Abusive Franchises, Freedom Is Not Free

There is a mistaken belief that what franchisees really need in order to facilitate rationalizing franchise relationships into harmonious mutual peace and profit making is a collective voice competently expressing franchisee needs to a “reasonable” franchisor. The reasons that is a mistake in so many instances is that the abusive franchisor isn’t interested in being reasonable, believing that the terms of his franchise agreement relieve him of any such obligation; what the franchisees want (what seems reasonable to them) would represent a reduced revenue from the relationship for the franchisor; and, finally, franchisors believe that once the franchisees sign contracts that provide for franchisor top down configuration of the business model, they are not required to “let the inmates run the  asylum”.

 

In these - all too frequent these days - situations, “reasonable accommodation” is not to be found anywhere in the franchise agreement; anywhere in the law applicable to franchise agreements; or anywhere in the “art of the possible” as seen through the eyes of educated ladies and gentlemen possessed of law licenses. There are a very few exceptions.

 

If franchisee existence is to become rationalized, resort will have to be had to leadership that is not parlor trained, church manners, play by the rules as they are written, ladies and gentlemen. Freedom isn’t free. Running your mouth on Internet blog sites, screaming epithets at the franchisor, never accomplishes anything positive. Moreover, it so poisons the atmosphere that in response to each epithet blogged, the recalcitrant franchisor only digs in his heels that much harder.

 

Today there are a few misled franchisee groups running their mouths on www.BlueMauMau.org, providing us with typical examples of impotent whining and name calling on the part of disgruntled, cowardly franchisees who either do not have a clue (nor does their  leadership) about how to get to YES; are too cheap to provide  resources to retain competent leadership for this kind of confrontation; who believe, incredulously, that all they have to do is keep on whining and cursing and eventually the franchisor will “see the light” and come to Jesus on the subject of giving them what they want; or all of the above. These groups are doomed to failure. In their insistence that they are entitled to better circumstances by some impelling notion of fundamental fairness, they are bogged down in an impossible regimen. They believe that intractable dictatorships of franchise abuse can be brought to “justice” by whining and hurling epithets, and that some divine or quasi divine power, God or the government, will come to their aid. Could there be anything on this planet less realistic?

 

Leadership to facilitate rationalizing the existence of franchisees who bought into bad deals and are living with abusive franchisors is different from leadership to facilitate rationalizing life in a good business model run by a franchisor with a long view to the future viability of the system.

 

The tough guy punk franchisors who couldn’t care less if their franchisees go on line and call them bad names – at least not enough to change anything – must be dealt with differently.

 

There is a long human history of victims having to try to overcome terrible circumstances in which the situation is extremely unjust, and the rules are drastically skewed against them. None of these vignettes of history apply to the matter of solving an immediate problem of having bought into a bad deal with a bad franchisor who really – no matter what he may say about it – doesn’t give a damn. These guys are in it for present tense interests only. They didn’t form the franchise system for long terms durability in the first place. Had they considered long term interests, the franchise business model would perform in a way that enables long term durability.

 

In most of these situations the costs of carrying the relationship – all costs, not just those in the FDD – is close to or above 20 % of sales. The franchisees are mostly marginal, and the failure rate is accelerating. A similar situation may be found in franchise systems that are really over the hill. Their business segments have become saturated to the point at which the name on the door does not generate sufficient differentiation to matter. The name is not worth paying for anymore, and in many instances it was never worth paying for. The franchisor did not achieve the ability to make the brand strong enough to have commercial presence. If you are in a good location – that you had to pick out in the beginning anyway – and are giving good value, the franchisor’s name is not contributing anything worth paying for. In reality, when a franchise system presents this profile and the franchisor is telling everyone to go to hell, the clearest observation is that the rules provide nothing that could change this game for the better over any short term.

 

Most of the people who seek to be retained by disgruntled franchisee groups are believers in the gentlemanly art of rational persuasion. They play by the rules. They espouse irrelevant notions like franchise fairness standards. No tough franchisor will ever give a damn about franchise fairness standards, and franchisees lack the resources to enthuse any government agency to come to their rescue. If it were otherwise, life would be better for these victims. This isn’t a recent phenomenon.

 

Effective leadership of franchisee groups in this situation has to be able and willing to change the rules – to stretch them so far that they are not even recognizable anymore – without actually violating any of them.

 

One of the rules that must be pushed is the apparent requirement that you tell the franchisee group you may seek to represent that you agree with them totally. Much of what franchisees believe is “wrong” is actually not wrong at all. Many franchisee notions of what should and should not be permitted are simply misplaced. The examples of these wrongheaded notions include the basis for determining when a franchisor must approve a franchise resale. The reality is that a franchisor can blow up a resale opportunity with virtual impunity under the terms of the contract the franchisees signed. That the franchisees failed to recognize the reality of this when they signed on is not grounds for changing this game. Between the franchisor’s arbitrary right – arbitrary if for no other reason than the absence of an economically affordable remedy – to refuse consent to any resale, and the franchisor’s ability to change the rules of engagement with every new agreement, including increasing the cost of the relationship itself, the capital value of your business in any resale context is never going to be what you think it is. And aside from the legal/economic analysis of this dynamic, there is the fact that on a “visit” by your buyer to franchise HQ for a screening interview, any tough franchisor can poison any resale deal just by his conduct. Tough franchisors ask why they should approve a resale or buy you out if they can default you under the contract and just take your business back for next to nothing – at most the cost of a lawsuit or arbitration that they can afford and you can’t.

 

Are you starting to get this picture into clearer focus?

 

Franchisee leadership must know the realities and must have the guts to tell his prospective clients about the issues where they are simply wrong and have little or no prospect for success. They must also know and be able to teach the techniques for dealing with situations where the franchisees are probably wrong on the law, but can still change the game by adopting effectively militant relationship management techniques. Even the transfer scenario can be changed with the right tactics. But realities must be dealt with as realities, and franchisees have to be taught what the realities of each situation are.

