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B.  FRANCHISE ABUSES

It is estimated that nearly one-third of all U.S. retail sales, amounting to hundreds of billions of dollars in products and services, are conducted from more than 500,000 franchise locations. Millions of people are employed in franchise operations, and tens of thousands of additional franchises start up each year.

The popularity of franchising is due to its unique method of conducting business. For an agreed-upon price, sometimes as little as $5,000, a franchisor grants the right to market products and operate a franchise in a specific location. The franchisee may acquire use of the name, designs, equipment, start-up assistance, and selling methods. Ownership of the venture may or may not remain with the franchisor; more often it does not. The average investment, including equipment and other costs, can exceed S100, 000.

Despite the success of franchises, abuses are prevalent. Unsophisticated investors are exploited because they are unable to evaluate franchise offers properly. Some franchisors exaggerate the potential for profit and provide little help if the franchise is not successful. People launch successful businesses but lose them through recapture tactics by franchisors. Others mortgage their homes and invest their life savings on the basis of exaggerated claims of potential profitability.

There are no federal laws specifically governing the franchising industry. This adds to the risk of abuse. Whereas some states have laws protecting potential investors from misrepresentation, false and misleading advertising, and fraudulent franchise schemes, others do not.

Beware of misleading ads promising high returns. Franchise operators often place deceptive advertisements to attract investors:

This ad may be misleading in several respects:

• Investors may be required to pay additional money for equipment, training, and start-up assistance. The ad doesn't say this.

• Financially unsuccessful franchises may be sold to anyone who puts up the cash.

• Exclusive territories may be promised but not allotted, with many competitive franchises offered nearby.

• Guaranteed sales maybe a fabrication or based on inaccurate figures.

The first step in analyzing franchise ventures is to examine all sales promotion literature and advertisements. Scrutinize claims telling you what to expect in profits, sales, and earnings.

Investigate the franchise. Before beginning serious negotiations, ask for:

• financial statements, bank references, credit references, and other written materials concerning the franchisor, officers, and key executives

• facts about the negative as well as the positive aspects of the venture

• books and records revealing the sales figures of other franchisees (One of the major reasons franchises fall is that investors receive misleading profit projections; reviewing the actual books and records may protect you in this area.)

• a copy of the franchise-offering statement (The Federal Trade Commission requires that all franchises include a detailed description of the business start-ups and applicable fees.)

• the names of other franchisees (Speak to them about their business. Better still, visit their operations.)

Investors sometimes sign franchise agreements without under- standing all the ramifications. Know the answers to the following questions to protect your investment:

• How much down payment is required?

• Is a down payment required before negotiations begin? (Most legitimate franchisors do not ask for a deposit until the contract is signed.)

• What is the entire fee for your investment?

• Are royalty, licensing, and advertising allowances included in the fee or are they extra? (These charges are often overlooked and can be substantial. If a royalty is not included in the fee-for example, 10 percent of the annual gross sales-be sure you know whether the business will be able to sustain profitability while paying these fees. You must calculate the effect of these expenses on your business before you decide to invest.)

• Can the franchise be terminated without your consent? If so, under what conditions? (Some franchisees lose their businesses as a result of unfair termination provisions in franchise agreements, such as failure to meet lofty sales quotas.)

• How long can you operate your franchise? (Some investors build successful franchises but are required to give the business back after a specified number of years.)

• Will the franchiser provide assistance such as architectural and location site assistance, job training for managers, and so on? Do you have to pay extra for this?

• Can the franchiser exercise control over your business? To what degree?

• Must you buy equipment from the franchiser in order to begin business? What is the entire fee? Is it fair? Are there exorbitant interest payments?

• Are you prohibited from starting the franchise in the location of your choice?

• Can the franchiser refuse to renew the franchise and/or purchase it back from you? How much money, if any, will you receive? How will it be paid? Is the price fair?

• Can you invest in the franchisor's business? Will you obtain a more favorable price for the franchisor's stock?

• Are you required to purchase products exclusively from the franchiser? Do you anticipate delivery problems?

• Are you obligated to do business with or pay commissions to third parties?

• Are you or members of your immediate family required to work at the franchise site?

• Are you relying on specific promises or guarantees? (Be sure to include these in the agreement. For example, if the franchiser makes claims about your potential earnings, insist that you receive appropriate figures to prove the accuracy of all claims, statistics about the number of franchises and the amount of failures, and the number of franchises that earn below the earning claims.)

Consult a competent adviser. Speak to a lawyer, accountant, or financial adviser before you buy. Representing yourself in the purchase of a franchise enterprise is almost always a mistake. A lawyer should negotiate and review your franchise contract. Franchise agreements are complicated documents that are usually prepared by franchisors and contain unfavorable clauses.

Contact a lawyer of your state's attorney general's office immediately if you believe you have been exploited. A number of states have franchise registration statutes that obligate franchisors to file offering statements before selling franchises. Some states require franchisors to provide franchise-offering documents to potential investors before a franchise contract can be signed. These laws disallow the sale in the event that the franchise-offering documents are not distributed. In addition, the FTC requires that a franchisor provide a prospective franchisee with an offering circular no later than the first serious meeting or 10 days prior to the execution of the contract. You can also seek remedies under antitrust and common law actions in fraud, misrepresentation, and breach of warranty. The FTC may be able to get you out of the deal if the franchisor has not met its legal obligations.