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Fraud in Franchising
Posted on November 1, 2010 by Tim Yow

With a suffering economy and several high profile cases being brought against well-known franchisors for misrepresenting an opportunity, it is becoming increasingly important to tread carefully before buying into a franchise. Even if the chain is a household name, you still need to look past the well-orchestrated sales pitch and be sure you know all of the fine details behind the opportunity being offered. While getting involved in a franchise can be a great solution for many looking to start a business, without due diligence you could find yourself stuck in a faulty business model, obligated to an unfavorable contract and, even worse, pouring tens of thousands of dollars into litigation against a franchisor.

It is important to understand that franchise agreements are written to protect the interests of the franchisor and that disclosure documents do not always tell the whole story. Do not take the Franchise Disclosure Document at face value. Investigate! For example, when a previous franchisee sells a failing franchise unit but it remains open, the disclosure document is not likely to list that as a failed business within the organization. After all, the store remained open. Even if it has been turned over to 3 or 4 owners and all but the current one were forced into bankruptcy, the unit is still up and running and, from all appearances, may look to be doing fine. It is important to evaluate how many of the original owners have sold to another party? And why? A business owner seldom sells a succeeding business. In addition to closely examining the FDD, a simple web search for the name of the company followed by the phrase “for sale” can reveal a weakness in the business model. If franchisees are “running to the hills”, it is important to find out why.

When you are in the negotiation stage, beware of promises and claims that the franchisor mentions verbally but avoids putting into writing. If it happens on multiple counts, this may be a red flag and a good signal for you to look elsewhere.

Likewise, be careful not to be drawn into a contract based on earning claims made by the franchisor without verification or based on incomplete information. If many have “enjoyed paychecks in excess of [fill in the blank]”, perhaps you should concern yourself with the ones who have not and discover what is preventing them from enjoying the same success. Could it be attributed to personal failure? Is it location? Or is it a failure within the business model?

It is true that a franchise can provide a way of being in business for yourself but not by yourself. At the same time, nothing can kill that dream quicker than signing a contract based on fraudulent claims. You must do your homework before buying into an opportunity. Also, make sure you are working with a qualified franchise lawyer throughout the buying process. Any business opportunity comes with risks. On the other hand, it is your duty to make sure those risks are minimized before you ever put your signature on a contract that you will be obligated to for years to come.

External Resources

Small Business Administration

A government resource for finding information on planning, mentoring, and strategies for franchises and small businesses.
SBA Small Business Planner Business Gateway

Resources for every step in planning your business or non-profit, from getting your EIN to handling wages. Business Gateway

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