Self-employment appears to be a valid answer to the need for a job and income and prospective franchisees are willing and able, of course, to make an investment in themselves in terms of the hundreds of thousands of dollars it can take to start a franchised business. Franchisees take out loans and use their cash savings, their home equity, even their retirement savings, 401K's, etc.. as collateral to invest in franchises that they believe provide great possibilities for a job and profits with little risk.
The status quo supports franchising and there is cooperation within the status quo that benefits from franchising to hide the very great risk of any small business venture, independent or franchised, because even those who start small businesses and fail after a few years do stimulate the economy in those years that they are working hard and long to try to bring their businesses to break even. The Franchisors are not even held legally responsible for faulty startup estimates because of language in the standard unilateral franchise agreements.
Academic Research backed by Department of Commerce Statistics, indicate that 50% of all small businesses, independent or franchised, fail within the first five years and only 29% of small businesses are still standing at ten years. Most franchise agreements are for ten year terms and the franchisees personally guarantee both the franchise and the lease for ten years. Franchisers can somewhat beat the odds of "small business failure" when they can acquire the "churned" and failed units who remain within the system and continue to earn gross sales upon which the franchiser realizes his profits in terms of royalties, fees, and commissions.
Contrary to what is hyped about franchising, most of the investors in retail franchises are not wealthy individuals who buy several franchise units as an investment. This is not to say that wealthy individuals do not use the Small Business Administration to finance several units under the SBA guaranteed loan programs in order to become multi-unit franchisees, and thus reduce their overall risk while maximizing the possibility of profits. However, the majority of franchise units are owned as single units by Mom and Pop types who are looking for a job and income to support their American Dream; to put their kids through college, or to continue their current lifestyle. They use their personal assets to guarantee both the franchise and the lease.
While the FTC indicated in late 1979, when noting the purpose of the RULE, that they were regulating franchising in the pre-sale process to protect franchisees and to give them information that would allow the new franchisees to assess the risk of the investment and compare it with other investments, there is a fatal flaw in the Rule as it stands today. Many attorneys in and around franchising have written to the FTC over the last many years and pointed out the flaw, but the FTC seems unwilling to fix the flaw in the Disclosure Rule. An article appeared in The American Business Law Journal in 2003, entitled Franchising Fraud: the continuing need for reform, that points out the flaw in the Rule and the legal ramifications for franchisees who become the victims of the flaw in the FTC regulatory rule.
The FLAW is the failure of the government to mandate in the FTC Rule that "earnings claims" or any proprietary UNIT performance statistics of any kind be disclosed to new buyers by the franchiser, HIMSELF. The flaw permits exploitative franchisers to churn first-owners of franchise units out of the view of the regulators and the new buyers of franchises. It is the franchiser who profits from the sale of the franchise and who is the seller and yet the government allows the franchiser to escape the obligation to disclose the risks as known to the franchiser by using franchisee references, current and past, who are listed in Item 20 of the Franchise Disclosure Document (FDD) as the resource for franchisee due diligence. These references have no legal obligation to disclose anything to a new buyer and many of the ex-franchisees are silenced by confidentiality agreements that they signed when they transferred their business in a fire sale to a new owner that had to be approved by the franchiser.
Item 20 of the FDD is just an artifice to allow the franchiser to sell the franchise without making any representations about success or profits in the written disclosure document, the FDD, or the written franchise agreement, and this lack of disclosure protects the franchiser from claims of fraudulent inducement/concealment in arbitration and the courts from those franchisees who fail and are angry because they didn't understand the risk of the investment.
The failed franchisees don't understand that all of the hype and puffery concerning success and profits made outside of the contract are NOT actionable after they fail because when they sign the franchise agreement, they have released the franchiser from any liability for anything that was said or done outside of the four corners of the written agreement and, in effect, are buying the franchise and acknowledging that they realize they have 100% risk of failure.
The arbitrators and the courts are put in the position of having to honor the signed contracts and the terms therein because the franchise agreements become the basis for public stock offerings and investment securities sold in the free markets of the world. It is almost impossible to prove fraud or fraudulent concealment in the sales process because the FTC has deemed that UNIT performance statistics are not MATERIAL and even "earnings claims" are OPTIONAL for franchisers.
Very few franchisers even bother to make an earnings claim in the Franchise Disclosure Document because this gives them even greater protection from claims of fraudulent inducement to contract. The new and small franchisers are more likely to make an "earnings claim" if the facts of their unit experience indicate that the units are earning profits beyond overhead because they can't use their visibility in the economy to indicate viability as do the older and more mature franchisers. But, those new franchisers with hot concepts who seed up all over the country at somewhat the same time don't make disclosure, as well, of earnings claims in order to be protected from those who will fail in the future and feel they were defrauded because of misrepresentations made in the sales process.
Until the Congress of the United States orders the FTC to fix the flaw in the FTC Franchise Rule, thousands of first-generation franchisees will lose everything they have when they unknowingly buy a high-risk and unprofitable franchise. Of course, conversely, thousands of franchisees may also have a job and be making a satisfactory living in that same franchise if 50% fail and 50% make it to break even within five years, etc... and many other second generation franchisees who originally bought the business for almost nothing from a failed first generation franchisee will be profiting because they got the business for nothing.
The franchiser can hardly lose and the other special interests, the banks and the lenders, who sell SBA 90% guaranteed-loan securities in the secondary markets win, as do the REITS and the Mall Developers. It is really ONLY the first-generation franchisee who takes the risk and loses when they can't bring the business to break even. Apparently, the fatal flaw in Franchise Regulation is justified as serving the "greater good" or the "greatest good" by all of those in and surrounding franchising who profit from franchising.
Franchising depends on cheap labor to survive, as provided by both the franchisee owner of the chain unit, and the employees of the franchisee owner. Franchise jobs are mostly PT jobs and the franchisee owners are generally not in the position to provide any benefits to employees such as health insurance or vacation or sick pay. Franchise jobs, however, appear to be the only jobs growing in our economy, and the government is apparently pushing franchising when they raise the SBA guarantee from 85% to 90% as was done recently by the Congress. The government has invited the franchisers to sell franchises and the banks to lend to franchisees but the fatal flaw in the Franchise Rule continues to exist. Experts like Richard Solomon of Franchise Remedies, who has over 40 years of experience in franchising, indicated that there is blood bath coming in franchising and that fraud in franchising is rampant, as never before.
Carol_Cross
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