Evaluating & Buying a Franchise

How to Protect Yourself from Franchise Scams

Through due diligence and expert assistance, you could be well on your way to financial and personal freedom.

Buying a franchise offers a relatively cost-effective and smooth entrance into business ownership; separating viable opportunities from snake-oil salesman is the key to a successful venture.

So you want to earn up to $5,000 a week. Unless you're independently wealthy, you'll have to log some serious hours to earn this kind of income. We've all seen advertisements for work-at-home franchise opportunities performing medical billing, envelope stuffing and many other seemingly "easy" work with generous compensation claims.

"With a huge and growing industry there are bound to be people out there at that are just trying to make a quick buck and will continue to try to do so no matter how attentive the FTC and state regulators are," said George Knauf, a franchise advisor with FranChoice, a company that provides free help to prospective franchisees in identifying franchises and guiding them through the franchise opportunity investigation process. "It amazes me that companies industry veterans have always warned against are still out there selling a lot of franchises."

Knowing the Good from the Bad

Despite all the "bad apples", there are hundreds of franchise opportunities available, with many completely legitimate offerings among them, including home-based franchises. So how do protect yourself from the scams? The old adage "if it seems too good to be true, it probably is" holds true for franchises as it does with daily consumer transactions. Fortunately, you don't have to reply on euphemisms to decide where to sink your savings. As with any business venture, a healthy dose of due diligence will help you in the long run.

"What a buyer needs to keep an eye out for are companies without a history," Knauf said. In the planning stage, Knauf recommends contacting existing or former franchisees to question them about their experience with the franchise company, as well as ensuring a particular franchise has an experienced executive team, is active in its industry and is affiliated with a franchise organization, such as the International Franchise Association (IFA).

Once you've narrowed your choices, reviewing the franchisor's disclosure document, or Franchise Offering Circular (FOC), is a must. The Federal Trade Commission (FTC) requires all franchisors to provide this document at least 10 days prior to asking a prospective franchisee to sign any contract or collect any money.

The disclosure document reveals:

• Prior litigation. The FOC tells you if a franchisor, or any of its executive officers, has been convicted of felonies, involving, for example, fraud, any violation of franchise law or unfair or deceptive practices law, or are subject to any state or federal injunctions involving similar misconduct.
• Bankruptcy. A franchisor must reveal any bankruptcies it or any of its executives have filed. This information will help you assess a franchisor's financial stability and general business acumen.
• Business experience. Before you buy into any franchise organization you'll want to find out who the executives are and their prior experience, as well as how long the franchise has been in business. For obvious reasons, investing with an inexperienced franchisor may present more risks than with an experienced, well-established franchise company with a recognizable brand.

Which franchise is right for you?

In many situations, there is more than one viable franchise opportunity. Even after weeding out the scams and blatant mismatches, you may still find yourself presented with many options. It's easy to lean toward a product or service we like or see doing well in a different market. Knauf advises his clients to take a closer look.

"When buyers begin looking at companies they often approach it from the perspective of a consumer saying to himself 'what would I buy' or 'what products do I love'," said Knauf. "While these questions are good for selecting a place to take the family for dinner, they are not the best for picking a business to buy. The fact that a consumer may love a product is good for possibly one sale per week, but a business needs much more volume to survive and flourish.

"This line of thinking also makes prospective franchisees vulnerable to sales pitches from franchisors who may not have their best interests in mind. While a reputable franchisor will screen candidates to make sure the relationship will be mutually beneficial, a company with bad intentions could use your enthusiasm for the product against you in order to close a deal without focusing on the business and how is will make money (or not)."

Expert Advice

Knauf presented the following tips for protecting yourself against franchise scams.

• Employ the help of a franchise expert who can help you evaluate yourself, the industry, how you fit into it and the best opportunities which are appropriate for your situation. The advisor you choose should teach you about the industry and keep you focused on your needs during the process, so that no one pulls you off track.
• The franchisors you consider should have proven track records that you can evaluate.
• A franchisor should be forthcoming with contact information for franchisees already in their system.
• A franchisor should never discourage you from taking disclosure documents to a franchise attorney.
• Visit a franchisor in person (most franchisors offer this as part of the investigative process called Discovery Day.
• Don't get so caught up in a product or service that you forget to look at what an owner in that particular business has to do every day. If it is a sales-oriented franchise, you'd better like selling. If the business requires a large staff of high school-aged workers, be prepared to manage this type of team.
• Investigate a business by checking with the FTC and Better Business Bureau. The FTC works for the consumer to prevent fraudulent, deceptive and unfair business practices in the marketplace and to provide information to help consumers spot, stop, and avoid them.

Making it all worthwhile

All of these considerations will carry more weight a year from now than simply wanting to sell a product that you love to buy yourself. Owning a franchise is a great way to realize your dreams of owning a business. Through due diligence and expert assistance, you could be well on your way to financial and personal freedom.