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10 danger signs to look for when buying a franchise: no-risk guarantees, customers' complaints and tough termination terms are just a few things to watch out for.

SHOPPING FOR A FRANCHISE can be like walking into a lion's den: There are lots of hungry franchisors looking to eat you up and spit you out. Although many franchisors practice the highest ethics, others are unscrupulous and will use shady tactics to get you to buy.

There are an estimated 550,000 franchised businesses operating in the United States. The number is growing by about 6% a year, according to the International Franchise Association in Washington, D.C. In retailing, franchised businesses account for more than 40% of the total sales volume, and this figure is expected to increase.

However, potential franchisees should not be baited by the promise of quick profits, low initial investment and freedom to be their own boss. When evaluating a franchise, too many entrepreneurs disregard red flags and fail to completely examine the franchisor or the contract, according to Robert L. Purvin Jr., a franchise attorney and author of The Franchise Fraud (John Wiley, 1994, $27.95).

Many people think the Uniform Franchise Offering Circular, a disclosure document required by law, is a stamp of approval by the government. Actually, the circular provides a jumping off place for you to begin your own investigation.

Start by talking to other franchisees. "Potential franchisees are foolish if they don't take advantage of this valuable resource," says Lewis G. Rudnick, a partner in Rudnick & Wolfe, a Chicago law firm specializing in franchising. The Federal Trade Commission requires franchisors to list the names of at least 10 franchisees operating in the applicant's vicinity. In addition, you should poll franchisees in various parts of the country to get a more complete picture. Then, you need to scrutinize the circular to separate the wheat from the chaff. Here are 10 franchise danger signs. If you see one or more of them, run.

ONE

Too-good-to-be-true promises of training, guidance, and marketing support. The most common complaint among franchisees is the lack of adequate training and ongoing support. Talk to other franchisees to see if they learned everything necessary to run the business. One week's training hardly prepares a neophyte to launch a new venture. Check to see if management offers assistance after the business opens. Is the home office available for help when unusual problems arise? Are there specialists in site selection, marketing and promotion?

When Ouida Alderman bought an interior design franchise in Pensacola, Fla., she was told she'd learn everything she needed to know to run the business, which provides decorating services to residential clients. "What a laugh," she recalls. "The training was so fast and furious there was no way I could absorb everything in a few days."

Alderman was also assured she would get ongoing assistance once she opened. However, her district manager knew little about the business and was no help. "She didn't even know how to measure a couch for slipcovers," reports Alderman, who went out of business in about six months. She and six other former franchisees in Florida are now preparing to file a suit against the franchise company.

Beware of the franchisor that collects advertising fees and uses them for other purposes, or advertises on the West Coast, which doesn't help franchisees in the East.

Watch out for fraudulent marketing schemes. A franchisee who owns four hotel outlets in the South, complains about having to kick in thousands of dollars last summer to help promote a $1 million contest for hotel guests. "Management never announced a winner," he fumes. "When I questioned them about it, they said no one qualified." He plans to sell his hotels and work with a more reputable hotel franchisor.

TWO

Poor quality products or services. No matter how great the franchisor's system, a franchise is only as good as what it sells. Check out customer complaints, consumer ratings and other barometers of quality and customer satisfaction. Are prices competitive? Beware of franchisors that require you to purchase supplies from approved vendors. Other suppliers may be able to provide the same equipment at a better price. Is the market declining for the product or service? "The demand for video rentals is likely to dwindle," predicts Chicago-based franchise consultant Donald Boroian, CEO of Francorp Inc. "New technology now lets you rent movies over the phone at the same price you'd pay at a store."

THREE

Rigged for failure. Some greedy franchisors set up a number of franchisees to fail. For example, when a franchise goes under, it's often sold to a new operator who is unaware of the situation. The former owner may have antagonized customers and given the business a bad name. So the new operator has the burden of overcoming customer resistance.

This scenario occurred when a woman in New Jersey unknowingly bought an interior design franchise that had failed twice. "Not only had the two owners created bad will, but they didn't cancel their phone numbers," she says. All calls from potential customers were forwarded to the home of one of the former franchisees, who had her own design business.

Headquarters repeatedly promised to rectify the situation, but the franchisee still had no customers. "Five months later, I found out the phone numbers were still in operation. Within a year, I went out of business," she says. When she contacted other franchisees who also had problems, the franchisor sued her for loss of potential franchisees. She countersued and the parties settled out of court.

