Franchising is
a method of retail business in which the investor/franchisee makes an
investment in the form of a franchise fee in exchange for the right to
promote goods, services, and/or processes directly to the public. A
franchise usually has a recognizable name or trademark. Franchising
involves the integration of independent companies at different levels
and in different areas of production and distribution. This integration
permits more effective sales and advertising.
Franchises exist in at least three different forms:
1. The manufacturer-sponsored retailer system
An
example of this arrangement is the car industry, where car
manufacturers license dealers to sell its product. The dealers are
independent businessmen who agree to meet certain standards and
conditions of sales and service.
2. The manufacturer-sponsored wholesaler system
An
example of this arrangement is the soft-drink industry, where
soft-drink manufacturers license wholesale bottlers in various markets
who buy the concentrate and then carbonate, bottle and sell the product
to retailers in local markets.
3. The service-firm sponsored retailer system
Familiar
franchises include auto rental, fast food, and motel businesses. Here,
a service firm organizes a complete system for bringing its service
effectively to consumers.
Pyramid schemes vs. Franchises
Legitimate franchises exist in all sorts of industries. There are
also illegitimate, and illegal, businesses calling themselves
franchises that are actually pyramid schemes. These schemes are not
focused on selling products, but rather on getting other people to pay
to join the scheme. This provides the organizers of the scheme with a
lot of money, but usually does little or nothing for the investors. Be
sure to investigate any franchise opportunity to make sure that it is
not a fraudulent pyramid scheme.
Choosing a Franchise
Purchasing a franchise can be a good way to become an
entrepreneur, and enter the world of business ownership. Potential
investors should be cautious - like any other investment, there is no
guarantee of success. While buying a franchise may reduce the risk of
investment by enabling the investor to associate with an established
company, it may be costly. Franchise owners may not control many
aspects of their business, and be contractually obligated to the
franchiser in a variety of ways.
A franchise typically enables the investor or "franchisee" to
operate a business. By paying the franchise fee, which may cost
thousands of dollars, the franchise may operate the business under the
format developed by the company, or franchisor, the right to use the
franchisor's name, and sometimes, assistance in setting up or
marketing.
Prior to entering a franchise arrangement, the BBB recommends investors consider the following:
- Franchisers frequently hire independent contractors on commission
to close a franchise deal. Remember that his/her claims for success in
the franchise and his/her extolling of the advantages of and potential
for the franchise merge into the signed contract. Check the contract
for a provision whereby the franchisee waives liability for any
representationsnot appearing in the written contract.
- Additional costs may overwhelm a new business if they are
unexpected. The costs for setting up a franchise may include: royalty
payments and advertising fees to the franchiser, the initial outlays
for rent or real estate, equipment, licenses, insurance, initial
inventory, and employees. Remember that all of these expenses may have
to meet exact specifications set by the franchiser, and may have to be
purchased from vendors the franchiser designates.
- Potential franchisees should remember that even though the
franchisee owns the business, they are not completely independent. The
franchiser may control the choice of site, design of the location,
advertising, methods of operation, the goods for sale and their prices,
and the sales area. The areas that the franchiser will control must be
clearly stated in the prospectus given to potential franchisees.
- Be realistic in choosing a franchise. Take into account not
just how much money will be invested initially, but how much money you
can afford to lose and how much income you must have. Also,
realistically assess your abilities in sales and business
administration.
- Potential franchisees should carefully investigate franchise
offerings, and take time to think about any offer that is made. Don't
let high pressure sales tactics sway you. Investors should be fully
aware of all costs and restrictions before committing to a franchise
agreement, which can last 20 years. The Federal Trade Commission (FTC)
and the New York State Department of Law have both instituted
disclosure rules to help protect potential investors.
