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How to spot a Good Franchise from a Bad Franchise

First, a Franchise to be avoided

Although the following is a true story, names have been changed to protect professional confidentiality requirements.

A fellow, let’s call him Pete, approached one of our experts in his capacity as a leading franchise consultant and asked him to rubberstamp a franchise offer he was about to accept. He openly admitted that he would have signed up without asking any questions, had it not been for misgivings expressed by his wife. As it turned out, his wife’s concerns were well-founded and it was indeed fortunate that he sought professional advice.

Background Information

The core business of the self-styled “franchise” was a service that is reasonably popular in the US but is virtually unknown in South Africa. The promoter of the “franchise” had developed the package locally. He readily admitted that he had not operated the business but claimed that his systems were superior to anything on the market. He also explained that to put the business on the map would require a high profile marketing drive. The high cost of such a drive makes a swift national launch a business imperative.

Moreover, the promoter told Pete that the systems and procedures he had developed are highly confidential and no details could be divulged unless Pete signed a binding franchise agreement first. Such a request is untenable but worse was to come! Before Pete would be permitted to even see the so-called franchise agreement, leave alone show it to an attorney, he would have to make a good-will payment of R50 000.

A few days later, Pete received an invoice for the requested amount plus VAT, although no VAT number was given. A note at the bottom of the invoice stated that “in the unlikely event that Pete should find the agreement unacceptable and decide not to proceed with the project, his money would be refunded.

However, “administrative expenses” incurred by the promoter would be deducted but no amount was specified.

Together with the invoice, Pete also received a “disclosure document” which was full of claims but contained no verifiable facts whatsoever. It did state, however, that in addition to the upfront fee, Pete would have to pay an ongoing “franchise fee” in the form of a fixed monthly amount of R3 500 which would increase by a set percentage each year.

A few days after receiving the invoice, Pete was admonished – via email – for dragging his heels by not having paid over the money. The promoter warned Pete that unless he effected payment within 48 hours, the initial fee would double; moreover, other interested parties would be considered for the territory he had been provisionally allocated.

Review of facts

The consultant had the following facts at his disposal:

  • The product is virtually unknown in South Africa and has no established market.
  • The promoter has no link with any overseas principal and the merits of the franchise package are unknown.
  • The promoter has not operated a pilot outlet, meaning that no local market acceptance has been established.
  • The brand, although registered, is unknown and enjoys no pulling power whatsoever.
  • The promoter expects Pete to pay over R50 000 without investigating the opportunity properly. The invoice for the amount was issued without Pete’s agreement. It is also illegal because the promoter charged VAT without being a registered VAT vendor.
  • The “disclosure document” does not contain any verifiable facts and does not conform to the salient guidelines issued by the Franchise Association of Southern Africa (FASA).
  • The ongoing franchise fee is a fixed amount rather than a percentage of sales; in most instances, this is contrary to sound franchise practice. Conclusions reached by the consultant
  • As the concept has not been tested, no franchise exists.
  • It is unethical to demand payments from prospective franchisees before they have been given the facts required to make an informed decision.
  • Seeing that the ongoing franchise fee is a fixed amount, the promoter carries no risk whatsoever. Once Pete has signed the agreement, he is compelled to pay the fee, even if his business should perform poorly.
  • The money-back guarantee is essentially meaningless, not only because it may be difficult to enforce but also because its wording allows the promoter to retain as much of the money as he sees fit for “expenses”.
  • No reputable franchisor will encourage a prospect to commit without both parties having investigated each other properly first.

The consultant’s recommendation

On the strength of the facts available, it is clear that the promoter is far more interested in collecting fees than in ensuring the establishment of a network that enjoys long-term viability. The package is without merit, no franchise exists and negotiations should be terminated forthwith.

Now, a professional franchisor’s approach

FASA has developed clear guidelines for the compilation of a disclosure document and these can be looked up on FASA’s website, Essentially, a disclosure document should contain comprehensive information on the opportunity including the franchisor’s history, full financial details, an explanation of onerous clauses contained in the franchise agreement and an auditor’s statement that the franchisor’s business is financially sound. It should also contain a list of existing franchisees and a copy of the franchise agreement.

FASA also stipulates a “cooling-off period”. This means that 14 days need to pass between the day a prospect receives the disclosure document and the day a binding agreement may be signed and/or any payments made to the franchisor.

Those franchisors who are interested in building long-term relationships go even further. The following is but one example of a franchisor’s pledge to prospective franchisees.

The franchisor’s pledge

Once you are my franchisee, we will be partners in the business. To ensure the network’s success, I shall depend on you as much as you depend on me. Indeed, your success will be my success and your gain will be my gain! The balance of this disclosure document tells you what I expect from you; here is what you can expect from me:

  • Pre-agreement stage – Should anything said in this disclosure document be unclear to you or make you uncomfortable, just ask, but please do so before you sign the franchise agreement. Total transparency is in mutual interest.
  • Preparations – I will assist with site selection, lease negotiations and the drawing-up of specifications for the fitting-out and equipping of your franchise. You deal directly with approved suppliers and I accept no financial incentives of any kind.
  • Training – I will train you and your staff in all facets of the business; this will equip you to operate the business like a pro from day one.
  • Launch package – Prior to the day you open your business for the first time, I will institute a pre-launch marketing drive. From the opening day onwards, I will spend a minimum of 10 working days at your side.
  • Ongoing support – I operate an emergency troubleshooting service that is manned 24/7. On a regular basis, you benefit from brand building initiatives and have access to bulk buying arrangements. Moreover, you will receive one visit per month by a qualified business advisor, have access to product and systems improvements as we develop them and participate in regional and national meetings.

Remember: Your success is my success so let’s join hands and do it together!