Black Franchise Hopefuls Beware

Owning A Franchise Is A Great Way To Break Into Business.  But Competition Is Stiff, Markets Are Crowded And People Are Getting Burned.
By Ronda Reynolds

Black Enterprise, Franchise Opportunies, September 1995

 Craig White did all the right things when he decided to buy a franchise five years ago.  The Cleveland-based corporate attorney was looking for a side-line business to help ensure financial security for his young family.

He spent years studying the franchise industry, reading various books and magazine articles and researching franchisee rights, laws and lawsuits.  White became fascinated with Sox Appeal, a unisex hosiery shop based in Eden Prairie, Minn.  At the same time, Sox Appeal had 30 stores nationwide and sold hosiery in shops near high-volume areas such as subways and malls.

In 1990, White bought a Sox Appeal franchise for about $150,000 and set up shop in an urban area.  After investing $20,000 in the franchise fee, another $90,000 in hosiery and $40,000 to $50,000 for a staff, White who was not giving up his attorney position, then hired his wife as a Sox Appeal manager.

After first-year sales of $300,000, White opened another Sox Appeal in Beachwood, Ohio, the next year.  But by 1993, White was negotiating a settlement with the head honchos at Sox Appeal.

"They just did not offer any support," White explains.  "I was on my own even though they knew I was just the owner, not the store operator.  I was promised help in hiring, ordering supplies and record keeping," vents White, who also anticipated higher-level sales. (Sox Appeal couldn't be reached for comment.)

Despite his scrupulous research and preparation, White still got less than was promised to him.  And many other franchise owners feel that they're getting a raw deal.  So much so that 137 franchisees battled to be part of the contingent that stormed Washington last summer at the White House Conference on Small Business.

The franchisees' main concerns included inflated sales estimates, unfair contracts and the failure of franchisors to obey federal disclosure laws.  Another sore spot: blatant encroachment practices, or the opening of competing franchises near existing outlets.

The Federal Trade Commission, the Washington-based watchdog for the franchising industry, reports that for the first six months of 1995 there were just 100 complaints against 90 companies.  While these numbers may not seem significant among 550,000 franchise establishments, there are a lot of unhappy franchisees.  And such complaints ripple throughout the industry explains Robert Zarco, an attorney specializing in franchisee rights.  "I get at least 12 calls a day.  It's not just a few disgruntled franchisees, It's a disgruntled country."

The Miami-based lawyer is representing a multiple-plaintiff suit against Burger King, the $6.1 billion fast-food giant on behalf of two minority Burger King franchisees.  The suit alleges that Burger King set up the franchise owners to fail by forcing them into high-cost, inner city locations, lying about anticipated sales and replacing existing kitchen equipment in their restaurants with older equipment.  Zarco is demanding at least $200 million in damages.

According to Zarco, minorities are getting dumped on because franchisors pick on those who have the least ability to fight back.  Minorities are the least likely to complain because typically they sink all their money into their stores and don't want to lose them.  At the same rate, they can't afford to just sit back and take it.  Minority franchisees must fully understand their rights, when necessary, fight for them.

Inflated Sales Projections

Money is a deciding factor for prospective franchisees and the home office knows it.  So all sorts of claims about average sales are used to lure would-be entrepreneurs.

According to the FTC's free brochure, A Consumer Guide to Buying a Franchise, always insist upon written substantiation for any earnings projections or suggestions about your potential sales.

Franchisors are not required to make earnings claims, but when they do, the FTC Franchise Rule requires them to have a reasonable basis for such claims and to provide supporting documentation.  FTC experts also explain in this must-have brochure that average sales figures can be deceptive.  So, by doing some basic math you'll save big bucks.

When the franchisor tells you that you can expect to net an average income of $75,000 per year, get the number of companies included in that sample size.  Of course, a particularly successful franchisee can slope the figures.  A top tip: Get average sales of franchisees in your anticipated area, not just nationwide.

Some franchisors provide gross sales, but these figures don't tell you much.  Hunt for net profits.  Most franchisors don't track this information.  Experts suggest pounding the pavement and interrogating franchisees.  A suggested shortcut: Contact independent franchisee associations and get net sales information from their members.

For example, take San Diego-based Mail Boxes, Etc., which had to hand over $167,000 to a former franchisee last winter as a result of a lawsuit.  Mail Boxes, Etc. claimed that at least 97% of its franchisees were successful.  However, the San Diego plaintiff showed that several Mail Boxes, Etc. franchisees were losing money and being forces to sell their companies for fire sale prices.  And an even greater number were not earning the purported average store wage of $60,000.  Mail Boxes, Etc. refused to comment.

The issue of anticipated earnings is sticky.  And it's a hard case to win.  You're better off hiring an accountant to pore over the figures and calculate average sales for you before you buy in.

Just The Facts

Franchisees think they're safe because of a simple, federally mandated document called the Uniform Franchise Offering Circular or UFOC.  Under the FTC's Franchise Rule, prospective franchisees must receive the circular, a comprehensive business document, at least 10 days before signing any final contract or paying any money to a franchisor.

The document describes the costs of buying a franchise, such as initial deposits, franchise fees and costs for initial inventory, equipment and advertising. Unfortunately, that's where most prospective franchisees stop reading.

For franchisees, the most useful information is in the back of the pamphlet where it discloses whether the franchisor or any of its executive officers have been convicted of felonies involving fraud, franchise law violations or unfair or deceptive practices.  The UFOC also indicates if any key individuals have been found liable in a civil action involving the franchise relationship.

