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This post is in reaction to the Wall Street Journal article 'Financing Programs Aim to Help Franchisees' regarding Franchisors providing 'Lease to Buy' programs and similar arrangements to potential Franchisees who are unable to secure traditional loans.
The Quiznos financing model requires only a $5,000.00 deposit with the condition that up to 80% of store profits are paid to the Franchisor until the debt is paid. Any initial trading losses are tacked on to the loan. The store is legally owned by Quiznos until the debt is paid off, and if the store doesn't generate a profit within 12 months, Quiznos can change ownership.
Churning is the practice of a franchisor selling a site or territory that is not generating a profit, knowing that it will collapse. The purchaser / current Franchisee closes shop with substantial losses yet the Franchisor makes money from changeover fees, whether it be an outgoing fixed fee charged to the vendor and/or a Franchise Fee and inflated start up costs charged to the purchaser. The cycle then continues and the franchisor isn't inclined to close the store as it is making money from the 'churn' rather than sales. The act of churning would be legally pursued as per the Trade Practices Act s52 and s51AC.
Major Australian franchisors such as Lenards, Michel's Patisserie and Howard's Storage World have been accused of churning. Unfortunately, the practice goes largely unnoticed because victims of churning are usually at the point of bankruptcy and cannot afford the extra stress and legal costs of litigation. Furthermore there is usually contributory negligence in that the Franchisee did not conduct their own due diligence or contributed to the losses by failing to adhere to operational standards, the practice cannot be easily proven because by the time a pattern of churning emerges, 3 or 4 franchisees have been and gone and years have passed.
Offering potential franchisees financing in cases where the banks would not is a terrible notion and a blatant conflict of interest as the Franchisor has an obligation to ensure the prospective Franchisee and the store is financially sound and commercially viable. The franchisor offers finance subject to strict conditions, and stands to profit whether the (already in debt) Franchisee succeeds or fails. The practice screams churning and Franchisors interested in long term profitable relationships with their Franchisees should not adopt it.
To read the rest of the article, click here.