Franchise Investments - Competent Interdisciplinary Due Diligence

You think you want to buy a franchise. You’ve had the sales pitch and been to Discovery Day, the day the franchisor sets apart to razzle-dazzle franchise buyers. You’re hotter’n a ten dollar pistol for this deal that you think is your future, financially and in terms of personal career achievement satisfaction. You are sold. But you probably don’t really understand what you are looking at. Why not? The reason you lack insight into the proposition before you is that you have not had any experience in small business investment vetting. You may have an MBA and twenty years corporate business experience. You may have more awards than Tiger Woods. But this is a different world than you could possibly imagine.

It is a world in which what you see is probably not real; and what is told to you is probably false, no matter how sound it seems and how much sense what has been said to you seems to make.

You have in your possession an FDD, a Franchise Disclosure Document. It says – because it is required to say – that you should not rely on it alone to acquire an understanding of the agreement/contract you are thinking of signing. Since the reference is “contract”, your mind turns to “legal” and “lawyer”. But it says you should consult a legal or other advisor. What does than mean?

It means that knowing the legal side of the proposition is insufficient for the making of an informed investment decision.

Practically every provision of the franchise agreement has an economic/financial consequence. It is not just what the initial fee and the royalty rate may be, or the advertising requirements. Every term in that document has economic risk implications. It presents a profile of economic/financial risk that is not fully accounted for in the FDD. If you can’t determine what that is, and if you can’t estimate competently what resources you must have in order to acquit yourself in the face of that risk profile, you will probably end up in bankruptcy court instead of as a member of some country club with money in the bank and a secure future.

Franchising today is full of scams – deals that are not real and that are masquerading as real investment opportunities. These scams abound and are operated by professionals who have fleeced smarter people than you. Go to www.BlueMauMau.org, the leading franchise investment blog site and read all the stories of people like you who have been fleeced and left totally destroyed. Read the expert advice articles and start to get a real appreciation of the extreme risk of investing in a franchise opportunity today. Then take a deep breath and step back from the deal on the table in front of you.

You don’t have to lose everything because you invested in a business relationship you don’t fully understand. But you can’t possibly sort it out by just going to a general practice business lawyer and having a “legal” evaluation of the proposition. You must have both a legal and a business issue evaluation of it. Your professional resource must be able and willing to provide both sides of it. Without that you are just trying to play football on one leg.

Interdisciplinary vetting of any franchise is absolutely necessary in order for you to understand the real risks. Even the most astute expert may miss something that a sophisticated crook may try to pull on you. But reducing the investment risks is something you cannot afford to forego. The disciplines of law, economics, financial planning, operational feasibility, market place analysis and knowledge of the franchising business are all indispensible. If the lawyer you choose can’t do it all, you are putting yourself at a serious disadvantage when you sign the agreement and write the big check and take out the big loan and sign the long term retail location lease. You are, although you may not fully appreciate it, taking on over one million dollars of risk in a deal that says that the total initial investment is from $ 200,000 to $ 300,000. The total initial investment information in every FDD in the world today is vastly understated. If your lawyer doesn’t understand what that is and how to evaluate it, you will not know whether you are adequately capitalized for the investment risk. You will find out too late that you face gambler’s ruin – an economic doctrine that says that even if the risk is possible of successful assumption over the long run, if you don’t have enough money to get you through it all, you will go broke before the goal is reached. That is precisely where the total initial investment information provided in the FDD is always misleading. The reason is that if you knew the truth of the matter, you would know that the investment is not a sound investment. And that is only one easy example of what you are dealing with.

The list of FDD inadequacies and the explanations why would fill a book. I can’t list all the variations of inaccurate statements about each aspect of a franchise agreement within the space of this article. This is intended to tell you that you need to assure that the person who is assisting you in evaluating a franchise opportunity must have not only a law degree and business law experience, but also a solid background in franchise business law and the ability to go beyond mere legal explanations of what legal documents say.

Very few lawyers can or will go there. Their errors and omissions insurance probably doesn’t cover their giving business advice. They don’t know enough about the subject to do it competently anyway. If you don’t use a lawyer who can cover all the interdisciplinary requisites of this assignment, you will never know the risks until it is too late for you to hedge against them. How do you find the right person?

You go to Google or any other search engine, and you do a search using the words Franchise Lawyer. You then call every one of them that shows up on the first two pages of search results and you ask them the following questions. Do you practice franchise law as your main professional activity? How much of your practice is focused upon franchising? How much of your practice is focused on pre investment franchise due diligence? Do you provide advice about the business and financial aspects and risks of franchise investments in addition to the legal advice about it? If the lawyer you are speaking to does not give you affirmative and definite answers to show that franchise pre investment due diligence is what he focuses upon, and that what he provides includes business and financial analysis as well as legal analysis, call the next person on the list and ask the same questions.

You can’t make an economically and legally rational decision relying on a one trick pony.

Do yourself and your loved ones the justice you want for them. It may mean changing your mind on things you have already decided to do and having to tell your family that you were about to make a terrible mistake. But that is a lot better than having to tell them later on that you have lost everything and have to file bankruptcy.

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Comments

due diligence

The above statement is so true. The Zors lie, they do not disclose new store openings that cut into your sales and then bring yo below break-even. I know someone who went to work for a Zor and they have totally changed. They have become a greedy mean pig and outlook on life has changed. It is terrible how some of the Zor's operate. Spying on people, reviewing their tax returns, stealing from Zee's funds. Very odd to me.
How can someone due true diligence when noone discloses the truth.

Outstanding!

Articles like Richard's are the very reason I refer people to BMM. The people I have talked to who have lost everything or are suffering because not knowing how much is involved in investing in a franchise will not understand everything you wrote Richard. Why? It takes months of studying the world of franchising.