 

Confronting tough guy franchisors in a business destroying mode can only be done through militant resistance.

 

What does effective militancy require?

 

It requires that the franchisees recognize when they are dealing with an intractable franchisor in a business destroying mode. Those two essential factors mean – in reality – that hiring leadership to reason with the franchisor is a waste of time and money. These “frat boy” office gentlemen are no match for a street smart tough guy franchisor. All he has to do is tell them in some polite and politically correct manner to go to hell, and the game is over. How go to hell is expressed includes delay, promises of consideration, propagandistic pretense to the adoption of fairer methods of dealing, and other nonsense responses that will never see the day when the talk is actually walked. The history of the now defunct AAFD franchisor appeasement club is a vignette on the subject of frat boy nonsense and bestowing BS awards upon some of the worst tyrants and opportunists of franchising. The AAFD published carefully parsed standards of franchise fairness that had no affect whatsoever upon any tough guy franchisor.

 

Once franchisees recognize that they are in a situation like this, they have to seek out someone who can show them how to organize effectively militant resistance and who can protect the organizers from franchisor retaliation. One of the main barriers to effective franchisee group action is franchisor retaliation against franchisee leadership. Tough guy franchisors don’t have to destroy the ineffective leaders of nonsense franchisee groups. Why bother the impotent? But they will go after effective leadership, and that leadership has to be invulnerable.

 

Invulnerability involves the retained leadership resource having the ability and the sheer guts to make himself the group leader so that the only place heat can be applied by the franchisor is on him. That leadership must also be capable of protecting the identity of the group leaders who are franchisees. The ways in which tough guy franchisors try to find out who is behind the movement must be known, and methods to resist that must be mastered. Lessons must be taught about how to be militant, and they must be taught by someone who is good at it, not by someone who may have read some books on it but never done it.

 

The franchisees must be provided with avenues of protected communication that are impenetrable by the franchisor. The retained leadership must know how to accomplish that. Password protected channels of communication are useless. Some Judas franchisee will give the franchisor his password or forward the communications to the franchisor in the hope of some inside favoritism. There are Judas franchisees in every franchisee group, and how to prevent them from imploding the group is another subject in which the leadership must be adept.

 

The franchisees must be told at the outset that there will be no possibility of success unless there is pervasive membership in the group and financial resources to support what is required. Protestations about not being able to afford what is called for need to be stymied. The cost of a pervasively supported franchisee organization is rarely more than the price of a pack of cigarettes a day. If franchisees can’t handle $ 1,500 a year in simple annual dues, paid in advance, they are not salvageable and will simply be written off. The truth is that the cost of not joining is far more every year than the cost of joining. Franchisees who cannot recognize that will experience what franchisees who elect to go without effective leadership experience. You cannot do this on nickels and dimes.

 

The lesson is that tough situations must be met with tough solutions. Tough solutions cost money, but not a prohibitive amount of money. Franchisees have to have sufficient intestinal fortitude to do what is called for, and they must be teachable. When the tough confrontation stage of franchisee group action is completed and the franchisor has come to terms in conduct as well as in words, the group can always go hire some frat boy advisor who plays by gentlemen’s rules. But until that time comes, leadership that knows how to wage the right kind of confrontation, to get the tough franchisor to recognize what is going to happen to rationalize relationship management one way or another, is the only solution.

 

Freedom is not free. Cowardice is incredibly expensive. It is bad enough if you bought into a really bad deal. But if you don’t do something about it by forming a militant independent franchisee association, it will eat uour guts out until you are in bankruptcy. FREEDOM IS NOT FREE!!

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Comments

They are not going to want to hear it

Hey Sol,

I'm with you.  But then I'm a "shill" dontcha know.  And now perhaps you'll be called one too since you have dared to say something other than "poor Zee, the Zor was so mean to you".

The problem on BMM is that many of the name-calling Guest posts are from people who have already lost their stores and gone bankrupt, or those who will soon be following them.  They have ZERO chance of fixing anything that is wrong with their franchise relationship, so have NO OUTLET except name-calling. And not much more to lose by it either.

Even a tough-minded independant association needs to have some kind of economic leverage to show the Zor that the Zor would be better off making peace (and concessions). Unfortunately the Zor's FA may be so bulletproof that the Zees don't have much leverage.  If only the poor Zees would have been a little more knowledgeable going in, so that they would know not to buy sh!t even if it was wrapped up with a fancy bow.

But the Hurt Zees don't want to hear that they should have known better (and that's why I'm supposedly a "shill"), they just want to whine about how the Zor didn't tell them.  If you don't know better than to play 3-card Monte with a guy in an alley, don't complain that the dealer didn't warn you!

The problem isn’t with franchisors.

Franchisees are slightly frustrating. Someone explain to this pygmy how you virtually always get a mix of impatience with an almost total unwillingness to actually make an effort and it doesn’t matter what the sex, brand, age or IQ of the franchisee or group of franchisees.

One or 2 days, weeks or even months of true commitment and exhaustion sets in with an appetite to follow meekly and then fade away in the hope others are doing the doing. Let someone else pay – let me pretend I cannot find a buck – ignore that I’m stupid enough not to invest a thousand dollars to protect my business, my home and my family – let me lose everything and wave to the bank manager as I move out.

I like the big ideas franchisees that come with a rush of confidence but not enough to invest in or insure their life. Tell me why so many seemingly intelligent people can plan and prepare for the day but refuse to acknowledge the battle.  

But the real problem for those franchisees who understand their situation and needs are the always evident growing group of pathetic cowards who tag along and drop off expecting that the few can win the battle without their help. They all get screwed that way and you can tell who the real cowards and morons are because they get to waste a few more years and crash out last.

How many franchisee groups are out there right now facing this frustration?  Seriously - how many?

Just Solomonspam (IMHO of course)

Just another BMM zee attorney trying to punch the hot buttons to push his own agenda, wanting Zee $$$.

Direct, but well said!

