The FTC advises that they have made the franchisor disclose to protect the franchisees but the FTC doesn’t require franchisors to disclose MATERIAL unit performance statistics, even on the new protypes, upon which new buyers can make informed decisions.

The fact is that the FTC Rule and the State FDD packaged with the binding franchise agreement acts a constructive fraud against new buyers of franchises. New buyers believe that the only way they can access the job and profits promised and implied outside of contract is to sign the boilerplate, non-negotiable franchise agreement, that post sale serves to protect the franchisor from charges of fraud by failed franchisees in arbitration and the courts.

Apparently, as long as franchisors appear to be compliant with the FDD, they can sell franchises at any degree of risk of failure and/or unprofitability with immunity under federal regulatory policy. The FDD and the Franchise Agreement is really a license to lie, cheat, and steal in the hands of those franchisors who are so inclined. (See Richard Solomon of Franchise Remedies excellent tutorial on the effect of Acknowledgement and Reliance Clauses in Franchise Agreements)

But! FranchiSORS, who are also often classified as small business organizations, do sometimes better survive the high and brutal odds of failure of startup businesses because they don’t share in the failure of their first-owner franchisees when the assets of the failures continue to serve the franchisor under new ownership.

This “churning” mechanism, which is a management tool for many franchisors, is not visible, looking at a franchise network from the outside. Many failed franchisees close down but don’t default on their loans and continue to pay on their business debt to avoid bankruptcy. These franchisees have signed confidentiality agreements and legal releases to the franchisors in order to get their permission to fire- sale-transfer their businesses to an approved 2nd generation franchisee. These franchisees don’t show up as failures in government statistics and are indicated only as transfers in the Franchise Disclosure Document, the FDD.

The real rate of failure of franchisees in any given system is hidden from the view of NEW buyers because franchisors are not required to disclose this material risk factor of franchisee failure to thrive, as known to the franchisors, to new buyers under government regulatory policy. Unit performance statistics, present and past, are not required to be disclosed by the franchisors to the new buyers under regulatory policy.

Due diligence with references supplied in the FDD in Item 20 is inefficient and ineffective and Item 20 acts as an artifice to protect the franchisor, himself, from making any representations about the success of the franchise to the new buyer. Obviously, if you act on the “misrepresentations” of the references who misepresented the “success” of rhe franchise to you, you have NO recourse against your franchisor after you have signed the frasnchise agreement, if your business is unprofitable and fails.

When the franchisor makes no “earnings claims” in Item 19 of the FDD, and the great majority of franchisors do not make “earnings claimsZ” they have 100% prortection from charges of fraudulent inducement to contract in arbitration or the courts because of misrepresenting the success or the risk of the investment to new buyers.

All franchise agreements require the new buyer to acknowledge that the purchase was made with no promise of success or profits and that they made the purchase without relying on anything that wasn’t within the four corners of the franchise asgreement.

In mature systems where “churning” is compounded over many years, it would take the FBI to determine the real failure rate of first owners of the franchise. LET THE BUYER BEWARE!!! of regulatory caputre and the hidden subsidy of the franchise industry.

Curiously, there is very little hard evidence to support this. If you search for “international franchise research centre” you will find an academic institute based in London (UK) that has done some research on it. Their research shows that franchises are LESS likely to be trading after 6 years than standalone startups with similar capital available.

The differences were marginal, but they were certainly not the “95% still trading after 5 years” rubbish you hear quoted by the franchisor community.

Cheers,

Lee Duncan
Business Coach & Trouble-Shooter

Dan

I advocate systemizing a business but there’s no reason to pay the massive upfront fees and crippling royalties for what is often a very simple (but well documented) business concept.