- Front Page
- Biz Tools
CHICAGO — Former Illinois franchise regulator Robert A. Tingler gives his impressions of the franchise industry to Blue MauMau via email. Out of office and more free to talk, he makes several suggestions for improvements.
Tingler was the franchise bureau chief in the Illinois attorney general's office until 2008 and a participant in the work of the North American Securities Administrators Association, a collection of state administrators devoted to investor protection. Attorney Tingler was influential in revising the Federal Trade Commission Rule, now referred to as the FDD or Franchise Disclosure Document, which incorporates prior disclosure efforts of the NASAA and FTC. He is currently a private practitioner based in Palatine, Illinois.
Q: As a reporter, I have to dig through stories of bad franchising all the time. Right now there have been a lot. I just don't have enough time or resources to report even a small portion of these horror stories. In your 23 years of working in the Illinois attorney general's office, you had to deal with a wide variety of investment opportunities and scams. So let me ask you: How bad is the playing field in franchising compared to other sectors, like securities?
Tingler: Trying to compare franchise purchasers and securities buyers sounds next to impossible. The franchisee is seeking a business that will normally have much higher costs — initial fees; ongoing franchise and ad fees; professional fees; repair costs; special equipment; insurance; lease payments; salaries. . . . Their motivation and expectations will usually be different. With full disclosure in a stock offering, especially when a prospectus says, in effect, "This stock is a really bad asset to buy," you have fewer public complaints than from investors in franchises. Unlike the small investor securities buyer, the franchisee is frequently betting everything on buying a business that will support a family and represent a source of retirement funds. It is not unusual for the small investor franchisee to use home equity and friends or family loans to finance the franchise purchase.
Whether the transaction is a franchise or a different business model, the larger the transaction the more likely due diligence will include a lawyer, accountant and perhaps a consultant, which should result in a high percentage of buyers not being surprised later.
The non-franchise business buyers are faced with [a worse scenario]: creating their own due diligence standards; without regulatory oversight and reporting of conflicts; and typically when the deal is consummated there is no continuing relationship between buyer and seller. I believe these three factors make it more difficult for such buyers to gather information comparable to the franchisor/franchisee relationship.
Q: Speaking of due diligence, what do you make of the Franchise Disclosure Document (FDD) that is provided to franchise investors by a franchisor? Is the information it asks of the franchisor sufficient? Is it reliable? Does it need changing?
Tingler: The current state and federal disclosure requirements are the product of over ten years of discussions involving regulators, franchisees, franchisors and their representatives. Despite instances that might be addressed by further regulation, the FDD and respective state requirements will probably remain unchanged for quite a while.
A downside to the Franchise Disclosure Documents results from prospective franchisees believing that renting an adviser of any kind is a waste of money, since the due diligence questions and answers are "already covered" in the FDD. The underfunded, non-franchise buyer seeks advice from his corner tavern bartender. Too often the franchisee prospect gets his advice by glancing at his FDD and, if he even asks a question, relies upon the salesperson's answer. Somehow reporters, regulators, professional advisors, and even franchisors, must convince prospective franchisees that the FDD is only the beginning of their investigation.
Franchisors have told me that prospective franchisees have attended one-on-one and group meetings without asking a single question. One franchisor solved this problem by telling each applicant signing up for conferences that there would be three separate meetings for the franchisor and prospect to get to know each other. At each of these meetings the prospect had to bring a minimum of eight questions about their concerns and the business they wanted to buy. Failure to do this resulted in cancellation of the meeting and a second failure to bring questions would deny the prospect any opportunity to buy. Their litigation was virtually nonexistent, their turnover rate was only due to death or retirement and the franchisees that survived the selection process were team players who believed that their opinions counted despite working in an environment of uniformity.
Q: That's a good example of getting answers in bite sizes to avoid impulse buying of a business. Before that you mentioned salespersons, which got me thinking how franchising seems more single-minded and organized to sell businesses. I wonder how badly false expectations are painted in franchising compared to non-franchised sectors, especially since often hundreds of thousands of dollars are at stake. I wonder how you find out which has more investor complaints?
Tingler: Unless a respected source I am unaware of has very recently prepared a new, comprehensive analysis of not only the success and failure rates for franchises vs. non-franchise small businesses, but also the number of pre- and post-sales complaints when both categories of business were sold, I don't know of a good source for making the comparison you are looking for. Combining all the success rate studies that I am aware of, my conclusion has been that there are not a lot of differences between success rates for independent vs. franchised businesses by the time three to five years have passed. The most ridiculous analysis touted by salespeople is derived from a chart still floating around on the web, which claims a 98 percent success rate for franchises.
This might be an attractive thesis topic if shopped to the hundreds of colleges, universities, law schools and journalism schools. I think the economy is driving a higher percentage of prospective franchisees with severance and retirement money to buy a franchise, which may skew a comparison of problems non-franchise buyers encounter — but overall I am not sure the two bundles of problems with becoming franchisees or independent business persons can be successfully compared. A serious suggestion would be to see if a university grant writer would take you under their wing to apply for federal funds to do this complex study, which if done well would serve every corner of the franchise business model.
Q: Do you have any suggestions on what could be done to better help franchisee investors?
Tingler: I suppose one additional disclosure, before a contract is signed, could be for the franchisor to have to provide a half page report added to the FDD, written by the prospective franchisee and franchisor, listing all significant problems they encountered and whether each was satisfactorily resolved. Such declarations would be made available to new prospects upon request. To be meaningful, there should be another half page for each franchisee to report any significant problems, regardless of how long the owner had been a franchisee. For example, requiring a franchisee to declare by a certain date that it is going to continue as a franchisee; but after doing so, the franchisor presents a new contract with increased franchise fees and new rules despite no opportunity to negotiate such issues.
A third report could be an exit interview when a franchisee leaves the system and which would give the new prospect an insight as to what expenses and problems the franchisee might incur. For instance, a franchisor requires a franchisee revamp the entire store, despite having already done the entire store a month earlier. (I guarantee this paragraph would create apoplexy and a firestorm of protests. A universal rule would need to be developed demanding this information and protecting the franchisee and former franchisee that relates to material issues from when he was in business.)
Perhaps a fourth problem is the number of default resolutions coming from arbitration, which many franchise buyers are not aware of and which are not allowed to be used as precedents.
Finally I believe misunderstandings, dropouts and post-sale litigation could be greatly reduced if a five-page evaluation had to be completed by both the applicant and the franchisor. What does the franchisee expect and what is the franchisor willing to provide?
An underlying issue most prospective franchisees do not understand is that if a buyer has a concern that is not addressed in the contract, the chances of winning a future argument because of assurances allegedly made by a salesperson are virtually nonexistent.