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4 signs it’s a franchise scam

PUBLISHED ON 22TH OF FEBRUARY 2017 ONLINE – FRANCHISING MAGAZINE (by Noha Shaheed)

So you’re in the market for a franchise and want a business with a strong future.

Unfortunately, among the many solid businesses in the sector, there are some which just aren’t worth your time and money.

Here are a few tell-tale signs of a questionable franchise model:

  • No trading history

  • No address, just a website

  • No trademark

  • Not a lot of disclosure

  • Unavailability of financials

  • Bad reviews from past franchisees

1. Franchisor is pushy

If a franchisor has a “get in quick or miss out” attitude, but is very vague about the details, the model could be questionable.

Jane Garber-Rosenzweig, principal at Gable Lawyers, says a “lack of transparency is a tell-tale” as well as “pressure to sign up, and a rushed process”.

She also warns against a pyramid scheme (each paying participant recruits two further participants, with returns being given to early participants using money contributed by later ones).

2. Franchisor requests a non-refundable cash before signing up

Franchisees need to keep an eye out for requests that cannot be made by a franchisor.

Garber-Rosenzweig says potential buyers should be wary of “significant capital expenditure not addressed or disclosed in the disclosure document before the franchisee signed the agreement.”

She adds, “release from liability”, which is a legal document between two parties — the Releasor or person promising not to sue — and the Releasee or person or company who is potentially liable, “cannot be requested by the franchisor from any franchisee.”

3. Low or no royalties/marketing fund

Rod Young, managing director DC Strategy, says there could be questions about how a franchise system will grow if it is “one that offers very low or no royalties” and “very low advertising contributions.” Think rationally – without sufficient fees, how will a growing network and need for a larger head office support team be funded?

4. Guaranteed profit with little or no effort

Many franchisors will advertise that their system comes with guaranteed profit or salary, and some may claim these can be achieved without effort.

“Franchisees should never blindly rely on any financials or projections provided by the franchisor and should do their own projections,” advises Garber-Rosenzweig.

“Franchisees are strongly advised to obtain advice from an independent accountant and do modelling and projections of cash flow and growth with such accountant.”

Young agrees, stating that realistic profit projections can be within reason, but potential franchisees should beware of “lifestyle franchises” that supposedly require no effort and are promoted as risk-free.

How to avoid being scammed:

  • Talk to those on the ground: the governing regulation, the Franchising Code of Conduct (The Code), says a franchisor must provide the contact details of past and present franchisees.

  • Invest in experts: too many franchisees skim on due diligence due to the cost of hiring a skilled accountant or lawyer. A franchise is a risk and large investment, which could cost you more if you don’t do your homework.

  • Put your foot down: Garber-Rosenzweig recommends buyers do not crumble under pressure if rushed to join the system.

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