There are many very smart intellects and very savvy business people who post here on BMM. The problem is there are many scams out there in franchising that target people who don't have the intellect and business savvy as the cast on BMM. I admit I am one of them.

After reading the blogs like Richard's now I understand alot more. What is sad is most people will not take the time to study and learn. When financially ruined many want to forget.

Thank you for valuble information and knowledge. .

Competent Interdisciplinary Due Diligence

As usual Richard, an excellent article, which only a person with many years of experience could write. Unfortunately, very few people who need this advice will read this and if they do the pro salespeople or most attorneys can use it to sell their clients. They just tell them they are not like the franchise as you describe. In my opinion, and I believe your opinion, as you have stated in previous statements, there are no franchises I would recommend which are available. I have been involved in almost every level of franchising for even more years as you Richard. A number of years ago I would state that I have probably sold directly or indirectly more franchises than anyone and that to my knowledge NO ONE has lost their investment in a franchise I (we) sold. A number of years ago, we used the 95% statement, which at the time was reasonably accurate in as much it was and has been misquoted as it did not say 95% were successful, it stated 95% did not loose their investment. Big difference! In a lot of cases then the franchise who was not succeeding was sold or taken over by the zor. The full story of this is a very complicated story but the franchise industry was totally different then.

Today, the whole economy, as well as the franchise industry is in a total meltdown. I, as well as many others have been yelling doomsday, but very few listened. Every body now is rushing in to cover their asses. President Bush will probably push for the bailout so his cohorts can lay the cost on the masses. I cannot communicate the whole story of the mess but have watched the franchise industry being attacked by the forces of doom for a number of years now. It is difficult to define the forces that have brought the country world) to its knees. I believe the main culprits have been the equity companies (EC) or M& A .I have a list of all the EC’s that have bought up hundreds of franchise companies and are basically bleeding them dry. They buy the companies at almost any cost as they finance most of the cost and derive a huge commission on the sale and in many cases promote them and sell off at a great profit of get back dividends which return their investment.They don”t care if the loans are paid back as they get there fortunes before and then usually slese out bfgore any crash and then let others take the rap. An article in the fortune magazine written about a year ago titled “Why the equity bubble is about ready to burst” was an excellent story on the big problem. I will try to attach the article Of course we all know it has burst.
A few years ago after deciding not to continue a development plan for franchising that I as well as others felt would be an effective plan to expand a franchise, but the zors would decide to make their fortune by ripping off the zees and investors as we observed with most of the zors listed on Bluemauma. My plan, that is working on a few franchises so far, is for a better title “ The Area Representative Program” which is a very comprehensive program which was used in part by several franchises I helped develop into international franchises. In essence it is designed to use Area representatives which manage areas under a very comprehensive uniform guidance system designed around a single software program which some call business intelligence program . It is also set up as the AR does not sell the franchises. We have learned the hard way that most good managers are not good salesmen and good salesmen are not good managers. Also, it is important that to develop this concept, you don’t do as most do today, to design the program around a national development program where you choose a number of regions nationally, usually at least ten to twelve and award the area to an AR and then develop all of the regions at the same time. The development program is designed to reach as many potential clients as possible in each area and show them that we will impact open, not only their area, but all 10 or so regions. This will maximize the economy of scale and would have a tremendous impact for the zor and the zees. It is also important that the monies from the fees, especially the AR fees, in the most part be invested back into the AR region . This should be part of the contract. To open a franchise here a there randomly if , as is done in most cases in the highly competitively market is a death wish. There are many details to this program that are important that can’t be explained here but would be happy to explain or show the details to all who are interested. It is extremely important that perhaps with a group of people from this forum can get together and help develop this program as the main purpose for me is to turn the franchise industry around a hopefully get the sharks out of the franchise business.

I have for many years tried to get a good simple definition of franchising and had learned what I believe was generated by my first franchise venture as it was the first conversion real estate franchise. When you approach real estate brokers and tell them to join together under one name all you have to offer is franchising as they are already in a successful business , ..right?

What we defined then was bringing a great many business people together to do the things together that you can’t do as one. Think about it!
Subsequently, every time I approached any group interested in franchising I would ask,”Give me ten reasons why you think franchising is so successful and list them in order of importance and don’t repeat yourself.” The answer is quite simple but you would not believe the answers I received.
That first Real estate franchise we developed had a saying we used .
“No Army can withstand the strength of an IDEA whose time has come” Victor Hugo
DonBeau "Your connection to the world of franchising"

Competence in the marketplace of franchising

Obviously, franchising has been part of the bubble that has burst and there will be some in Big Franchising who will go down, perhaps, if the Rescue Package to be passed next week doesn't give them some relief.

Predatory lending, securitization of royalties and leases, etc.. will now take their toll. I read recently on Goliath or one of the legal sites that in May of 2008, several big franchisors had plans for 2008 to securitize royalties, and that the securitization of royalties allowed franchisors to save money long term, over the traditional methods of raising money.

Richard Solomon tells the TRUTH ---There is now great incompetence in the marketplace of franchising. These are dangerous times for franchisors and especially dangerous times for franchisees who will become victims if they don't do their due diligence with experts like Richard Solomon, and other franchiSEE attorneys.

As Richard Solomon so ably demonstrates in his article. The Regulation of Franchising is a joke that can become a tragedy of great proportion when prospective buyers of franchises buy franchises based on the appearance of government oversight of the industry and the government disclosure document.

Franchisors do survive recessions because of their visibility in the economy and because of their ability to churn units within their systems out of view of new buyers of their franchises.

LET THE BUYER BEWARE