DEAL QUALITY - NOT LEGAL WORK - IS WHAT KILLS NEW FRANCHISEES
Among the myths that lead franchise investors to ruin is the myth about the quality of the Franchise Disclosure Document (FDD). According to this myth, the FDD is the reliable resource, when coupled with interviews of franchisees listed in the exhibit and having a “lawyer” tell you what it all means. If you do all that perfectly you will not be anywhere near ready to make a competent franchise investment decision. People do not appreciate that the FDD is more decoration than substance.
The FDD is a compilation of unverified information that fits a template designed by government agencies to provide information that the government believes – pretends to believe – will make a potential franchise investor knowledgeable about franchise investment risks. Its reliability is a fiction perpetuated by those who profit from having investors believe it. Who might such people be? Who benefits most when investors believe things that are simply not so? Here are some of the main reasons why that is so.
Reason one is that there are no enforceable quality standards for preparers of FDD packages. The contracts have become mostly standardized and are incredibly draconian. The preparer has nothing much if anything to contribute to contract draftsmanship. I see the occasional odd ball, really quirky and inept attempt at outright fraud – like using the “obey the operations manual” clause to revoke express rights granted to franchisees elsewhere in the contract – but those are such obviously illegal and transparent ploys that one wonders why so many lawyers fail to spot them. Hoping to fix a non disclosure problem, the franchisor would let you see the manual before investing if you sign a non disclosure agreement. This franchisor believes correctly that the investors and their lawyers won’t figure it out even if they get to see it. I am working on one matter now where over 200 lawyers failed to spot that over the last four years of selling this scam. So much for lack of professional insight I suppose. It is easy to spot, but you have to know how to look for it.
Lawyers for these same 200 franchisees also failed over the last three years to figure out why it is that the “trick” play on contract versus operating manual language is not enforceable. Only now are these franchisees learning that for a few thousand dollars each they could all have prevented being victims of this scheme and escaped from this bozo franchise entirely. If the franchisor in question, recognizes that he has been caught, he will probably change this years’ contracts to try to eliminate the granted right entirely from the agreement. This would further reduce the value of his already worthless deal, but that seems not to matter. Its management is so angry at getting caught pulling a fast one that they have simply gone berserk. The changes apply only to future franchisees. Will future franchisees see through this terrible scam and save themselves from being skinned alive financially, or will they continue just as did the first few hundred to buy blindly into their own financial oblivion?
These same lawyers, having no deal quality due diligence competence, failed to notice or assign any value to the fact that in the business segment of this franchise, no company was a franchise system except this company. Here is this total anomaly in which historically the products in question were distributed by independent resellers dealing directly with traditional vendors in the chain of distribution. In this deal, if you were a franchisee, you would be carrying the costs of the franchise relationship, roughly 15 % of gross sales as it turns out, that your competitors would not be experiencing. Even nominal historical research into the business would have informed them that the business was becoming saturated with foreign supply, making oversupply a price threatening situation where a significant cost of doing business disadvantage could not possibly be absorbed. The franchisor knew this, and was saying to franchise investors that they had negotiated such favorable pricing from vendors that the favorable pricing would more than offset the cost of the franchise relationship. This additional outright lie, offered with no substantiation whatsoever, was swallowed whole by the franchise investors and by their lawyers, if indeed any of them even thought of this issue at all. These are not deep pocket franchise investors, and for the most part, those who have not already closed their doors are working to pay off leases and start up loans, staving off bankruptcy for as long as they can.
Had not the few remaining strong franchisees come to have the courage to back a well advised and professionally managed independent franchisee association, they could have labored under this ridiculous scam for years to come, being advised by incompetent attorneys that they have no remedy.
