Saturday, 30 June 2012

UK Franchising: Profitable Partnerships?

Whilst franchising remains one of the fastest ways to grow and expand a business, does it also mean that it opens the door for those who want to get rich quickly with little or no regard to the ones, who trust them and invest their hard-earned cash into such "franchise" schemes? Who benefits the most from franchising? What can one do to ensure that they don't fall into the "bad franchise" trap? And should franchising finally be regulated in the UK?

I was lucky enough (and unfortunate at the same time) to have been involved with and witnessed a few franchise models, where the negatives outweighed the positives. And the positives were not in the franchisees' favour, especially when they decided to leave... Why? There are a number of reasons and I want to touch upon a few of them here from my personal experience.

Lack of Due Diligence

For business owners that franchise their ventures, it is only natural to want to attract more potential franchisees in order to expand the influence of their business as well as grow their income. There is no shame in trying to make money if a business model is well thought through with developed systems and processes and allows franchisees to earn a decent level of income. However, potential franchisees also ought to be wary of the "franchisors" that are trying to sell them an idea with no developed or proven business model. There are a number of such ventures operate in the UK that pose themselves as franchises and are driven by greed.

In times of economic uncertainty people want to ensure their financial stability and are seeking additional, or in a lot of cases replacement income. This can be because they own a small business and buying into a franchise would allow them to provide a wider range of services or products and earn more money or because people were made redundant and want to invest their redundancy package in running their own business without spending a long time to establish it. Some business owners "savvy" enough to recognise such a need create a model that attracts people with the promise of a good and stable income. In reality, a lot of these have nothing to support their offering to franchisees and have poorly or no developed systems and processes. In some cases, they use other businesses' intellectual property and pass it off as their own. Unfortunately, franchisees often don't do a thorough due diligence on franchisors and discover that such models do not work only after they join a franchise and part with substantial amounts of cash, which can run into tens and sometimes hundreds of thousands of pounds.

So, how could potential franchisees protect themselves from falling into the trap of joining (and investing into) schemes that portray themselves as genuine franchises? Do your homework!

  1. If you have never heard of the Franchise you are considering joining, check if the franchisor ran a pilot scheme and ask for the results of such a pilot. Check how successful such a trial was by examining financial reports, if pilot franchisee(s) are still with the network and talk to them to find out their opinion;
  2. Obtain contact details for both past, present and prospective franchisees and talk to them, asking direct questions about their experience in the franchise network in question: how successful is their business; why they consider or decided to join this particular franchise; what attracted them to this business model; why they left and what was their experience in exiting this franchise;
  3. Look up the franchise and the franchisor's names on the internet (including forums) to see what people say about the business, its owners and franchisees. Watch out if no information (positive or negative) is returned about either, as it might be an indication of a number of things: a) the business has not been trading long enough to demonstrate its viability; b) the franchisor went out of their way to remove his/her details from the internet; c) former franchisees were "gagged" by the franchisor;
  4. Ask the franchisor to disclose the financial information (annual accounts for the last 3-5 years, audited if possible) for the franchise company as well as franchisees'. You will be required to sign a Confidentiality Agreement, but this will provide you with the information of whether the franchisor's business is profitable and whether franchisees are happy financially and successful;
  5. Check if the business is a member of a reputable organisation (such as the British, European or International Franchise Associations, etc). If not, ask why, and listen carefully to the answers! Some franchisors use excuses such as cost of joining such an organisation and that they wouldn't get any value for their money. In reality it is often an indicator that the business does not want to adhere to the Code of Ethics prescribed by such organisations because their interests are elsewhere;
  6. Search the internet for possible claims and lawsuits against the franchisor or former franchisees. If there were any lawsuits, find out why they happened and what the outcome was. This will give you an indication as to how fair and easy it would be to leave the franchise if things don't work out;
  7. Look up the franchise company and its directors on the Companies House website. This will show you whether the franchisor (i.e. the owner) has any other past and present interests and commitments as well as whether they have ever been struck off the register. Beware of the difference in the franchise company and the trading company registration details: whilst it makes a good business sense for franchisors to separate their franchise operation (i.e. the company franchisees have contracts with) from the trading business (i.e. the company that provides service or products to clients), this may also mean that the franchisor is trying to shield his or her interest from clients and/or franchisees in case of any claims against them. Ask them why the business is set up this way and seek independent professional advice.

Unfair Franchise Agreements

There is no special legislation regarding Franchising in the UK. Thus, the basis for the relationship between the Franchisor and the Franchisee is a general commercial contract, called Franchise Agreement. The term of any Franchise Agreement is always fixed, usually for 5 years, and is rarely terminable just by giving notice by either party.

