Falling in love with a franchise is easy, especially when executives from the firm make glowing promises and refer you to a shiny website filled with testimonials from happy franchisees. Beware of offers that sound too good to be true, and stay away from any business pushing you to sign a franchise agreement right away. Franchise fraud costs honest entrepreneurs hundreds of millions of dollars per year.
The Federal Trade Commission is in-charge in regulating the franchise industry, but the oversight is spotty at best. For instance, the FTC does not verify the information in franchise disclosure documents. Some franchisors even use their FDDs to make it appear as if the FTC has vetted and approved their system.
What is franchise fraud?
Franchise fraud is a type of scam where a seller persuades a buyer to invest in a franchise that does not exist, is not legitimate, or is a pyramid system. The scammers may promise big profits or claim to be affiliated with an established company.
In reality, it is a performance, and the victim may never see any of the promised money.
You can do several things to protect yourself from franchise fraud. In this blog, we will discuss the 6 ways to successfully avoid fraudulent franchises.
1. Do your research, including a review of the franchise disclosure document.
Consult the disclosure document as part of your research into a franchise business. This type of document is legal disclosure that U.S. franchises must give to interested prospective buyers. Reviewing this document is essential due diligence even if the FTC does not verify the statements.
Pay attention to each area, including the franchisor and any parents, predecessors, and affiliates section, business experience, litigation, and bankruptcy. The franchisor and parents section informs you how long the franchisor has been running. It should line up with what the franchisor has been telling you thus far and the data you find online.
The business experience section describes the qualifications of the executive team running the system. These executives should possess relevant expertise.
Litigation covers pending, prior, and material legal actions against the franchisor. A short list is not necessarily a sign of a shady prospective investment, but an extensive list is.
Search online for information that corresponds with FDD statements
Make sure your research goes beyond simple online Bare-bones-bones searches that can make you believe a new franchise is legitimate if the franchise website is engaging and well-written and franchisees and customers post positive reviews.
These things are easy to fake. You may need to ignore brand-new franchises altogether since they might just want your money to test unproven ideas or to commit fraud (more on this later).
When you search,
look for information that supports details in the FDD.
failure rates
legal issues
the executive team’s history
Search for misrepresentation, too.
For instance, some franchises claim in the FDD that they give franchisees exclusive territory. In reality, they do not.
Talk with franchisees, preferably the ones you choose to approach
Your due diligence should include consulting with franchisees, both past, and present. Visit them in person when possible. Otherwise, a phone call should suffice.
It could be a fraud red flag if the franchisor gives you lists of franchisees to talk to. This is not necessarily misleading. It might be authentic transparency, but approach such a move with caution.
Many franchise scammers use the recruits on the list to put on a false performance and “shill” stories of amazing success.
You tend to get the most honest and authentic results from franchisees you find and approach yourself. Keep a few things in mind during these talks.
The general attitude among the majority of the franchisees is likely how you would feel in their situations. You may end up talking with franchisees who are positive and happy.
Still, ask questions about what they wish the franchisor would do better and whether they would change anything about the process.
Try to find at least one unhappy franchisee.
Take note of the person’s complaints. Why this person in particular has a different view than the other franchisees do?
If your personality, attitude, financial approach, and mindset are similar to the unhappy person’s, this franchise might not be right for you. (Not necessarily a fraud, simply not a good match for you.)
Good questions to ask include these.
How did the franchisor make it easy (or hard) for you to get your unit open and operating? How was the process of site selection, leasing, construction, design, and getting permits?
Are you happy with the ongoing support from the franchisor? What is the franchisor’s assistance like?
Does the franchisor’s purchasing power get you discounts and save money on inventory and supplies?
You usually should wait until the end of the conversation to discuss the franchisee’s earnings. Folks can be hesitant to discuss their income with strangers but more willing to do so with people they have talked to for 15 or 30 minutes or an hour. Do discuss income, though. The franchisees were in your shoes at one point and understand that earnings are a key component of franchise assessment.
