It’s almost like clockwork. We write a story on problems in a franchise system causing people to lose their life savings. We post said story on social media. And then somebody dismisses it all by saying, simply, that franchisees need to do better “due diligence.”
This happened again after I wrote about Dickey’s, the fast-casual barbecue franchise that has been rapidly cycling through franchisees while operators close their doors and file for bankruptcy.
To some, these situations can simply be stopped if franchisees just did the thing they should do when making an investment: Do proper research. Talk to existing franchisees. Read the entire franchise disclosure document. Etc.
And that is true, to at least some extent. A lot of franchise problems would be cured if the operators did something as simple as a Google search on the system they were considering. We’ve spoken with a number of franchisees who bought a concept because they liked the food and thought franchises were a safe investment. More than a few jump head-first into these deals without consulting an attorney or a consultant.
But it’s also entirely too easy to dismiss such problems that way.
First, many of these franchisors actively target people in the same way you might sell skateboards or herbal supplements, by marketing the franchise to people on social media. And then they use aggressive sales tactics to get people to sign a franchise agreement.
Burgerim, the worst franchise fraud in history, was adept at this, using social media to get people to fill a form and deployed boiler room sales tactics to get people to send in their franchise fee. The company even talked some people into borrowing money to get that fee together.
The “due diligence” issue also ignores the fact that many franchise disclosure documents are massive and complex and difficult to understand. Yes, franchisees should consult attorneys who can actually understand the things. But it’s also a document that badly needs reform, both to simplify the document and make it far more readily available.
And, as some advocates I speak with point out, some franchisors will threaten franchisees that tell truth to prospective operators about the true conditions of a system.
Franchising is a difficult business to break into, and much of the incentive for early-stage franchisors is to get a lot of franchisees into the business quickly. You need a good concept that is scalable. And then you need to get people interested in owning one. Getting to that point requires revenue, so companies can establish sales and support systems. Many brands sell very aggressively early in their histories, to get enough franchisees and stabilize the business.
These franchisors compromise good business principles in the name of generating early revenue, which can create serious problems down the road. They get inexperienced or under-capitalized franchisees, relying on people who wouldn’t be legally allowed to buy stocks in certain companies without first consulting a professional broker.
Or they open stores too far from the original location and without proper marketing support. Or they do a poor job instructing operators on choosing the right real estate. Or they underestimate just how much it can cost to open a store, which leads to cost overruns that doom early stores. The worst situations we’ve seen do some combination of everything.
(This also happens in older systems taken over by growth-at-all-costs private-equity firms, but that’s another issue.)
And then when things don’t work, the franchisor easily blames the franchisee for not following the business playbook and it increases tension and leads to worse problems. And others dismiss such problems as franchisees simply not doing their due diligence.
But franchisors that target inexperienced and undercapitalized operators both damage their brand’s long-term potential and doom these investors into serious financial problems. Franchisees tap into retirement savings, drain their accounts, take out second mortgages and borrow from friends or family to cobble the cash together to open a business.
Many get SBA loans, using a personal guarantee. When such loans fail, the investor can lose their home, which happens all the time. The Slutty Vegan founder Pinky Cole just found out the risk of such loans the hard way.
The true onus on who should do their “due diligence” when entering into a franchise relationship is not on the unsophisticated investors many of these brands target. It’s on the brands themselves, who have a responsibility both to their own business and to these investors.