In established and reputable franchise operations, Franchise Agreement is well-balanced and provides fair terms to both franchisees and franchisors. Of course, the Franchisor will seek to protect their venture and ensure the future success of their business. However, in "get-rich-quick" schemes, the balance of the Franchise Agreement will be heavily and unjustly tipped in favour of the Franchisor, where most, if not all onus of establishing, developing, marketing and running of the business will be on the Franchisee with very little or no responsibility taken by the Franchisor. In addition to that, the "get out" clause could be a few pages long, permitting the Franchisor to terminate the Agreement based on a host of things with no termination rights given to the Franchisee until the expiry of the Term.

Consider this, if someone has joined a franchised network because they liked the idea and were charmed by the Franchisor and seduced by the prospect of running a successful and profitable business, but which doesn't work in reality, has no proven business model, no tried and tested systems and processes, they didn't do their homework and didn't check out the Franchisor and their business and didn't seek legal advice regarding the Franchise Agreement and paid thousands or tens of thousands of pounds in License and Monthly Service fees (or Royalties) etc, 5 years is a very long time to have a loss-making business that costs them money without being able to get out of it! And if the Franchisee decided to leave the Franchise, some "Franchisors" could adopt a bully tactics to extract money from such franchisees by pointing finger at the Franchise Agreement and then gag them from telling their story, because their Franchise Agreement has a clause not to bring business into disrepute. Therefore, when considering joining any franchise and prior to putting your name on the dotted line, one should always seek legal advice from expert lawyers, who specialise and have experience in Franchising. If at a loss as to where to find such expertise, contact the British Franchise Association. But here are a few things to consider when reading through the Franchise Agreement:
  1. Always obtain a copy of the Franchise Agreement and get it checked by an independent lawyer, who specialises in franchising. Do not take the Franchisor's word for it and do not use a lawyer, suggested by the Franchisor;
  2. Ask to see other Franchisees' Franchise Agreements. A good and honourable franchise will have one standard agreement which applies to all franchisees, and therefore the Franchisor should not have any reason to hide it from potential franchisees. Where any differences to the contract were negotiated between the Franchisor and their franchisees, these will be recorded in the Side Letter. Beware if the Franchisor refuses to show such contracts or confirm that there is only one Franchise Agreement used or where you find out that some franchisees have different Franchise Agreement Terms, as this shows that either the Franchisor doesn't know what they are doing, or they might be treating their franchisees unequally. This could also mean that there is no standard system in the business model which could undermine each franchisee's business;
  3. Watch out for clauses, where the Franchisor waives any rights of the Franchisee to any claims against the Franchisor based on representations made by the Franchisor prior signing of the Agreement. This could mean that whatever promises the Franchisor made to the Franchisee, they are unsubstantiated and were most likely made to get the Franchisee to join the business and part with cash;
  4. Carefully read through the Termination Clauses of the Agreement, as should you decide to join this particular franchise and it doesn't work for you, you could be liable for any moneys owed to the Franchisor to the end of the Term.
I have also found the article Grounds for terminating a franchise agreement by David Bigmore very useful, and I'm sure you will too.

Absence of regulatory control of UK Franchising

As I mentioned earlier, Franchising in the UK is not regulated. This means that anyone could franchise their business, regardless of whether it's right or wrong for them and potential franchisees, and without anyone to watch over the franchisees. Many people enter into franchise agreements without a full understanding of what they are letting themselves into. Lucky are the ones, who chose an established, tried and tested and reputable franchise. God help those, who joined a business that calls itself a "franchise" and is driven by the Franchisor's greed, as franchisees are drained of their cash and left disheartened, disappointed, angry, broke and powerless to do anything to bring the Franchisor to justice.

The BFA and the British Government pride themselves on the fact that franchising sector is not regulated in the UK, because they say this removes the "red tape" and allows for more freedom for businesses as well as attracts foreign franchise models into the UK, thus contributing to the economy. Instead, the BFA adopted the European Code of Ethics, which has no statutory backing and, of course, those who are not members of the BFA do not have to comply with it. However, what they won't tell you is how many ex-franchisees are there in the UK, who suffered from so-called "franchises" and how much money they lost collectively, because they had no legal protection.

In my humble opinion (having been a franchisee of an organisation with no structure, systems, processes or substance), it is high time that Franchising in the UK is regulated to protect the rights of the franchisees and to put an end to such extortion schemes, that some "businessmen" call "Franchise". I think that if UK can lead the way in Europe and beyond with some legislation (such as the Bribery Act 2010), it can certainly ensure that such a vast commercial activity as Franchising is regulated too (the estimated annual turnover of UK franchise sector in 2011 was £12.4 billion, according to NatWest/BFA Survey)!

Share your views on and experiences of Franchising by leaving a comment on this blog. You can also join our Facebook group Ethical Franchising and participate in discussions there.

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