I have taken a far different path than Richard (10 years as a franchisee, active litigation in support of my rights, and now principal of a research business for the franchise industry) and come to a similar conclusion.

My White Paper (here on Blue MauMau and also at http://www.franchisefactsusa.com/articles.php) begins to delve into how this current situation has come about and proposes ways to resolve these problems.

In the end, however, I believe it comes down to franchisees becoming properly educated about the realities of business, developing the fortitude to fight for their own interests and being prepared to make the required investments to support these efforts.

Perry Shoom is the founder of FranchiseFacts, a company that provides research services for the Franchise Industry.  The company also publishes an Annual Report of the results from its National Franchisee Survey.  The 2010 Annual Report, and the 2011 Franchisee Survey that is currently in progress, can both be found at www.FranchiseFactsUSA.com. The survey is open to all franchise owners and store managers.  FranchiseFacts does not disclose identifying information that may be provided by survey respondents.

I believe it comes down to

I believe it comes down to franchisees becoming properly educated about the realities of business, developing the fortitude to fight for their own interests and being prepared to make the required investments to support these efforts.

Now that is critical but to leave it there is exactly what franchisors and the IFA want. Nothing can protect every investor from fraud but to single out the ‘smarter’ investors for special treatment ensures the frauds have a life and the fraudsters can evolve how they counter.

I believe it comes down to

I believe it comes down to franchisees becoming properly educated about the realities of business, developing the fortitude to fight for their own interests and being prepared to make the required investments to support these efforts.

Now that is critical but to leave it there is exactly what franchisors and the IFA want. Nothing can protect every investor from fraud but to single out the ‘smarter’ investors for special treatment ensures the frauds have a life and the fraudsters can evolve how they counter.

Re: They are not going to want to hear it (GB)

GB has the most honest and correct assessment yet of Richard's blog:  " Unfortunately the Zor's FA may be so bulletproof that the Zees don't have much leverage."

While I agree with Richard that a unified, strong front is the only way franchisees can win, GB's analysis is the most likely why the problem of confronting the franchisor will likely net very little.  The FA  is so one sided and comes right out and states (in many cases) that even if you find fraud was involved in your purchase of the franchise you waive your rights to sue. 

The movie "Patton" was on yesterday (one of my favorites).  It begins with the General speaking on stage to his men where he is quoted saying (actually the quote is "attributed" to him - never been proven it definitely was from him): "No bastard ever won a war dying for his country.  He won by making some other poor dumb bastard die for theirs."

From that quote, Richard is correct.  Go on the offensive and try to make it hell for the franchisor.  Unfortunately, in this case the enemy (the franchisor) holds almost all the cards with the FA deeming all rights and laws null and void and is the arbitor of any and disputes. 

Last, Richard, I believe most franchisees from most systems don't put up a fight because they realize it doesn't matter even if they win concessions from the zor.  The systems usually suck and there is little chance these franchisees will ever see much, if any, profit anyway.  Better to go find a real job.

That is the best argument for submission to abuse put forth to

date. Surrender is superior to putting up a fight. The frachisor holds all the cards and you can do nothing, so why put your arse on the line for anything. That is the motto of sheep about to become mutton stew, not one abgout people with guts. If your position is that franchisees are gutless and therefore should be used for making franchisee stew, you can find many who agree with you,

You may actually be right. The history is certainly on your side. Maybe I should write a franchisee cookbook instead of writing ridiculous resistance articles - On Preparing Franchisees for Sunday Dinner, with recipes for several appropriate sauces - "Ragu Piquant des Franchisees".

Re: That is the best Argument (Solomon)

Richard I am not arguing that they should just give up.  I am arguing that they see their franchise system for what it is (in most cases) - a money losing proposition.  By the time they get pissed off to fight they have little to no money.  Second, they view their system as being unable to produce a profit. 

WHY bother hanging in a system that they know, after years in the system, that it does not work.  WHAT do they get when they win?  The right to stay in an unprofitable system?  Think about it.  Its like the Quiznos win.  They got $3000 and the right to continue losing $100,000 a year.  Yeah, one hell of a win (for the attorneys!).

know when to hold & know.....

Solomon (sarcastically) imparts: "Surrender is superior to putting up a fight. The frachisor holds all the cards and you can do nothing, "

Ya gotta know when to hold, and know when to fold.  If you find yourself in too deep with a structurally flawed system, it might be better to cut your loses sooner, rather than ride the loser all the way down to the ground throwing good money after bad. General Custer wasn't afraid of a fight, but heckuva lotta good it did him & his men.

Either that or don't do a dog darned thing either way until you run out of savings, credit, home equity, 401(k) and first born children, and then whine on BMM for the next five years about how the Zor did you wrong and you are only here "to help others". 

Custer picked the wrong fight due to his attitude and arrogance.

You gotta know which fights to pick and pick those where there is a verifiable point of effective attack.

The last association I was dealing with had just such a point of effective attack. The FDD and the contract said that franchisees could buy from any legit vendor. There was another provision that said that franchisees had to comply with the ops manual. In the manual the franchisor said that franchisees had to buy from him. The franchisor can't do that. I lined up a few good vendors for the franchisees. The franchisor threatened to terminate any who bought direct from a vendor. The membership had a golden door to walk through that would have given them hope for a future. They chickened out.

If they had had any guts, we could have had the franchisor over a real barrel because without that overcharge revenue stream the franchisor would have had trouble paying his bills. And so the association collapsed and the failure rate went through the roof.

The franchisor was so afraid of our advantage that he was afraid to change his franchise contract and FDD. He had prepared a new contract and FDD but didn't register it anywhere. He would only show it to people who signed a non disclosure agreement to keep it secret  (from me). What they didn't know was that I already had it and was ready to use it to show that the franchisor knew that he had been caught. Some disgruntled employee inside the company had sent it to me.

So if you pick your fights carefully, you can often find a way to choke the franchise chicken.