Equally important, the UFOC should list current and former franchisees.  "Get the list" counsels attorney Zarco.  "Then whoever they tell you to contact, call the opposite people."  Val Gomez, a Merry Maids franchisee in Wappingers Falls, N.Y. won't air too much dirty laundry about his franchise, but he does admit that he could have avoided some strife had he called his peers.  "I know I wanted this business and researched the financing part of the deal.  I called about six franchisees but skipped visiting existing locations.  That was definitely a mistake.

It's wise, too, to determine how many franchises are currently operating.  A pool of franchises in your area may mean stiff competition.  A number of terminated canceled or non-renewed franchises spells trouble. Be aware that some companies try to conceal the number of failed franchises by repurchasing outlets.  Find out who the former owners were and call them too.

If you buy an existing outlet, ask the franchisor about previous owners and the time period in which they owned it.  Beware of any franchise that has seen it share of owners come and go over a short period of time.  This could mean that the location isn't profitable for the franchisor hasn't provided that outlet with promised services.

John And Jane Hancock---Not So Fast

Before you sign on the dotted line, make sure you renegotiate the contract.  "When the franchisor tells you that the contract cannot be changed they're lying." Says Harold Brown, a Boston-based franchise attorney with a namesake firm.  "These holier-than-thou guys are always lying, and they're laughing like hell," says Brown.

For the record, the franchise contract has been penned for the protection of the seller or franchisor.  As the buyer, you must look out for your own interests.  Robert Purvin, president of the San Diego-based American Association of Franchisees and Dealers, says, "The association has turned into a lightning rod of franchisee complaints."  The group, a nonprofit franchisee rights and educational organization.

Although franchising is a sellers market, Purvin, author of The Franchise Fraud: How to Protect Yourself Before and After You Invest (John Wiley, $27.95), counsels prospective franchisees to "protect themselves with that first contract because litigation is expensive and franchisors can prey on people who can't afford to protect themselves.

Cleveland's Craig White renegotiated his contract all along the way.  Among White's major coups was an arbitration provision that allowed him to sidestep a courtroom drama in the case of an irreconcilable difference.  White's contract also let him leave the franchise family before his contract expired and without being penalized if Sox Appeal did something unethical or illegal.  Another shrewd legal maneuver enabled him to operate a different hosiery store out of his Sox Appeal spot if he terminated the union since he had already invested in the location, materials and staff.  Note: Most franchisors won't allow such deals.  Says the 38-year-old lawyer, who settled his case with Sox Appeal out of court in 1994.  "I learned an expensive lesson, but I protected myself before I put out a nickel.  So I was able to walk away with my investment."

Not In My Backyard

Encroachment, the problem of putting franchises too close to mature operations, is quickly becoming the leading legal issue of the '90s.  In some cases franchisors are boldly erecting new stores around the corner, down the street or across the street from old outlets, arguing that franchisees' contracts don’t' prohibit them from doing so.

Three years ago, Leslee Scott talked five of her family members into investing in an existing Blimpie franchise in Tampa, Fla. (A basic Blimpie franchise costs about $100,000.)  The 27-year-old Scott ran such a crackerjack operation that she bought another Blimpie restaurant just 13 miles away.

Last year, a convenience store opened 1,000 feet away from her first store.  Shoppers strolling through the aisles stumbled upon a sandwich counter emblazoned with a Blimpie sign.  "I could throw a ball 1,000 feet." fumes Scott; that's how close the store was to hers.

Now she can't give her two franchises away, and she's trying.  "I just want out of the whole industry," She says.

For about a year Scott battled with the home office and fought with regional directors.  After having no luck getting the competing Blimpie pulled out of her area, Smith hired a lawyer. "[Blimpie] had 10 full-time attorneys while I have one guy at $375 per hour whom I can hardly afford, and these suits can take up to six years."

From 1991 to 1994, Blimpie endorsed that Scott's stores were clean her staff polite and sales strong.  But according to Scott, Blimpie got tough once she hired a lawyer.  Inspectors started scanning the stores with microscopes and suddenly her outlets were a mess, her staff was rude and her sales were slipping.

Terror tactics continued through the summer of 1994, but by fall Smith settled out of court with Blimpie, which refuses to comment.  A gag order prevents Scott, and most franchisees, from disclosing the actual figures of the settlement.

"Franchisors induce someone to buy in and then become their adversary," says Susan Kezios, president of Women in Franchising and the American Franchisee Association, a lobbying group that's 7,000 members strong.  The AFA is trying to pass legislation to establish minimum standards of conduct concerning franchise business relationships.  Kezios believes minorities are the first to be encroached upon, but Matt Shay, general counsel for the Washing-based IFA, says, "That's just not true.  It's a complicated issue, but you have to look at the development process of a business."

The "development process" Shay mentions refers to the franchisors' need to achieve a significant market presence, say a McDonald's on every corner.  A franchisor makes its money on sales of franchises and royalties from existing franchises.   Obviously, prime retail space is scarce, and common sense dictates that if an area is a good market for on franchisee, it's good for two and maybe four.

"There's a fine line between appropriate levels of penetration and encroachment and cannibalization," admits Shay.  "Franchisees struggle to find a balance," This problem won't be solved any time soon.  Says Kezios: "The easy-prey concept will change when there are more minority franchisors.  But that's a couple of generations off."

The idea is not for African Americans to sidestep the franchise industry altogether.  But a game plan is needed, which includes some basic preparation, smart legal and accounting help and a lot of common sense.  The goal is to stay in the franchising game for the long haul, not to get eliminated before you even enter the playing field.