Be wary of franchisors that open a number of units rapidly. Five years ago, American Speedy Printing Centers launched a big campaign to sell inner-city franchises. "They became so saddled with debt that they cut back on operational support to the franchisees," says Susan P. Kezios, president of the American Franchise Association, a Chicago-based trade group for franchisees.

Charles E. Peppers, an African-American, was one of those left high and dry. In 1989 he quit his database management job at Illinois Bell to open a franchise in Chicago's Loop. "They had a suburban mentality and knew nothing about city codes," he says. The franchisor's floor plans were rejected, so Peppers had to wait six months to renegotiate a lease and was out $75,000. When he finally opened, he was given no marketing support and only one week of on-site assistance. "We were on our own. They were trying to open too many stores. If they had taken the time to work with us, we would be more successful now," says Peppers, who is just breaking even. The franchisor filed Chapter 11 last year.

FOUR

Guarantees of success at no risk to you. Watch out for franchisors that promise minimal risk and investment for maximum financial return. Any business is a gamble, even with a tested formula. It takes dedication and hard work, with 80-hour work weeks often the norm. Still, thousands of franchises fail each year. Though the industry claims that 95% of all franchises still exist after five years, at a 1992 congressional hearing franchise attorney Rupert Barkoff, then chairman of the American Bar Association's Forum on Franchising, testified that failure rates of 30% to 40% and as high as 50% are more likely. So when shopping for a franchise, talk to franchisees to get the real story.

FIVE

Who holds the lease? Before a franchisor becomes financially secure, it is more likely to avoid lease obligations, allowing the franchisee to find a location for his or her outlet and hold the lease. However, as it becomes more financially sound, it is in the best interest of the franchisor to sign the lease and sublet to the franchisee.

Then, if the franchisee wants out, the franchisor gets the property. The franchisee must walk away from the business, and usually, his or her share of any equity.

SIX

Tough termination terms. What does it take to get out? Contract provisions can trap you for life. Termination terms can call for everything from de-identification from the franchisor to strict non-compete clauses. Worse, some franchise agreements allow termination only if initiated by the franchisor--meaning a franchisee could be stuck with a business regardless of whether he or she wants it. "Review the termination provisions with the greatest caution," warns Gerald A. Marks, a Red Bank, N.J., attorney specializing in franchise litigation. "See if the agreement gives the franchisor the option to purchase the business at a price substantially below market value, or severely inhibits the franchisee's ability to sell the business."

How do you break a contract? "The only way is to prove breach of contract on the part of the franchisor," says Marks. Take the case of Jennifer Smith (not her real name), whose print franchise became a top producer within months after she opened. Everything looked rosy until she learned from a company source that the franchisor had a new sales policy: Minorities and women need not apply. According to management, they just didn't cut it as business owners.

Outraged, Smith sued the company for breach of contract, claiming her agreement did not require her to support a company policy that was illegal. To avoid unfavorable publicity, the franchisor negotiated a six-figure out-of-court settlement. The next day, Smith hung out her own shingle and it was business as usual.

SEVEN

When selling franchises is the franchisor's prime focus. Franchisors whose chief goal is selling franchises rather than goods and services are a considerable danger to avoid. Such a franchisor is motivated to: (a) oversaturate a market with outlets, limiting profitability for each franchisee in that market, (b) resell stores at higher prices as their value increases, thus fueling growth by attrition, and (c) terminate franchise agreements in order to convert to company-owned outlets. "Lacking market power, franchisees are continually cannibalized," observes Purvin.

A franchisee in the South who owns four hotels saw his profits decrease by 20% when the franchisor built a unit across the street. "We share an 800 reservation number, so we're competing for the same guests. The franchisor gets royalties from the two properties, so what does it care?" he grouses. When a franchisor sells just an address, franchisees are under the constant threat of competition from their own brand.

EIGHT

Bad franchise relations. You need to know whether franchisees are happy and if not, why. Beware of franchisors that block you from talking freely with current and former franchisees, or steer you to their most successful franchisees.

When a client of Marks' was considering a mailbox franchise, he called past and present franchisees to check out the company. "One franchisee offered to sell his franchise to my client for less money than the franchisor was asking," says Marks. "That signaled that the guy was trying to bail out of a bad situation." Calls to other franchisees indicated that they were all disappointed because they weren't making as much money as they had been led to believe they could. Needless to say, the prospective franchisee continued shopping.