Exclusive Suppliers

There are many franchisors that are pull the same tactics Richard describes. One system even claims their franchisees own the supply chain so their ability to rape the franchisees is limited. However, the franchisees don't control supplier "approval". The ability to control supplier "approval" means the franchisor controls the front end agreement where the "rebates" are negotiated. Today, the franchisees are fighting to keep control over the supply chain they supposedly own. However, the franchisor is going public and needs to predict their quarterly financial performance. With supplier "approval" they're able to match marketing programs to demand and estimate their kickback revenues. Franchisees in this system need total control in order to remain competitive in the market. The franchisor needs EBITDA. The flock is getting fleeced every time the franchisor "approves" a new program. Shareholder value is important than franchisee profitability.

Shareholder value is

Shareholder value is important than franchisee profitability.

You say that as if it is a bad thing. Who owns the company? 

Shareholder vs Franchisee Value

Fuwa, I don't believe shareholder value is a bad thing. What I do believe is a franchise system, such as Dunkin', shareholder value creation should be linked to franchisee value. After all, who contributes the capital to create shareholder value in a 100% franchised model?

With Dunkin', franchisee value is diminishing in the favor of shareholder value.

so how do you "link"?

Jerry says: "After all, who contributes the capital to create shareholder value in a 100% franchised model?"

The bank provides the capital.  The franchisee provides the operating management. So should creating shareholder value be "linked" to creating bank value?

Yes in an ideal world the Happy Zees make money for the Benevolent Zor and the Zor wants to keep the Zees happy so they keep producing.  However when push comes to shove, whose company is it?  The same might be said for the way the Zees treat their employees.  You want good employee morale but how does that translate into action?  If you pay them all $12/hr. to start plus free Health Insurance and 4 weeks' paid vacation each year, they would like that.  But would the Zee make money from it?

Just to say "should" isn't enough.  You have to have a reason WHY somthing that makes the Zees happy is good for the Zor, not just that the Zor SHOULD.  WHY "should" they is the question not answered by mere assertion.

(Hey Fuwa, good to see you're back...)

The Franchisee "Link"

Granville, If franchisees are merely operators, then why not just get a job at your local McDonalds and aspire to become a store manager? There is no reason for any franchise to set a financial requirement if it's the banks that risk all the capital. Let's not forgot it's the franchisees that guarantee the bank loans.

I used the word "should" to keep it simple. To expand a bit further, I believe there is a correlation between franchisee EBITDA and franchisor EBITDA. These 2 components can be linked together by an effective IndFA to benchmark performance. This is a gauge that can be applied to a publically traded franchise to determine the overall health of the system. Wall Street rewards performance by enhancing shareholder value. Franchisees are happy when their profitability remains intact and grows. The world can become a better place for all.

If franchisees are merely operators...

Not MERELY.  As OWNER operators they enjoy the profits of their good operations.  Someone who is merely a Manager might get a bonus but they don't obtain all the profits nor suffer the losses. If you want to use a joint EBITDA metric, you need to demonstrate a correlation, not just a belief.  It would be convenient to your position but I consider it as yet an unproven assertion.

We have been 100% leveraged for some time.  Our successful operations pay for our cost of renting the capital from the banks and repaying it on a rolling basis.  Our expansion has nothing to do with our own capital but with our operations which satisfy the bank to advance us capital.  If our operations failed we would be on the hook, but ironically if our operations failed we wouldn't have the assets to make good on the guarantee.

Jerry overrates capital and underrates Management.  Management is the key to an operating business.  Without management, having more capital would merely increase tha amont lost before final failure of the business.

Operations Management

Yes. Quality operations management is the key to a successful business. Quality management is needed on both sides of the franchise fence. An effective IndFA and an independent 3rd Party data mining service is needed to create the metrics that will support the theory on EBITDA correlation. Dunkin' would be an ideal system to test the theory.

GB, You're So Silly...

"The bank provides the capital. The franchisee provides the operating management. So should creating shareholder value be "linked" to creating bank value?"

GB - In our multi-unit network we maintain a 40/60 capital structure which means for every dollar we invest we leverage an additional $1.50. The banks share the risk with us and not our franchisor. We "invest" because we seek "returns" on our dollars invested. Our risk is tied to the franchisor's initiatives to drive sales that build our profitability. The more profitable we become - the more my businesses are worth. Therefore, our "risk" is tied to the long term financial performance of our franchisor.

I believe Jerry has a point that EBITDA "should" be a reportable financial performance metric for a publically traded franchise system. Most publically traded franchisors have this data but choose not to report it because they know they can squeeze the franchisees when times are tough to hit their quarterly financial targets.

Jerry Kickapoo - Another Bonehead Proposition

How would you be able to take the various reported unaudited EBITDA numbers from franchisees and prove their validity under FASB and the SEC?

Bonehead Guest

It's big picture thinking, something that your shallow little mind lacks.

Back at you...Bonehead

It's about practicality and relevance.

Nanee Nanee Poo Poo

EBITDA is a very relevant and practical measure of financial health. It is the basis of valuation for most businesses. In fact, Dunkin' stores do trade on the secondary market and such resale valuations are determined as a multiple of EBITDA. Are you suggesting the valuations paid on franchisee to franchisee sales are bogus since they are not based off of audited statements?

When a prospective franchisee buys into the Dunkin' system they must put together a proforma statement for their financing banks to determine cash flow and potential profitability. By suggesting that an aggregate system wide franchisee P&L could never be properly audited means the collapse of the financial market for franchise financing as a whole. Now, to me, that is a foolish bonehead idea to think franchisee P&L's would never pass muster with a regulatory agency.

Unaudited numbers is not the answer. Using tax returns AND

P/Ls allows you to come up with rational numbers. Tax returns are prepared under the tax accounting rules - and so should be the P/Ls (which they usually are if prepared by an accountant). Unaudited is not a valid criticism when you are looking for comparability. Audited numbers can skew everything to the same or worse degree as unaudited numbers. Audits versus unaudited is not the valid issue here.

The FASB has nothing to do with this discussion. Neither has the SEC. Those are totally useless references.

