earnings claims unless they’re contained in a specific document, called a uniform franchise offering circular. Make & Take did not provide the franchisees with that document before actually selling them franchises, Einbinder says.

…the system was not registered to offer franchises in New York state (although there was a legal requirement to do so). The U.S. law defines a franchise very, very broadly and intentionally so, as to stop this weasel marketing efforts.

This is why the franchisor’s lawyers are being sued:

The firm helped Make & Take circumvent state requirements by creating licensing agreements for the company, the suit charges. The actions were part of a “scheme” to sell franchises in violation of the law, according to the suit.

While none of these allegations are proven, this is good example of an Accidental franchise (sometimes called hidden, inadvertant or unintentional franchises).

• Accidental franchises are disguised as distributorships or licenses so as to avoid state and federal legal requirement and obligations [read: consumer protection laws].

There is, of course, seldom nothing accidental or unintentional about these situations. These are all grown-up gentlemen and lady lawyers who have a duty to their client and their Courts not to be engaged in a conspiracy to commit fraud against specific investors and the good people of New York state.

And the old “ignorance of the law” chestnut applies to everyone, right? Even lawyers in limited liability corporations, right?

• With the operating losses in the $2-million for each of the three plaintiffs, you’d wonder why the lending institutions were not named in the lawsuit because they should have not released any funds without having on file the appropriate client paperwork [releasing the funds would have breached their lending duty]
• Statements of Claim can always be amended, I suppose but…
• Richard Solomon explains how proving predatory franchise lending is so tough.

How can banks get away with repeatedly and knowingly lending into crapola franchises?

It ain’t called a bank shot for nothing.

It’s as simple as Richard Solomon explains over at Blue MauMau.

First, Richard spells out the weasel play in an article named The Complicit Loan Broker In Franchise Fraud. [Whether there is a broker or not doesn’t matter.]

It is common practice in franchising for a franchisor, especially a fairly new franchisor, to steer its franchise investors to a particular loan broker, and sometimes even to a particular bank. It is also fairly customary for the loan broker or bank to pay the franchisor for the “traffic”.

The information in the business plan always comes from the franchise sales/marketing people of the franchisor. The franchisee has little or no input in the whole matter other than to sign what is put before him by the loan broker without reading it or with scant attention being paid to it. The information is almost always false in the sense that it is full of exaggerations, to put it nicely, and the pro forma financial information has little or no basis in fact.

Richard goes through the details and asks rhetorically with knowing what the answer is:

What is the likelihood that a franchise investor, on these facts and with this testimony, will get a favorable verdict? Anyone care to guess? Since it may be a somewhat novel case, what is the likelihood that a favorable verdict will be upheld on appeal? Anyone care to guess?

And when Michael Webster asks a pertinent question:

How can the franchisor provided information to the loan broker, an agent of the franchisee, which amounts to an earnings claim when the franchisor disclaims making earnings claims in their Item 19?

Richard goes on to explain:

In the mind of the jailhouse lawyer crooked franchisor, providing information to help a franchise investor obtain a loan and complete a business plan (which it all total crapola anyway), is not considered (by them) to be the making of an earnings claim. In the weasel word play of franchising there is the FDD, and then there is everything else. The position that we weren’t defrauding the franchisee; if anything we gave the bank false information by providing it for the franchise investor’s business plan, is not just some cynical homorous thaing I made up. That’s how it really goes down.

It is useful to read the whole thread and then keep an eye on the posting.

Here’s a clip from one comment (named appropriately Hindsight) that has shown up:

How I wish I had read an article like this 12 months ago. This type of article should be covered on a major publication small business section.

Betcha wish you had read this article before signing up, eh?

The Franchise Fraud by Robert Purvin

Bob Purvin’s book is a must read.

Don’t listen to Richard Solomon’s rants against Purvin and the American Association of Franchisees and Dealers. Richard needs a distemper shot.

In a Blue MauMau posting, Bob tries to explain what he meant by fraud:

Purvin explained it was a much bigger problem which he addressed in a book he wrote, The Franchise Fraud, which was republished recently. He told them that it wasn’t so much about the people that were out selling fraudulent deals, but that the franchising industry had painted a rosy picture about franchising. He said they tell you that when you buy a franchise you are reducing your odds for failure and dramatically increasing your odds of success, because everybody knows when you buy a franchise you buy a proven commodity. He said, “That’s false. Most franchises are much weaker than they appear to be. The blue chip list of franchise opportunities is a very short list.“

He goes on to state that any legal protection is an illusion:

He also said that people believe that they are protected by a fabric of laws that would prevent them from being defrauded. “That also is false.” The point of his book was to wake up the buying masses that when they buy a franchise they have to be very careful and treat that purchase every bit as cautiously as the guy in the corner who says, do you want to buy my Rolex watch. Unfortunately, hundreds of thousands have been bitten by the franchise bug and can’t believe that they weren’t buying into a sure thing, Purvin said.

Sound advice from a real pro.

1. Most franchise systems are unproven.
2. The blue chip franchises are very few.
3. There is no legal protection.
4. Treat buying a franchise like you would buying a “genuine” Rolex on the street.
5. Hundreds of thousands have been burned.