2. Take your time.
Here are the signs of legitimate franchisors:
They follow franchise law.
Willing to disclose information in the initial, middle, and late stages.
Understand the risk and that you are maybe investing virtually all of your life savings.
They want you to take your time and do your due diligence as a prospective franchisee.
Genuine businesspeople appreciate that the chances of you succeeding in franchising are better when you go into the process fully informed and feel like you can trust the franchisor.
3. Ask questions.
Look for consistency in the answers to your questions about the franchise’s background, experience, cost, and financial stability. In franchise fraud, scammers may give misleading answers or deviate from details on websites or in franchise disclosure documents. That inconsistency is a bad indicator.
Get answers with numbers and metrics, not vague replies that ring false.
4. Get everything in writing.
Get your franchise agreement and all franchisee agreements in writing, including the amount of money you are investing and any fees or royalties you are required to pay. It should include the franchisees’ responsibilities, such as making payments on time and abiding by all franchise rules. The franchisor should also agree to provide you with training and ongoing support.
Ask an attorney to review the documents for areas of concern and red flags.
5. Spot the red flags
Guard yourself against the following franchise fraudulent signs.
The company is vague and hesitant to disclose its background or downright not transparent about its history, experience, or financial stability.
The franchise opportunity is too good to be true. Be wary of any franchise business that promises a franchisee high profits with little work or capital.
The franchisor possesses a gleaming, blemish-free background. Even the most established, most profitable franchisors have had failures, subpar location choices, public relations messes, and struggles with rising costs.
The franchise agreement is not in writing. Steer clear of any franchise opportunity that does not have a written contract outlining the terms and conditions of the sale.
The franchise fails to give you its FDD or the FDD lacks any of the 23 sections that the Federal Trade Commission requires. Likewise, a franchise that hesitates to give you its FDD but eventually does is likely a scam.
The franchise claims it will give you the FDD but only if you make a cash deposit, Oh, and the deposit happens to be nonrefundable. This is a dirty move. The company knows that most people will walk away after reading the FDD so it is trying to make money anyway. Under the law, you should never have to pay to read FDDs.
Online reviews skew mixed or negative with a fair number of complaints saying the franchise is fraudulent, an outright scam, or a pyramid or multi-level marketing scheme.
You are unclear on the products or services the franchise is selling. Every time you try to ask about this, the person gives a short, fuzzy initial answer and jumps to discussing another part of the business such as how easy it is to garner huge profits and a million dollars in your first year.
The franchise says working with an attorney is unnecessary.
The franchisors employ pressure tactics.
Businesses that hound you to sign an agreement ASAP
Shady practices are at play when franchises set frantic deadlines and rush you to make decisions. These actions are a violation of franchise law.
Franchisors must give a prospective franchisee two weeks for reviewing and signing a franchising agreement. Leave the room, so to speak, when a franchisor demands you sign right away or miss the best opportunity to make a million dollars in a year, especially when it does not give you critical numbers and details.
Businesses with inexperienced leaders
Franchise fraud could occur when people running the business lack experience in the sector. They could be looking to steal your money outright or to use it for testing an unproven idea.
It is fine to put up money to test new ideas. That is how many new ventures get started.
However, it is not OK when you are under the impression your money is for other purposes. Consider why the franchise owners are not putting up their own money if they believe so strongly in the idea. I believe in it. They know the chances of success are low and don’t want to lose their funds.
6. Talk to the Right Person to help you find the right franchise
Enlist the help of a franchise consultant to sift through franchise opportunities and make sure you are not a victim of franchise fraud. The right person can guide you from beginning to end and mentor you. Contact Adam Goldman today for a free consultation.
It is always best to have an impartial third party review franchise agreements, FDD, financial statements, and any other relevant material related to the franchise opportunity.
By doing this, you can be sure that you are getting the most out of your franchise opportunity and that it is not just too good to be true. There’s no need to risk falling prey to franchise fraud when you have the tools to avoid it!