I disagree Richard

'Tax returns are prepared under the tax accounting rules - and so should be the P/Ls (which they usually are if prepared by an accountant).'

Considering that I work on financials and used to do audits, almost all of our audits were based on FASB (very few were based on tax accounting). Where I work at now, our internal statements are accrual basis and our tax return is cash basis. The accounting firm I worked at did the same thing.

Tax numbers can skew just as well as audited numbers. Section 179 allows a taxpayer to immediately for tax purposes deduct a certain amount of fixed asset purchases all the way down to $0 taxable income.

JD, surely if you are looking

JD, surely if you are looking at P&L’s and tax returns identifying asset deductions and any creative expenses allows you to de-skew the result to usable performance information. That process begins with questions and ends with 'show me the evidence'.

Measuring franchise performance metrics has nothing to do with

auditing anything. The goal is not to find pennies or to assure compliance with "rules", but to sort our the metrics of financial performance. You are going to be determining things like ranges, geographic and seasonal variations (think flip flops in MInnesota), time in service as a variable, single versus multi unit performance characteristics, and every other significant variable that comes up.

This is not tax practice and the people who attempt to do this project will need the flexibility to write new methods. This is now done with great effectiveness in other industries and to answer other questions. We used it years ago to identify niche markets - think idiosyncratic demand pools. When you embark upon new work it is often counter productive to tie your mind down with old rules. They are useful to some extent, but they cannot be allowed to become a sort of bible.

So are you backing away from your taxes comment

That tax returns should be used for your metrics, and if so, I agree.  If business people were smart, they start looking at their taxes early enough to minimize their taxes owed.  It could come down to whether you want to purchase inventory now, or wait until the first week of your new year.  That's an easy way to skew your numbers for the year on a tax return.

I believe I mentioned 4 years ago that there were industries out there that had an effective way to gather and distribute data (HUD & Homebuilders, being the ones I had knowledge of).  For HUD, you were expected to transmit your financial statements to them within either 60 or 90 days after your year end.  They had some formulas set up that if certain 'Miscellaneous' categories were over 10% of the total for that category of expenses, you would have to breakout those expenses. 

With everything being all computerized, I'm sure it would be easier to compare data and look at specific line items to determine if more information would need to be looked at.

Now, getting compliance from your franchisees is the first step into using a similar format.  Will this information be shared with franchisees only?  Personally, I think this is the best way.   The franchisee shares and gets information back for use in their business.  If you open it up for prospective franchisees, then I think you create a situation where a prospective franchisee is relying on the information and the franchisor is going to be more critical of the information, and possibly audit the franchisee, which would create a hostile relationship.

No. Of course not. I am not backing away from anything. I use

tax returns as sources of information, like any other information source, except that it is prepared under oath and contains the most conservative possible statement of financial performance. It won't be "worse" than as shown by tax returns. The next step is to see how much better it may be by changing optional treatments and other things like non-cash charges and "perks" (the Bentley company car; the twin engine airplane; the cigarette speedboat used for "meetings"; the mistress who is on the payroll as a public relations consultant (that is a joke to honor former Senator Edwards who is being indicted today for doing just that); and other things to arrive at a rational comparison of gross income and costs that are real and that are functional variables rather than convenience variables. Then you are getting closer to zeroing in on what typical EBIDTA ought to be for this kind of business in this model operating under this franchise agreement.

Then you also take into account the impact of restrictive franchise agreement and ops manual provisions as well as the actual practices that may further inhibit cash flows. In this way you are not only getting to appreciate actual EBIDTA ranges, but also enabling the tracking of the proximately caused metrics impairment resulting from predatory franchising practices.

These projects have all sorts of potential benefits in addition to providing the underlying evidence upon which future "experts" will have to rely (that they could not generate for themselves when the time came and the data was needed but nonexistent.

The list of positives from doing this is almost endless. 

Richard and Jd: Taxes, Profitability and Lending

"For HUD, you were expected to transmit your financial statements to them within either 60 or 90 days after your year end."

Damn, am I loving this thread.  Guess what Jd?   The same rules apply to SBA loans!!!  FYI:  Financial institutions underwriting SBA loans are REQUIRED under SBA Standard Operating Procedures to collect ANNUALLY the Income Tax Returns/P&L's of every SBA loan borrower. 

Since approx 80% of all SBA loans are underwritten by 8 banks AND, if you know anything about SBA franchise loans, franchisors try to funnel their new franchisees to just one or two banks for all the loans you will then understand that these banks KNOW what the real first, second and third year gross revenue numbers are. (they have so many loans from each specific system they are fully aware of the {lack of} profitability of these systems).

Jd, we don't need EBITDA.  In order to determine if the system is even coming close to profitability a simple "average" of franchisee gross revenue (broken out by first, second, third yr) is all we need.  AND, once and for all, it will show the actual gross revenues do not even come close to what the franchisors are giving (whispering, writing on knapkins - you know what I mean) to new franchisees to use on their proformas in order to gain SBA loan approval - and, again, a number the banks KNOW is not consistent with reality based on those annual income tax returns.

"They had some formulas set up that if certain 'Miscellaneous' categories were over 10% of the total for that category of expenses, you would have to breakout those expenses."

The same can be done with franchisees.  BUT:

"If you open it up for prospective franchisees, then I think you create a situation where a prospective franchisee is relying on the information and the franchisor is going to be more critical of the information, and possibly audit the franchisee, which would create a hostile relationship."

its quite clear you don't want this information out there for franchisees to see.  I wonder why?

Unaudited numbers is not the answer. Using tax returns AND

"The FASB has nothing to do with this discussion. Neither has the SEC."

Well not if we're talking about Dunkin after its IPO and for Wall Street to use this Zee to Zor EBITDA comparison.

Reporting Numbers

Richard and Jerry are right: FASB and the SEC have nothing to do with this academic issue.

I sense that GB just doesn't want to do the work, since he is a zor financial type, and the burden would fall to him. 

