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Buying a Franchise - Evaluating Franchise Investments and Franchise Disclosure Documents

More Information About Franchise Law

Part 2

SOLD It: An American Dream That Turned Into A Nightmare
An example of a franchise company in trouble that failed to meet basic threshold standards is iSOLD It, an eBay drop-off store franchise. The company started its one and only company-owned store in November of 2003. Just weeks later, on December 10, 2003 they filed an application to sell franchises. The California Department of Corporations didn't say What are you thinking? You've only been in business a couple weeks, how can you even consider selling franchises? Nor did they require this be disclosed as a risk factor on the cover page of the Franchise Offering Circular, as it should have. Disclosure responsibilities ultimately rest with the company (and its attorneys), and this will become one of many issues in future franchise litigation.

Instead, the Department simply collected its $675 filing fee and issued an order declaring the franchise registration effective the next day - on December 11, 2003. Then the magic of franchise marketing took over. By 2006 the company had nearly 200 franchised drop off stores in operation and was touted by Entrepreneur Magazine as #1 in their list of Top New Franchises for 2007 and #17 on their Hotter Than Hot franchise list. Entrepreneur Magazine, which requires franchise companies to submit their FOC's (Franchise Offering Circulars) for supposed review each year before they're listed, didn't consider the high attrition rate (franchise owners leaving the system) or the fact that the audited financials in their FOC showed the company hadn't operated profitably since 2004 as serious negatives and awarded iSold It the #1 listing for Top New Franchises of 2007. How did all of this happen? It's yet another bizarre reality in the world of franchising.

The franchise company's audited financial statements for the year ended 12-31-05 showed an operating loss of $1.1 million. Nine months later, in September of 2006, the net operating loss mushroomed to over $4 million.

In its November 3, 2006 Franchise Offering Circular, the table in Item 20 disclosed a total of 10 franchise owners leaving the system, yet a hand count of Exhibit D-3's Former Franchisees revealed a significantly different number: 44. A similar discrepancy exists about franchise transfers. Item 20 says 12 transfers whereas Exhibit D-3 discloses 27.

In a long overdue letter distributed to franchise owners on April 5, 2007, CEO Ken Sully painted a dire picture of an American Dream that had turned into a nightmare. Mr. Sully's letter admitted the company has not been profitable since 2004 (according to the audited financials, the company showed its one and only operating profit of $356,286 in 2004 before the precipitous downward spiral of 2005 and 2006). Over 60 franchised stores have closed and many more are struggling for survival. Mr. Sully observed Tragically, many individuals who believed passionately in the potential for the category have lost sizable investments, including homes and retirement savings.

Lost homes and retirement savings? How could such a travesty happen? I counseled a number of persons considering an iSold It franchise and warned all of them against the investment. Fortunately, they followed my advice. The concept was never proven in the marketplace before franchise efforts began, violating the most basic Franchise 101 precept. I also felt the management team lacked strong franchise credentials and the five-day training program was woefully inadequate. Finally, the franchise company was operating increasingly in the red and had a high attrition rate (owners leaving the system). It didn't take a lot of brain power to see this was an accident waiting to happen. I predicted the bubble would burst and, sadly, it did.

Common sense could and should have prevented so many people from losing so much. Unfortunately franchise sales persons appeal to emotions (passions and potential, to use Mr. Sully's terms) and strive to keep common sense and business logic out of the buying equation. If a franchise company is able to obtain a ranking on a media list, the sale is even easier. Reprints of high rankings on lists, like Entrepreneur Magazine, are included in the package given to franchise buyers, who are lulled into a false sense of security and begin to stumble over each other in a rush to sign up before someone else takes their desired territory (another favorite closing technique used to sell franchises).

iSold It! amended its FOC at the end of May, 2007 to add some long overdue risk factor language to the cover page of its Franchise Offering Circular. The new FOC cover page risk factor language says their franchise system is still new and unproven. That's very interesting. How can they say a franchise system, that's approaching its fourth anniversary, is still new? Maybe they're looking at things from a "how old is our universe' perspective? The word unproven is another play on words. The system is most certainly proven in the sense that many people, to quote Mr. Sully, have lost sizable investments, including homes and retirement savings. So why not use this quote directly in their Franchise Offering Circular? Answer: can't sell any franchises that way.