Read the book.

Solomon on Modern Franchising

Richard Solomon on Blue MauMau: Competent Risk Assessment Through Killer Pre Investment Due Diligence.

Absolutely right on the money.

Richard’s statement of problem:

The hoards of potential investors with access to over $ 500,000, coming out of downsizing companies and merger resulting reductions of work forces, have brought sharp practitioners to the small business opportunities field. These phony franchise opportunities masquerade as real business prospects, using the same descriptors as the legitimate franchise opportunities.

Does he see Any Protection?:

That Rule [FTC Rule, or similar disclosure type scams] does not, however, provide any reliable investment protection. The reason for this is that when you have parted with your total initial investment of upwards of $ 350,000 or more, and are on the hook for a ten year lease and to repay a large SBA business loan, and have personally guaranteed the performance of the franchise agreement (as they all now require), and have agreed to pay upwards of $ 100,000 to the franchisor as liquidated damages if you fail (which they all now also require), you have no resources left to pay for expensive litigation when you realize you were defrauded and are just plain broke. You are looking at bankruptcy as your only avenue of escape.

Richard versus Les: I agree with 100% the diagnosis. We part company regarding post-signing franchisor opportunism.

The problem, for me, is after you sign, the franchisor reserves the unilateral rights to:

1. turn into the most predatory S.O.B. operator imaginable [sign with Dr. Jeckyll who turns out to be Mr. Hyde].
2. Force you to sell to him your very high volume and profitable store at 15% of its value.
3. Or sells the whole system to a sleaze ball.
4. Or goes bankrupt/insolvent [new squeeze, divorce, switch teams, boredom…who know/cares?: result is the same for investor].
5. Or decides your store looks good on Son #1 or the moron brother-in-law.
6. Or [screw u du jour: a hundred other ways of excercising their discretion in an opportunistic way].

Yes, Killer Due Diligence works if the franchisee:franchisor relationship were to stay the same over the first term of the contract. But it does not.

• Pretending that the “good guys” will stay “good guys”, is too much of a leap of faith for me. I believe individuals are much more complicated that good or bad, black or white, evil/honest, etc.

I think the temptation to coerce more cash from a practically defenseless franchisee is too great for the vast majority of businesspeople.

I don’t think that franchisors are any more greedy than anyone else. I just think their situation [monopoly on supplies, renovations & equipment, $ from top not profits, etc.] gives them more opportunity to act selfishly than most business situations.

• BTW: I have zero doubt that if the roles were reversed, the vast majority of franchisees would be just as nasty. [Sorry…franchisees have just the same human strengths and weaknesses as anyone else. Easy to be morally superior when you have never been seriously tempted.]

For now, For the subordinate party, I say: Franchising is Unsafe at any Brand.

Get Smart. Get Solomon on franchising

Richard Solomon is an experienced U.S. franchise lawyer. His Franchise Remedies website is a very valuable educational resource. Everyone should bookmark it.

Especially spouses.

If you are thinking of investing (as a family) in a franchise, you will want to use Solomon’s FranWhack service. Priceless.

Solomon has several Franchise Fraud Symposium Articles that are just excellent.

Want to know how the lenders try to cover their breaches of lending duty or how franchise agreements create A License to Lie, Cheat & Steal? or how immigrants are targeted in franchising?

Words of wisdom from someone who was there when franchising was just a kid.

Catch Solomon as a regular Blue MauMau contributor (ie. The FranWad Manifesto column and discussion).

Get Smart. Get Solomon.

Selling a McLaw: Solomon on Oz

In an op-ed post on Blue MauMau, U.S. attorney Richard Solomon presents his extremely important views on the future of Oz franchise law. He speaks with true authority.

The article is called Australian Franchise Law: Assurances of Protection or Just More Christians Thrown to the Lions? and should be nailed to the forehead of everyone who thinks government or the ACCC will do anything other than serve their masters.

Richard starts his summary in his usual, no BS manner:

…Will Australia become a dumping ground for over the hill concepts that can no longer find growth in America? Yes it will in very many cases. Will American franchise companies pre-empt the market, stifling Australian concept creation? Probably. Will the flavors of Australian culture now found in its native small businesses be lost or diluted? Of course. Now aint that a shame?

What about the useless U.S. “protection systems”?

Will the Australian regulatory scheme track the franchisor advantaged regulatory scheme in America? You’re damn right it will. If that is what’s in store for our friends down under, why the hell do it at all?

Isn’t it bad enough that America blindsides its citizens with a pretense of investment protection in the franchise business? Why are the Aussies considering a similar system for themselves? Are they so self loathing that they would consciously set their own people up for investment disaster?

The franchisor lobby will win any battle in the political arena.

When the IFA [International Franchise Association] is finished with the Australian government, it will have either no franchise regulation or it will have regulation so weak as to be a ridiculous charade.

The only power the franchisor lobby fears is digital information sharing because it cannot control its distribution. They use the law (word-, type-based, linear); the fools use the new media: the internet (electric, acoustic, all-at-once)

Power never takes a back step – only in the face of more power. Malcolm X