Every franchisor in the world needs sales, in order to calculate and test royalties. And every bank in the world needs EBITDA.  So does the franchisor, since they must approve sales and transfers.

The Franchisor's auditor must test sales to test royalties via a sampling technique. Unit level  EBITDA (no G&A) is then collected annually via the franchisor. 

These values would be reported in the management analysis and discussion section of a publicly traded company's 10K.

Since the FDD disclosure must be reasonably supported, the same basis technique can be employed there.   

Via common law development, this is non-GAAP data as the data is not embedded in the face of the income statement, balance sheet, etc. The must be reasonably accurate and supportable, and not created in an attempt to decieve and mislead.

 

John A. Gordon

Here's the problem...

You got Richard getting tax returns, scrubbing the data.  You've got Oldsword saying all they need is gross sales by year, and you got John saying that Unit level EBITDA (without scrubbing the data) is what's needed.

Here you have three different franchisee advocates (unless Richard is getting paid to represent a zor) and they all have a different way to get to the data. 

So, which one is it?

Scrubbing data

JD: we did not, not advocate scrubbing the data.

There is NO problem

I'll tell you what, Jd.  If I had known the actual average gross receipts for a first year new site for my franchise was $250,000 rather than the $500,000+ number that we all were given, none of us would have bought into the system (especially when seeing the $100,000+ loss that real number generated).  That goes with a new UPS store averaging about $230,000 in their first year but needing over $400,000 (according to a Boston Consulting Grp report commissioned by the franchisor) to be profitable.  Or, last night during my conversation with a Quiznos franchisee from a number of years ago who was given their proforma numbers by the franchisor and whose real numbers didn't come close (something Quiznos is known for given their 4000 failed sites in the last few yrs).  Another system (that I can't mention), did the same thing - even while knowing that only one franchisee within their system was profitable (I can't say more about this great system. . .yet) - but they made sure the proformas showed other wise by inflating the gross revenues.

You are trying to make it difficult.  Its not.  Actually, its very, VERY simple.  You can fudge alot of things but gross revenue is what it is. 

However, given the fact that the banks get the info (not just gross but net as well), its not too difficult to do WHAT YOU SAID WAS A GREAT THING ABOUT HUD!!!  Have a formula that cuts out certain expenses, etc. that can show a reasonable bottom line.  It won't matter, Jd.  It will show that most of these systems do not produce the revenues required for the banks to provide lending.  Which is exactly why the franchisors don't want it public and why the IFA and the banks are doing their best to bed the SBA and open up the spigot.

I stopped at this...

' If I had known the actual average gross receipts for a first year new site for my franchise was $250,000 rather than the $500,000+ number that we all were given, none of us would have bought into the system (especially when seeing the $100,000+ loss that real number generated).'

You are leaving out the fact that your zor's Item 19 showing average gross receipts of around $430k (and you were all given that).  Instead of using that number, you used an inflated number to get the loan.  You felt that you were better than the current franchisees.  Out of curiosity, did the Item 19 disclosure go up or down each year in terms of gross sales? 

Jd, don't stop - keep digging. You'll find the same zor tactics

Aaaawwwww Jd, sounds like someone is scared.  You are trying to focus on me instead of the facts. 

Since I never stated who my zor is you must be very concerned over the truth of my statements for you to try to do "homework".   You are in way over your head.  You can try the typical zor strategies of blaming the zee but, in this instance, the sheer number of franchise systems that I have spoken with, the info I have been able to gather and ALL of them showing the same exact thing - inflated revenues on SBA loan applications - helps prove that this is a concerted effort on the part of franchisors, the IFA and the banks on defrauding the SBA. 

No incentive for a zee to lie about the numbers.  Who would want to tie up their life savings to buy into a system that has historical evidence proving it doesn't generate a profit?  But, research the SBA loan apps for almost any given system and you will see similar revenue numbers, almost all the loans from the same bank, and many times using the same loan consultants.  All one big happy family!!  Keep digging Jd!

I could care less about the SBA

As GB and Fuwa have stated, why go to the SBA if you can't finance it on your own.  You talk about the SBA having all of the numbers, but the SBA only has the numbers for the stores they service.  Hey, how about a store that doesn't have debt (you know the ones that probably are successful), they only have to share with the franchisor (if the franchisor requests them).

You can't get over the fact that you signed your name to a document knowing that you were showing sales in excess of the Item 19 disclosure.  I'd feel more sympathy for you had there not been an Item 19 discloure and you were grasping at a number out of thin air. 

So, out of the stores that opened in your franchise over the last 10 years, what % have been through the SBA?  For those that weren't using the SBA what projections did they use?  Did they think for themselves or rely on the zor to do them and then just sign their name (and probably personal guarantee) like you did?

Re: Care less about SBA? It's their life blood!

Jd, you and the "Guest's" have been spanked by everyone on this site, including GB, with regard to this subject.  You keep trying to turn the subject to me when, in fact, it is a serious systemic problem where franchisors, the IFA and the banks are taking advantage of the SBA underwriting system.

(The bank gets the loan application and decides whether it is deserving of a government gtee to protect its profit - gee, I wonder if the bank is going to say no - or look the other way when an obviously inflated revenue projection is put forth to them - on the 3rd try!!)

As for not caring - you're full of sh&#.  If it were not for SBA loans many of the systems that use this for financing new purchases would fold up and die - banks would never loan to these systems unless:

1.  The franchisor laid all the financial info on the table INCLUDING first, second and third yr avg gross revenues (which would only prove to the banks they shouldn't lend).

2.  The franchisee had assets totaling about triple the loan amt so loan repayment was certain should they default.

The IFA and franchisors rely on the SBA to keep the sales flowing.  Look what the hell happened to franchise sales during the credit crisis AND the subsequent tidal wave of sales after the SBA loosened the standards and gtd 90% of the loan.  The IFA, franchisors and the banks right now are pushing like all hell to get the SBA to loosen again.  The banks see this as easy profits. . .and so do the IFA/franchisors.