In another matter of recent representation, an over the hill franchisor with a system in decline and decay was still selling and reselling failed former franchise markets as though the system were still in its heyday. The contracts contained in its FDD were so completely tortured in their language to enable escape from liability for every possible contingency that it should have sent alarms ringing in the minds of all the lawyers who advised these franchise investors. Since they had no idea that what they were looking at was nothing but an elaborate legal trap configured by very sly people, they never spotted the hooks. In resale situations even the fact that historical tax returns were showing steadily declining sales were overlooked. And in this particular business the franchise investors were wealthier, more extensively experienced in the world of corporate business and all had rather high opinions of themselves as being equal to any Mensa member.
Try to imagine a franchise deal in which you don’t get the whole range of requisite business permissions when you buy the franchise. The franchise agreement purports to shorten the statute of limitations on claims against the franchisor from the normal multi year period to one year. Then, when you realize about three months into the deal – although it was disclosed in the FDD – that what you need to succeed isn’t yours yet, you have to sign another agreement to get that. In this ancillary agreement there is a release of all claims you may have against the franchisor . So your shortened period to bring claims is now brought to expiration by a release signed three months into the deal. If you bought a resale from an existing franchise, you have to sign another agreement in which you agree that if what is said to you is not correct, it is your responsibility to pay whatever the cost may be to make it correct. Yeah – I know – How silly can you get? But the upper crust investors signed these agreements willy nilly and their lawyers – if they even hired any – had no idea they were looking at an Olympic screw job agreement.
The franchise agreements were so off the wall that the absurdity should have been obvious. This was a total failure of both legal and business quality pre investment due diligence.
The franchisees of the second group are still not courageous enough to fund and establish an independent franchisee association to confront the abuses they deal with every day. They think that if they just keep whining on Internet blog sites, things will change. They won’t.
These are but two of recent illustrative examples of franchising disasters that could have been avoided by competent deal quality pre investment due diligence.
Even with a sophisticated investor, failure to understand the deal quality issues leads often to disasters. Conversion franchising involves franchisees who were already in the business. They ought to know better. They don’t even do the arithmetic despite the fact that I provide the formula for them totally without charge on this web site. http://www.franchiseremedies.com/conversion-franchises.htm
Recently here in Houston a third generation of a great retailing family lost control of almost 30 stores in a franchising deal they and their lawyers simply failed to understand. It may not even have been misrepresented. The franchisee and his lawyers simply were out of their depth. They had no insight into the realities of franchise relationships that comes only from many years experience specific to this kind of business. Their losses – all preventable for a few thousand dollars worth of expertise – were in the millions.
The competence level of your professional resource is the only safeguard you have to prevent being fleeced like sheep. You are not smart enough to beat the crooks by yourself or with just some regular business lawyer “reading and explaining” the FDD before you invest in a franchise.
The disclosures part of the FDD is prepared with no preparer due diligence. Franchisors do not pay for preparer lawyers to investigate them to assure that what is said in the FDD is truthful. Preparer due diligence can infringe on the “salesmanship” aspects of the whole selling presentation. A franchisor – especially a crooked franchisor – does not want his FDD to so openly contradict his sales and marketing materials that even the village idiot could spot the contradictions. You will see in the franchise agreement that you agree that you were never told anything that is not actually in the FDD. In other words any salesmanship outside that document never existed even though you may have saved copies of it. You also agree in the franchise agreement that if you were given information beyond that contained in the FDD, you did not rely on that information in making your investment decision. If you think this is a ridiculous absurdity, read the “Acknowledgement”, “Merger/Integration/Entireties” and “ Non Reliance” clauses of the franchise agreement that came with that FDD you are looking at. You are agreeing that things that really did happen actually did not happen. If you applied for a start up loan and submitted a business plan with your loan application, and the business plan contained a pro forma presentation of what you expect the first few years of your franchise life to be like financially, the information for that pro forma could not possibly have come from any source but your franchisor, no matter how indirectly, but you agree that none of that ever happened and that if it did, it played no part in your decision to buy the franchise. You know that is false, but if you decide to buy the franchise knowing that you were in fact influenced by that information, count on being made to look like it is you who was lying if you later complain that your investment decision was induced by fraudulent misrepresentation.
