The Coming Franchise Investment Bloodbath
Tens of thousands are exiting companies due to tough economic conditions. They have poor job prospects. They have access to half a million dollars and more in liquidity. They are considering small business ownership as their next move.
Whatever their prior experience, none has ever done pre investment due diligence on any small business investment, and none has ever done pre investment due diligence on franchise investment. Despite their education and experience, they are fish out of water.
They are also targets of crooked franchise scams that now abound in this target rich environment. The scams abound mainly in new/recently minted franchise pseudo concepts and in over the hill concepts whose past history of success does not describe their current present tense prospects. Both are being touted as the way to a secure financial future as your own boss. Both will use slick professional looking documents and well rehearsed dog and pony shows called “discovery day” in which the victims are smooth talked with lies that they agree in the franchise contracts they were never told because the franchisor disclaims oral representations and anything else that is not specifically stated in the FDD material; the franchisee acknowledges that no such oral representations were ever made; and the franchisee also agrees that if any pregnant representations were in fact made, he did not rely upon any of them in making his investment decision. Neither the victim nor the incompetent lawyer who advised them will spot that language trap or be able to appreciate what that does to them in many courts and in arbitration hearings. Both types of franchise investments are nothing more than assured visits to bankruptcy court after a significant period of intense suffering during which the franchisee who got ripped off is unable to imagine how he got taken advantage of. By then it will be too late to remedy for the following reasons.
The franchisee will be broke and unable to afford legal representation to go get his money back. The franchisee will have waited too long to take aggressive action and the statute of limitations will have run on his best claims. The franchise agreement will contain a cleverly written mediation/arbitration provision that places dispute resolution into an unlevel playing field in which arbitrators are drawn from large law firms that represent/hope to represent and pander to franchisor interests and fear not getting franchisor or future arbitrator business if they find in favor of aggrieved franchisees in arbitration proceedings. The franchisor who ripped them off will have gone broke or be otherwise incapable of repaying all those whom it cheated. Competent lawyers will not agree to represent the franchisee on a contingent fee arrangement because of the reasons just stated. Competent lawyers will agree to represent substantial groups of franchisees on contingent fee arrangements, but the odds will be against recovery for the reasons just stated – or – recovery will be successful but the contingent fee percentage, plus expenses, will consume most of the recovery.
Very few of these suckers will have had the smarts to hire competent killer pre investment due diligence representation and pay for it. They will, for the most part, decide to pay incompetent lawyers small fees to READ THE DOCUMENTS for them. This useless exercise will not competently inform them of the investment risks they assumed without understanding anything about them.
By way of an easy illustrative example, Item 7 of the FDD they will have been given will disclose, usually in great understatement, their total initial investment. Among other deficiencies, Item 7 will not disclose that they need to have sufficient additional funds to live on and finance the business operations to potential break even that is often three years away if it ever gets there at all.
Nothing in the FDD adds up the ongoing risks of having to personally be on the hook for the following obligations - - a personally guaranteed lease agreement for the entire term of the franchise, without option to terminate for reasons of lack of business success, and that limits business operations to the operation of a business that is the business of that franchise using that franchise name - - a business loan that must be repaid over time or all at once if the balance is accelerated for reasons of default – a liquidated damages provision in the franchise agreement that purports to obligate the franchisee to pay upwards of $ 100,000 in the event of termination of the franchise, regardless of reason (the franchisee is automatically in default under this provision, regardless of the circumstances). This arithmetic will account for several million dollars of ongoing financial risk that is not disclosed in the FDD and that the incompetent lawyer they use for pre investment counseling will have no appreciation of.
Most of these folks don’t even have the smarts to go on a search engine and type in the words franchise pre investment due diligence lawyer. Most of these folks don’t even have the smarts to go on a search engine and type in the words franchise lawyer – and then call each one on the first two pages of the search results and ask them the following questions:
- Do you focus on advising franchise investors concerning pre investing due diligence counseling?
- Do you do franchise investment due diligence counseling that focuses on both the legal and the financial/business issues/risks?
Without YES answers to both those questions, you are not talking with the person you need. If you think you are going to get the level of work you require out of a
$ 500 fee lawyer, you would do getter not to have any lawyer at all, as the fact that you went to see “a lawyer” before investing will be used against you in any claim that you were swindled. You need to be prepared to pay a legal fee in the range of $ 3,000 to $ 5,000 for competent due diligence, but you can expect due diligence assistance on numerous potential investments for that fee if the first one you think you like turns out not to be suitable.
As most of those coming out of large company melt downs won’t follow this advice, there will be a sea of dead franchise fish stinking up the franchise world for many years to come in the near future. That is really sad.