These three are lobbying Congress and the SBA heads hard right now.  They have to.  They are trying to kill something that they weren't supposed to be aware of - but the SBA are in their pockets -  (which would give you an idea of who my zor is and is possibly why you think you know who - because I have never named it - too convenient that now you think you know just as this inside info has been "compromised".

Re: Re: Care less about SBA? It's their life blood!

"Jd, you and the "Guest's" have been spanked by everyone on this site"

Who cares what a bunch of partisan whiner former and disgruntled franchisees have to say? Oldsaw you chose poorly in your franchise investment, you chose a known crook of a franchisor and we have no idea what kind of operator you were. Successful franchisees don't post on BMM and why would they.

Oldsaw, I comment on your angst ridden polemic posts for the fun of it.

Re: Re: Care less about SBA? It's their life blood!

"Jd, you and the "Guest's" have been spanked by everyone on this site"

Who cares what a bunch of partisan whiner former and disgruntled franchisees have to say? Oldsaw you chose poorly in your franchise investment, you chose a known crook of a franchisor and we have no idea what kind of operator you were. Successful franchisees don't post on BMM and why would they.

Oldsaw, I comment on your angst ridden polemic posts for the fun of it.

Oldsaw the Magnificent

"Jd, you and the "Guest's" have been spanked by everyone on this site"

Who cares what a bunch of partisan whiner former and disgruntled franchisees have to say? Oldsaw you chose poorly in your franchise investment, you chose a known crook of a franchisor and we have no idea what kind of operator you were. Successful franchisees don't post on BMM and why would they.

Oldsaw, I comment on your angst ridden polemic posts for the fun of it.

Oldsword

You are making yourself look foolish. When have I ever been in favor of SBA loans and why am i 'full of s&%*'? I could give quite a good explanation, but I'll let you answer that since you say I've been spanked by everyone including GB on this conversation.

As for your franchise, if I wanted to figure it out, you've given plenty of clues, like saying that they cracked the top 25 of the SBA failure list this year and the fact that you said that they had an Item 19 disclosure and your UFOC/FDD said that avg store sales were in the $460k range.

Well

"Jd, you and the "Guest's" have been spanked by everyone on this site"

Who cares what a bunch of partisan whiner former and disgruntled franchisees have to say? Oldsaw you chose poorly in your franchise investment, you chose a known crook of a franchisor and we have no idea what kind of operator you were. Successful franchisees don't post on BMM and why would they.

Oldsaw, I comment on your angst ridden polemic posts for the fun of it.

It would seem no one would

It would seem no one would dispute that those wanting to go into business but cannot get finance without an SBA loan aren’t ready to go into business or their business of interest is a dud.

It would seem that most people are therefore agreeing that SBA should not be backing loans to dud businesses or dud business operators however the SBA failure rates indicate SBA is doing just that.

It also seems that the SBA loan program is ideal for dud franchising encompassing all that dud franchising is including dud operators passing selection, FranWhacks and your average churn franchise.

Franchising is probably the most organized sector of small business to take advantage of the existence of the SBA loan program.

It seems that Oldsword argues that dud franchising passes bogus figures to the wannabe franchisees and they for whatever reason play along with franchising’s organized and professional ‘gltiz and glam’ approach to scamming foolish franchisees and the SBA loan program.

It would seem others underestimate dud franchising.

Based on the failure rates of franchise SBA loans I would think it more appropriate to howl down the many thousands of failed SBA loan franchisees who didn’t come out in an attempt to inform the stupid market that bogus figures equal failure. 

It would seem no one would

It would seem no one would dispute that those wanting to go into business but cannot get finance without an SBA loan aren’t ready to go into business or their business of interest is a dud.

It would seem that most people are therefore agreeing that SBA should not be backing loans to dud businesses or dud business operators however the SBA failure rates indicate SBA is doing just that.

It also seems that the SBA loan program is ideal for dud franchising encompassing all that dud franchising is including dud operators passing selection, FranWhacks and your average churn franchise.

Franchising is probably the most organized sector of small business to take advantage of the existence of the SBA loan program.

It seems that Oldsword argues that dud franchising passes bogus figures to the wannabe franchisees and they for whatever reason play along with franchising’s organized and professional ‘gltiz and glam’ approach to conning foolish franchisees and the SBA loan program.

It would seem others underestimate dud franchising. The ease at which much of the prospective franchisee market is conned is a given.

Based on the failure rates of franchise SBA loans I would think it more appropriate to howl down the many thousands of failed SBA loan franchisees who didn’t come out in an attempt to inform the stupid market that bogus figures equal failure. 

Given the cost of SBA franchising failure rates it seems clear that either those that oversee the program are blind or stupid or someone very senior saw the light and stuck a hand out. 

The problem I find perplexing is that I cannot think of any franchising entity that could possibly coordinate a generous industry response?

<i>none of us would have

<i>none of us would have bought into the system</i>

I doubt that is true.  Why you as an individual may not have, experience would dictate the majority would still end up buying into the system.

Point one, I have not seen you refute the allegation that you deliberately submitted inflated numbers to the SBA.   Why there can be some charitable and uncharitable interpretations of that, I'll go with charitable and run under the assumption your were lead into that action by the zor.

If my charitable position is true, this would indicate that you are also susceptible to pressure, misdirection, and salesmanship.

My guess is, you were already sold on the idea of owning a small business and you were sold on the idea that franchising was the way to go.  Which is to say: you were probably already psychologically damaged goods when you got to the point of doing your do diligence and thus very susceptible to soft sales tactics.  An dif this did not apply to you, I would suggest it applies to most.  

In the end, while it is convenient to label one factor as the inducement to buy, there are usually a myriad of subconscious and conscious factors that lead to the choices made.  Good sales people know this and manipulate the circumstances in their favor.  Invariably if one approach does not work, they will switch to another.  And they are excellent at knowing which approach is likely to work with whom.