A strong franchisee organization that has negotiating leverage with the franchisor is a plus. Clues to the integrity of the franchisor can be found in the Uniform Franchise Offering Circular, which must provide a list of the lawsuits that have been brought against the franchisor.

NINE

The franchisor is unwilling to disclose sales and earnings figures. Look out for the franchisor that tells you it is prohibited by law from giving you these numbers. "Such a statement is simply not true," says Robert Purvin. "Franchisors are permitted to give past sales performances--as long as they qualify them as being representative of a franchise in a particular area."

Misleading sales and profit claims are a common ploy of dishonest franchisors. Make sure that financial statements have been audited. Have your accountant check to see if the income of the franchisor mainly comes from initial franchise fees and not ongoing royalties. If so, this may indicate the franchisor is in the business of selling franchises and not developing a franchise system.

If franchisors refuse to supply financial data, your only recourse is to redouble your questioning of current and former franchisees. Have an accountant scrutinize the financial statements to see that the earnings claims justify the costs of buying the franchise.

TEN

The franchise agreement doesn't measure up to the Franchisee Bill of Rights, a code of ethical business conduct developed by the American Association of Franchisees and Dealers (AAFD). The franchise marketplace is not a level playing field. Approximately 800 franchise companies belong to the IFA, a trade group that enacts legislation favorable to its members. But who represents the franchisees? Increasingly, they are joining trade groups such as the AAFD and the American Franchise Association, which were formed to negotiate better terms and conditions from franchisors.

To bring fairness to franchising, the AAFD drew up a Bill of Rights that sets forth a list of "minimum requirements of a fair and equitable franchise system." For example, one provision of the "bill" is "the right to local dispute resolution and protection under the laws and the courts of the franchisee's jurisdiction." Seeking redress for grievances in the state where the franchisor is headquartered can put an out-of-state franchisee at a serious disadvantage, both in terms of cost and the franchisee's lack of familiarity with laws outside of his or her local business area. The Franchisee Bill of Rights also calls for franchisees to have the right to such accommodations as equity in the franchised business, the posttermination right to compete, ongoing support and full disclosure from the franchisor.

These 10 danger signals provide a strong foundation for your investigation of franchise companies. If a franchisor passes these tests, chances are it is serious about providing a franchise business opportunity worthy of your investment.

FRANCHISE INDUSTRY RESOURCES

The following trade groups can be an invaluable resource to your investigation of opportunities in franchising:

* International Franchise Association (IFA), 1350 New York Ave. NW, Suite 900, Washington, DC 20005-4709; 202-628-8000. The IFA, an association of 800 franchise companies, is the world's leading source of information on franchising, offering publications, seminars and videotapes on how to franchise your business, how to buy a franchise and on trends and opportunities in the industry. The IFA's Alliance for Minority Opportunities in Franchising focuses specifically on increasing the number of minority franchisees, as well as increasing the use of minority suppliers and media by franchisors. In addition, the association sponsors a series of national franchise expositions.

* Women in Franchising Inc. (WIF), 53 W. Jackson Blvd., Suite 205, Chicago, IL 60604; 312-431-1467. WIF, a training organization, which promotes the advancement of women in franchising, also offers seminars aimed at bringing more minorities into the industry.

* American Franchisee Association (AFA), 53 W. Jackson Blvd., Suite 205, Chicago, IL 60604; 312-431-0545. The AFA is a trade association that represents franchisees throughout the country by lobbying for legislation and providing educational and referral services for its members. Members are also eligible for the AFA's purchasing group, through which they can receive cost benefit discounts on merchandise.

* American Association of Franchisees and Dealers (AAFD), 1420 Kettner Blvd., Suite 415, San Diego, CA 92101; 619-235-2556. The AAFD is a national nonprofit trade association representing the rights and interests of franchisees and independent dealers. The AAFD provides a broad range of member services designed to help franchisees build market power, support legislation of interest to franchisees, and provide legal and financial support.
COPYRIGHT 1994 Earl G. Graves Publishing Co., Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1994, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:includes trade association resources
Author:Delaney, Joan
Publication:Black Enterprise
Article Type:Cover Story
Date:Sep 1, 1994
Words:2547
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