Nothing Wrong With Franchising That Franchisees Cannot Fix

Free market economics assumes that there will be tough people doing tough things. It assumes that these will include crooks who will do anything to separate folks from their money, regardless of the theoretical consequences. It also assumes that markets can only remain free if there is a minimalist approach to government interference. It is axiomatic to free markets that they govern best who govern least. It is for that reason that there are rules so organized that government can step in when things get really way out of hand, but restrain the governing hand where there are adequate resources for people operating in the market to take effective steps to protect their own interests. 

In the context of franchising, it has been necessary that regulations be created not only to prohibit dishonesty, but to affirmatively require certain protocols of disclosure to be observed in order to lessen fraud. As an adjunct to the regulations themselves, agencies were empowered to take enforcement action in instances where non compliance is sufficiently pervasive to require government intervention to deal with widespread risk of criminal or hard core civil wrongdoing. This regimen has been established in overlapping jurisdictional configuration with cumulative responsibility at federal and state levels. 

It has always been the case that the main enforcement of these regulations was to be private action. Government action was always intended to be reserved for situations where private action was incapable of dealing with active threats. Accordingly, appropriations were never made available for pervasive government enforcement. Whenever you see the availability of a private right of action, the intention is that the private right to take action is intended to be the mechanism to deal with all problems that may arise in that business. In franchising, it was never intended or contemplated that people should rely upon government enforcement to protect their private interests. In addition to the regulations themselves, there remained available all the common law and other statutory remedies that were designed to facilitate addressing the grievances at issue. 

Self defense was and is intended to take three forms. The first is, of course, that you cannot simply take what sellers of business investment opportunities say without thorough investigation. Individual small business investment is unlike investing in securities in that the buyer will actually be operating the business rather than relying upon others to operate the business as in the instance of securities. That puts the buyer up close and personal with the hands on day to day realities of managing the risks. 

This first line of defense has been the most lacking in quality up until now. Franchise buyers do not know how to vet franchise offerings, and no one in the legal or accounting professions knew a lot about how to go about that either. Consequently, potential franchise investors would go to business lawyers who could do no more than explain what the franchise contract said and who are unable to opine regarding the degree of business risk. When asked if they think a proposition is a good investment, the only competent answer that any lawyer or accountant could give has been that it could be a good investment if what the sellers are telling you is true.

The techniques to ascertain whether what is being said to the prospect is true remained arcane until now. Now there are some, but not many, who can do due diligence on franchise investments that is at a very high level of quality. It still isn’t perfect and it never will be fool proof, because the mind of the crook is ever fertile. But so many more risk management questions can now be answered effectively that there is less and less of an excuse for an investor not availing himself of this resource. The cost of this assistance is higher than the small fee for just reading contracts. Instead of a few hundred dollars, the investor must now plan for upwards of $ 3,000 to $ 5,000 for effective franchise due diligence. On the other hand, if you are going to risk anywhere from $ 250,000 to over $ 1,000,000, including loan and lease liability in addition to the initial cash outlay, assumption of that risk calls for the higher quality of due diligence assistance. Between the sheer size of the financial risk and the risks inherent in very unfavorable contract terms, failure to budget for adequate due diligence could now be said to represent negligence on the part of the franchise investor. Simply put, if you go off the high dive without assuring that there is enough water in the pool, it’s your own fault if you break your neck by hitting the bottom of the pool.   

Post closing risk management can also be facilitated by franchisees having the temerity to form an effective franchisee association early on. It is possible to observe direct relationships between the profit potential of a franchise system for the franchisees according to whether the franchisees are competently defending their own turf. Many times, collective self defense can overcome the terms of the contract, as in the case of purchasing management. There is no buying power benefit for a franchisee unless the franchisees control purchasing. Where that is not done, it is the franchisor who gets the benefit of the collective franchisee buying power. 

With a strong franchisee association, expensive modifications to “new look” store appearance and other similarly large capital outlays get sorted out before the franchisees have to undertake the cost. Without strong franchisee association influence, “new look” capital expenditures can be and are mandated without any sorting out operationally of whether the modification/upgrade has any potential to improve sales and profits, and new looks get abandoned/changed without prior proper market testing by the franchisor. Renewal terms and new contract terms are also matters that can be influenced by a strong franchisee association. 

There are so many benefits to a strong franchisee association being established and competently managed that one could reasonably posit that failure to do so constitutes franchisee negligence. They simply shot themselves in the foot and are nothing more than a group of cowardly, cheapskate whiners who get what whiners always get. 

The third leg of franchisee self defense is litigation. Litigation, however, is too expensive and risky. It is the worst possible way to resolve business issues. But it is available when all else has failed. The important point is that formal dispute resolution in court or arbitration is far less likely to be necessary if the franchisees have done what they should do in the first two categories of self protection, due diligence and group action. 

There has been a great deal of pain in franchising because of the failure to address the heart of the problems of the franchising industry. It is now no longer acceptable to throw yourself into a meat grinder in order to invest in a franchised business relationship. Accordingly, if you do throw yourself into a meat grinder, you will simply be out of luck. The system of market regulation is not going to change to accommodate those who will not help themselves. A perfect example of that is the impotent whining for rules of “good faith and fair dealing” that has been heard in the halls of Congress for so many years. Franchisees have been told that they now have what they need to survive in the world of franchising. If they fail to avail themselves of the proper resources that are there for them, they will simply suffer dire consequences.