The legal work that goes into an FDD is now so mediocre, and the preparers of these documents now so numerous and desperate, that a crooked franchisor can find some ex in house franchise lawyer living hand to mouth to prepare one for as little as $ 3,000. The normal market for experienced FDD preparers who will still not be doing any due diligence on the truthfulness of the information put into it is between $ 25,000 and $ 50,000, sometimes depending upon what ancillary legal work has to be done to complete the whole project. Scammers tend not to pay big bucks for bozo FDDs that can be bought from cut and paste people for very little. There are outside franchise sales organizations that will package the entire project and include the FDD in the package so long as they also get the right to sell the franchises. The FDD preparation process has not gotten higher in quality since franchise “disclosure” became the thing to do back in the late 1960s.
The other thing that makes it unlikely that you will ever recover if you bought a bozo franchise deal is that the relationship is engineered to scare you out of taking action until it is too late. You sign a ten year franchise agreement and a least of store location to match that- both of which you have to personally guaranty. You also have a start up loan that you personally guaranty. If you bust the franchise and go for litigation or arbitration, you know that you are going to be out of business while that process goes on (in most instances) and that you will not be able to pay the rent or the loan and that there is also a “Liquidated Damages” clause in your franchise agreement that says that if your franchise terminates or goes out of business for any reason, you owe royalties out to the end of the contract term, regardless of the reason for the failure. That is in there to scare you out of making a stand. By the time you are willing to accept the realities of your impossible situation, your only meaningful resources are in the Bankruptcy Code, personal and corporately since you had to personally guaranty everything.
The bottom line is that if you buy a bad franchise, it will be the lack of deal quality that kills you financially, and that the agreements you signed will probably be sufficient to kill you legally except in the most egregious cases. Finally, if you decide to make your stand after you no longer have money to pay a lawyer to fight for you, you simply won’t be able to find a lawyer who knows what has to be done and how to do it who will represent you. Contingent fee lawyers who know what they are doing will only take cases that are close to slam dunk winners on all liability issues; where there is a ton of money to be won; and where there is no risk of a win not being collectible because the franchisor’s assets will by then have been put out of reach. Usually the contingent fee cases are class actions with lots of plaintiffs. They take many years to conclude. They end up settling on terms upon which the lawyers are handsomely paid and the franchisee plaintiffs get next to nothing. There are some very rare exceptions.
The net effect of all this is that your only real salvation in franchise investing is competent pre investment deal due diligence. Legal due diligence – having a lawyer (including a franchise lawyer) read and explain the FDD will not provide the insights you need to avoid being defrauded. Unfortunately, franchise fraud is today a raging epidemic with misrepresentation being so flagrant that you would almost not believe anyone would consider doing such things. You expect people who are advising you to invest to be at least reasonably honest. In franchising today that is simply not so. Not only are new franchises misrepresented to be proven concepts with assorted fictitious economic advantages and very low failure rates – known for many years to be the hallmarks of scam franchises, but over the hill franchise “concepts” from which past profit performance has been eroded by excessive competition and overcrowding of the business segment are being sold as leaders in their field. Whole categories of impossible prospects are being sold under well known brand names that you probably think must be successful because there are so many of them. If you have competent deal quality due diligence resources available to you before you invest, you will see these for what they are before your only exit strategy is bankruptcy court.
When you consider that the terms of the long term contracts you will sign in any franchise investment are so terribly skewed against your interests, it is compellingly obvious that the business side – deal quality – has to be excruciatingly vetted to prevent a disaster. You cannot rely upon what you learn from any FDD or from franchisee interviews. You must overcome your already cooked decision to invest based upon all the probably false positives you have been fed, and allow these positives to show you whether they can withstand withering challenges to their truthfulness and reliability over the many years of the contract term. What you spend for this work will be the best money you spend in the entire process.