In an August 31, 2007 Business Week article, CEO Sully claimed it wasn't necessary to disclose these risk factors in the FOC. His reasoning: "We told everybody that this is sort of like the wild, wild West" he says. "It's a brand-new concept and nobody knew for sure where it was going." Disclosure was added to the UFOC recently, he says, "because of the number of stores that weren't understanding the complexity of the business." Hello? You don't tell your franchise investors after the fact what you were required to disclose in the FOC before they bought so they could make an informed investment decision. That's the purpose of franchise disclosure laws. And claiming written disclosure of risk factors in the FOC is not necessary if a prospective buyer hears a salesman's verbal wild, wild West story ignores franchise disclosure responsibilities and is really an admission the company failed in this regard. With its amended FOC, the company incredibly continues marching forward with franchise marketing efforts.

Now, let's consider the franchise checklist and factors to consider before any leap into franchising.

INDUSTRY TREND
Is the franchise in a cutting-edge industry that is doing well currently and is projected to do well in the future despite any economic slowdown? Education and home-improvement services are stable categories. Food is over-saturated generally and, except in exceptional circumstances, is not worth the high investment, long hours, headaches and marginal income.

TOTAL INITIAL FRANCHISE INVESTMENT
In general, don't expect a franchise that requires a five-figure initial franchise investment to produce a six-figure income. As with most things in life, you get what you pay for. On the other hand, don't assume a six-figure investment will lead to a six-figure income level. Be realistic and conservative. Is the total initial franchise investment range (including working capital) $125,00 or less; and the maximum investment less than $200,000? You can find solid companies in this investment range if you're willing to look around.

Don't forget to consider long-term financial commitments, particularly the real property lease (see discussion below under "LEASING AND LOCATION"). Also, the working capital estimate (called additional funds in Item 7 of the company's franchise offering circular) does NOT cover operations up to the break-even point. It only covers a short initial phase (usually only three-months) of operating costs As the break-even point (where revenues cover all operating costs) may not happen for one, two or more years, knowing only what it's going to take to get you through the first 90 days is not helpful " in fact it may set you up for financial suicide. In many cases, reaching the break-even point can require more reserve funds than the total initial capital investment. Don't ever forget the name of Item 7 in the Franchise Offering Circular: Initial Investment. If you don't have enough reserve capital to reach the critical break-even point, your entire investment will go down the drain and franchise failure occurs.

One franchise owner in a relatively low investment and low operating cost window cleaning franchise said his biggest surprise was how long it actually took his franchise to be profitable. Going in, he thought it would take 12 to 15 months. It ended up taking twice that time. Fortunately, he had enough reserve capital to make it there, but declined to say what his actual franchise profits or income level were once he reached "franchise profitability." If you're operating just above the break even point and making less than minimum wage, is that anyone's definition of success?

© 1990-2008, Kevin B. Murphy, B.S., M.B.A., J.D. - all rights reserved

Kevin B. Murphy, Franchise Attorney, MBA - Mr. Franchise

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Perfumes, Splashes & Colognes: Discovering and Crafting Your Personal Fragrances

Description

With Nancy Booth's easy instructions and "Personal Scent Profile Quiz," readers will learn how to create customized perfume blends and re-create favorite commercial perfumes at a fraction of their retail price.

Reviews

Rating: 5 / 5
Date: 2009-10-30
Summary: "review"



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Rating: 1 / 5
Date: 2009-08-31
Summary: "Most recipes include chemical fragrance oils"

This book was a disappointment to me because I thought it was a natural perfumery text. The majority of the recipes include chemical fragrance oils.

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Very useful book, describes fragrances and essence oils in detail, has a great many recipes. Easy to read.

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Date: 2009-03-17
Summary: "Good Smells Coming"

Love this book. It was just what I was looking for to start making my own fragrances.

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Rating: 5 / 5
Date: 2009-01-08
Summary: "Loved it"

I actually loved this book and it was just what I needed in my research.