In the past few years, several concepts emerged where the zor did not even have a concept built, and yet the found zees eager to hand over their money for what they felt would be the next hot thing?  How does that happen?  It happens because we are all too human and have many psychological frailties that can be exploited by the duplicitous among us

 

Re: None of us would have (Fuwa)

Fuwa:

1.  NO, I did not deliberately submit inflated numbers (projections) to the SBA.  Once again, no franchisees were forthcoming and we all (yes 120+ borrowers out of 120+ borrowers) were given these numbers thru a third party that the franchisor sent us to (and the zor told us this they were not allowed to give us this info but this third party could and had all the finc'l info).  And I have documents showing other systems were doing the same exact thing.

2.  Yes, I used an accountant and a lawyer to go over everything (and I have yet to speak with a franchisee who says they did not consult an attorney and accountant prior to purchasing).  And yet, all 3 of us were duped.  Yes, we were played/duped/taken/hoodwinked/(you get the picture).  So, while I may have been "sold" on the idea, my professional consultants also missed this info because it was not clear as to what was truly happening.

3.  Yes, all franchisees go in thinking that franchising is safer.  Think of your logic here Fuwa - if we believed franchising was a fraud do you think we would buy into it?  No one going into franchising thinks of googling "franchise fraud".  BTW, does that make the fraud any less of an issue?  Is it OK to defraud someone because they didn't figure it out beforehand - is that your argument?

4.This is NOT about my system.  This is how franchising is now established.  This problem is pervasive in franchising.  It not only defrauds the franchisee;  MOST important, it defrauds the U.S. Gov't thru the gtees provided by the SBA.  The franchisors know, as do the IFA and the banks, that they are playing the current system whereby the banks give themselves a govt gtee knowing full well these system do not generate the cash flow necessary to meet SBA guidelines.  THINK LIAR LOANS.  These three groups are in bed together making sure the application meets the minimum standards by using inflated projections and then fall on the argument that "projections are just projections" when in fact they know the projections provided have no basis in reality.

While I could go on with other points I will sum it with this last one:

5.  You are wrong regarding your statement "experience would dictate the majority would still end up buying into the system."  If the numbers were clearly stated the franchisee, who is thinking franchising is safer, will not only have a black and white picture of the true profitability of the system in front of them BUT. . .they will now have two/three additional objective parties (accountant, lawyer and, if applicable, spouse) telling them this system is no good.

Think of it this way (and perhaps the lawyers here would like to chime in):  If the accountant and lawyer clearly see that the system generates multiple year losses (based on first, second and third gross avg) do you believe they would allow their client to sign on without first obtaining a signed document stating clearly that the new zee has been told by them that the system is not expected to produce a profit and they were advised to step away from this system?  Do you think the spouse would allow (think Century 21 lawsuit by the wives) the other to place their home, savings, retirement savings, college savings on the line for a system that clearly shows the average zee LOSES 6 figures in their first two/three yrs of operation and few obtain profitability after that?

No, Fuwa, in this instance, with real info (not just speculation) in front of them potential franchisees would be made fully aware of the "proven business model" put forth and the great majority (I will give you maybe a handful wouldn't) would walk away thereby making it impossible for the zor to continue their charade.

Re: None of us would have (Fuwa)

Fuwa:

1.  NO, I did not deliberately submit inflated numbers (projections) to the SBA.  Once again, no franchisees were forthcoming and we all (yes 120+ borrowers out of 120+ borrowers) were given these numbers thru a third party that the franchisor sent us to (and the zor told us this they were not allowed to give us this info but this third party could and had all the finc'l info).  And I have documents showing other systems were doing the same exact thing.

2.  Yes, an accountant and a lawyer reviewed everything (and I have yet to speak with a franchisee who says they did not consult an attorney and accountant prior to purchasing).  And yet, all 3 of us were fooled.  Yes, we were played/fooled/taken/hoodwinked/(you get the picture).  So, while I may have been "sold" on the idea, my professional consultants also missed this info because it was not clear as to what was truly happening.

3.  Yes, all franchisees go in believing franchising is safer.  Think of your logic here Fuwa - if we believed franchising was fraudulent do you think we would buy into it?  No one going into franchising thinks of googling "franchise fraud".  BTW, does that make the fraud any less of an issue?  Is it OK to defraud someone because they didn't figure it out beforehand - is that your argument?

4.This is NOT about my system. This problem is pervasive in franchising.  It not only defrauds the franchisee;  MOST important, it defrauds the U.S. Gov't thru the gtees provided by the SBA.  The franchisors know, as do the IFA and the banks, that they are playing the current system whereby the banks give themselves a govt gtee knowing full well these system do not generate the cash flow necessary to meet SBA guidelines.  These three groups are in bed together making sure the application meets the minimum standards by using inflated projections and then fall on the argument that "projections are just projections" when in fact they know the projections provided have no basis in reality.

While I could go on with other points I will sum it up with this last one:

5.  You are wrong regarding your statement "experience would dictate the majority would still end up buying into the system."  With the numbers were clearly stated the franchisee, believing franchising is safer, will not only have a black and white picture of the true profitability of the system in front of them BUT. . .they will now have two/three additional objective parties (accountant, lawyer and, if applicable, spouse) telling them this system is no good.

Think of it this way (and perhaps the lawyers here would like to chime in):  If the accountant and lawyer clearly see that the system generates multiple year losses (based on first, second and third yr gross avg) do you believe they would allow their client to sign on without first obtaining a signed document stating clearly that the new zee has been informed that the system is not expected to produce a profit and they were advised to step away from this system?  Do you think the spouse would allow (think Century 21 lawsuit by the wives) the other to place their home, savings, retirement savings, college savings on the line for a system that clearly shows the average zee LOSES 6 figures in their first two/three yrs of operation and few obtain profitability after that?

No, Fuwa, in this instance, with real info (not just speculation) in front of them potential franchisees would be made fully aware of the "proven business model" put forth and the great majority (I will give you maybe a handful wouldn't) would walk away thereby making it impossible for the zor to continue their charade.