Franchise Disclosure Document - Let the Buyer Beware Of Red Herring!

Franchises are sold throughout the United States, and throughout the World, as if there was very little risk involved in the purchase of retail franchises that require an investment of hundreds of thousands of dollars in order to wear the brand name of the franchisor. Those who sell franchises, and who profit from the sale, often represent the franchised business as being more successful than the independent small business startup but this is not true according to the few academics who produce research statistics on franchising.

The brutal truth, however, is that the research that is available shows that ALL small retail businesses fail at a rate of 50% within the first five years, and only 29% survive as long as ten years. Why, then! do most retail franchise agreements require that the buyer of the franchise commit to a ten year contract, and then personally guarantee the franchise, and the lease, for ten years with their personal assets, the house or the 401K, or whatever assets the franchisees may own? The personal guarantee on the ten-year franchise contract and the long-term lease that often is for ten years does act as inducement to give the business away to a second-generation franchisee when the business doesn't thrive and a franchisee fails in that first five years.

The Franchise Disclosure Document (FDD) mandates that franchisors disclose 23 items of information to the new buyer of the franchise, only two of which have anything to do with the performance of the franchise itself. Unfortunately, Item 19, "Earnings Claims" is OPTIONAL and only a small percentage of franchisors make "earnings claims" and even when they do, they are based on averages what can be cleverly skewed. Item 20 provides an overview of the franchise system and a list of references that prospective franchisees are supposed to talk to to accomplish their due diligence on the purchase.

Prospective buyers of franchises should note, however, that optional Item 19 together with mandated Item 20 act to enable the franchisor (who profits from the sale from the franchise fee and from the royalties that are paid from the first day the business is open) to sell the franchise without making ANY success or earnings claims within the FDD or within the written franchise agreement. Interestingly, since it is against the law to make an earnings claim OUTIDE of the FDD or the written franchise agreement, under the law, and all franchisors deny that they have done this, the FDD does protect the franchisor from claims by failed franchisess of fraudulent inducement to contract or fraudulent concealment of material risk factors when the franchise fails sometime in that first five years because the FDD doesn't mandate disclosure of MATERIAL risk factors in the possession of the franchisor. See the Article: "Franchising Fraud, The Continuing Need for Reform" published by the American Business Law Journal on 01 Jan 2003, and on the Internet, in mid 2008, to understand the ramifications for franchisees from this fatal flaw in the Federal Trade Commission Rule that governs the Franchise Disclosure Document.

Prospective franchisees should think of that FDD that they have in their hand as a "smelly" red herring, especially if there is no "earnings claim" and even if there is an earnings claim, and refuse to sign any franchise agreement until they have paid an experienced franchise attorney and CPA to Vet the purchase.

Carol_Cross

Enter Your Email Address For Update :

Delivered by FeedBurner

Related Post :