Competent Risk Assessment Through Killer Pre Investment Due Diligence

At the risk of repeating myself, we live today in a world of high risk small business investment opportunities.

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. They claim to be proven concepts; to have name recognition; to have buying power; to be able to reduce start up expenses; to have site location expertise; and numerous other advantages that a legitimate franchisor might use to describe what it is offering.

The potential franchisees that attend franchise expos and fairs have no capability to sift out the scams from the real deals. Many of them find it hard to believe that someone would stand there and tell you to your face bald face lies they know not to be true. More of them find it even harder to believe that these companies would actually put the misrepresentations in print in the marketing and sales brochures and Franchise Disclosure Documents they hand out.

The contracts they give you to sign recite specifically that they did not say the things to you that were false and misleading, and, moreover, that if anything was said to you that was out of order, you agree that you did not rely on it in making your investment decision. Some courts will actually enforce these contract provisions. The rationale is that if something was stated to you that you agree was not said to you, and that you agree that you did not rely upon, you cannot later claim such statements to have been fraudulent inducements that caused you to invest in the bad franchise.

The epidemic has reached such enormous proportions that the new FTC Franchise Rule adopted this year prohibits the enforcement of those exculpatory acknowledgements.

That Rule 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.

Thousands of victims of these scams are strewn across the landscape of franchising, many of them appear on Blue MauMau lamenting what happened to them and furious that the government does not have any apparatus whatsoever to prevent franchise fraud and franchisee abuse through opportunistic enforcement of draconian franchise agreement provisions. Among the most vocal of them are the franchisees of the Quiznos sandwich system who claim and are in litigation over the allegations that Quiznos requires them to buy everything from vendors that pay Quiznos commissions on the sales, making the prices for everything so noncompetitively expensive as to preclude any possibility of profit. Moreover, so every sandwich franchisee complains, price competition has so lowered their sandwich sales prices that they are squeezed dry and find it impossible to make any profit. The UPS franchisees claim in their litigation that they are going broke due to overcharges by UPS. The fitness franchisees claim that they were lied to about the ability of the fitness franchise concept to succeed, and those franchisees are up for resale by the hundreds all over the country. The Cuppy”s Coffee franchisees who claim that substantial deposits were required of them, only to find out that they were not going to be franchisees and that the deposits were claimed by the franchisor’s affiliated company to be not refundable.

In this particular instance, the dishonest franchisor was awarded a fair franchise contract seal of approval by the AAFD, a phony association of franchisee groups that claims to be a “leader” in the battle for franchisee rights. When these useless associations present fairness awards to scoundrels, who then tout the award as evidence of their investment worthiness, you get the smell of what franchising is really like today.

The horror stories go on and on across the franchising landscape. The franchise sales people never tell you about these nightmares. You find out that you have been fleeced only after it is too late to extricate yourself from the investment trap. Your calling franchisees on the list of franchisees given to you to ask them about their experiences as franchisees of any given franchise company do not yield the input you expect. Existing franchisees won’t give out the bad news, because they believe you are an agent of the franchisor trying to find out who is badmouthing the company. They also don’t want to say things that might make it harder for them to sell their bad franchises to some other poor guy so that he can take the financial lumps. They won’t say good things either, more and more these days, because some of them have been sued claiming that they were part of the fraudulent franchise sales scheme.

While that isn’t so in every instance, it is so with sufficient frequency that the value of the list of franchisees to call as a due diligence quality control facility has been completely compromised. It is simply no longer a reliable indicator of the quality of the franchise relationship in any franchise system.

You simply cannot sort out the risks by yourself. You don’t know enough about the industry to spot the traps.

A general business lawyer without a great deal of experience in the franchise industries providing due diligence for franchise investors is also not of competent quality to advise on franchise investment opportunities. There are a few – a very few – franchise lawyers who have sufficient knowledge about how everything works in franchising to be of real use to you. You have to get on the Internet and find them. If you don’t know how to go to a resource like Google or MSN.com or Yahoo.com and do a search using the words “franchise lawyer”, you are not ready to invest in a franchise. Even among the lawyers who do turn up on that search, you have to ask them when you call them whether their practice focuses on pre investment due diligence.

You have to budget for this assistance. Most franchise due diligence specialists will offer a flexible fee structure to fit what you want to accomplish. You can pay them to vet one deal at a time or a larger flat fee to vet as many proposals as may interest you over a period of six months or more. You need to count on devoting between $ 3,000 and $ 5,000 to this resource by the time you are done. You should never assume that you will end up buying the first franchise you bring to the lawyer for due diligence. The usual pattern is that the first deal doesn’t work for you and that you will go through three of four additional investment concepts before you find one that fits. Hiring some lawyer to “read the contract” or “read the disclosure documents” is useless. It’s cheap. But it won’t provide any insight into the most serious business risks. Every failed franchisee hired some cheap lawyer to “read the contract” When you add up what you are risking, you will appreciate that a few hundred dollars for an incompetent review of documents by someone who doesn’t know where else to look for what needs to be considered is really stupid. You can’t afford that approach. But it’s your money and your decision.

Litigation and arbitration are not acceptable ways to deal with the risks inherent in franchise investment fraud. Only killer pre investment due diligence can serve to identify and reduce critical risks. If you have read the other franchise fraud tutorial articles on this web site, you will appreciate that this is not a safe investment environment.