The Federal Trade Commission Franchise Rule
Federal Trade Commission (FTC) Franchise Rule requires
franchises, vending machine and display rack business opportunity
ventures to disclose material facts in a prospectus, and further
prohibits material misrepresentations in the offering and sale of
franchises. The following types of businesses are covered by the FTC
rule:
A. The franchisee sells goods or services that meet the franchiser
quality standards or bear its mark; the franchiser exercises
significant control over or extends significant help to the franchisee;
and the franchisee is obligated to pay $500 or more to the franchiser
within the first six months of commencing business; or
B. The franchisee sells goods supplied by the franchiser; the
franchiser secures vending machine or rack display locations for the
franchisee; and the franchisee is obligated to pay $500 or more within
six months of beginning to do business; or
C. While the business opportunity does not actually fall within the
above definitions, it is represented as falling within one of the above.
The following information must be furnished to prospective franchisees at least ten days before signing the contract:
- identifying information and financial information about the
franchiser, and a description of the franchise; business experience,
litigation and bankruptcy history of the franchiser and the
franchiser's directors and key executives; money required to be paid by
the franchisee to obtain or commence the franchise operation;
- continuing expenses to the franchisee in operating the franchise business that are payable in whole or in part to franchiser;
- a list of people with whom the franchisee is required or
advised to do business, and the services or real estate that must be
purchased, leased, or rented;
- description of fees that must be paid (e.g., royalties,
commission, etc.) by third parties to the franchiser or any of its
affiliates as a result of a franchisee's purchase from such third
parties;
- description of any assistance available from the franchiser, such as financing, training programs and advertising;
- restrictions placed on a franchisee's conduct of its business;
- required personal participation by the franchisee;
- termination, cancellation and renewal of the franchises;
- statistical information about the number of franchises and their rate of terminations;
- franchiser's right to select or approve a site for franchise;
Further, a franchiser (or a franchise broker) who
makes an earnings claim through advertising or a direct sales pitch,
must provide the prospective franchisee with a document which includes
the following information:
- a statement describing the material bases and assumptions for each
earnings representation made, including the number and percentage of
outlets achieving the same results as those claimed;
- cautionary language - whose text is set forth in the rule -
concerning the projectability of the representation to the prospective
franchisee's future experience;
- a notice that evidence to substantiate the representation is available for inspection upon reasonable demand; and
- a cover page which sets forth the name of the franchiser, the
date of the document, and a statement - in the rule's terminology -
advising the prospective franchisee of the importance of the document.
While the franchiser is not required to provide the substantiation
for such claims, he/she must have back-up material for each claim
available to prospective buyers or the FTC upon reasonable demand. The
rule also requires the franchiser to provide a copy of the franchise
agreement to the prospective buyer at least ten days before the
agreement is to be executed.
New York State Law
New York State law requires the franchiser to register a
prospectus with the Department of Law, Franchise and Securities
Division. The prospectus must disclose all of the above information, as
well as the following:
1. if the franchiser is subject to a restrictive order barring the
registration of such person as a securities broker or sales person.
2. the length of time the franchiser has conducted business of the
type operated by the franchisees, has granted franchisees for such
businesses, and has granted franchisees other lines of business.
3. the franchiser's most recent financial statement.
4. a statement as to whether franchisees or subfranchisers receive an exclusive territory.
5. a statement as to whether the franchisee is limited in the goods
and services he/she may offer to customers. For more information:
To file a complaint against a franchiser, or for more information,
contact the Better Business Bureau in the area where the company is
located. The BBB serving Metropolitan New York can be reached in the
following ways: for immediate assistance, call 212-533-6200. The charge
is $3.80 plus applicable tax, charged to a major credit card. Consumers
can also call 1-900-225-5222. The charge is 95 cents per minute; the
average call costs $3.80. For free information or to file a complaint,
write to 257 Park Avenue South, New York, NY 10010-7384 or check our
site on the World Wide Web at www.newyork.bbb.org
Potential investors can also get information from the following sources:
Franchise and Securities Division
New York State Department of Law
120 Broadway, 23rd Floor
New York NY 10271
Federal Trade Commission
Office of Consumer and Business Education
Room 403
Washington DC 20580
202-326-3650
http://www.ftc.gov
