Can You Profit as a Franchise Pioneer?

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To date, nearly 600 iSold It stores have opened—but more than 60 have closed or been sold in distress. The company halted the sale of new franchise units in the U.S. this year, and CEO Sully issued a letter to franchisees stating that the company "has not been profitable since 2004," and that "We do not feel comfortable selling any new franchises until we get the failure rate lower."

That caused Entrepreneur magazine, which had bestowed the franchise with the title of "Top New Franchise of 2007," to remove it from its online list in June. And in July, franchise owners received a revised version of the company's Uniform Franchise Offering Circular (UFOC)—the central document in a franchise contract. In boldface underlined type on the second page, the document reads: "The iSold It franchise system is still new and unproven…. We cannot and do not guarantee that your store will be profitable."

No Disclosure Necessary?

That disclosure should have been made when iSold It first franchised its stores, says attorney Michael Webster, whose Toronto firm specializes in franchise law. "ISold It had no business experience," he says, so it was never in a position to make earnings estimates like the one McGinn and Bowen say they were given during a meeting for potential franchisees in January, 2005. Webster has kept up with iSold It's story on franchise Web sites such as Blue MauMau. He has not advised any of the chain's franchisees; however, he thinks the company could be held responsible for civil penalties.

Sully stands by his belief that early franchisees knew they were buying into an unproven chain, and that no disclosure was necessary. "We told everybody that this is sort of like the wild, wild West" he says. "It's a brand-new concept and nobody knew for sure where it was going." Disclosure was added to the UFOC recently, he says, "because of the number of stores that weren't understanding the complexity of the business."

Mark Moger, a retired DEA agent who opened an iSold It store in Buckingham, Pa., in January of this year, has no qualms with the way the opportunity was advertised to him. "Did they promise me a pie in the sky? No, they didn't," he says. "But I didn't want to sell food, I didn't want to get involved in retail, so I got into what I know: service." By focusing on the larger inventories of business-to-business clients, and developing some product niches, like jewelry, Moger eked out his first profit in August. He plans to open another store next year.

Call Your Lawyer

Ultimately, it is up to the buyer of a new franchise to sniff out an opportunity where the risk may be too high. "A new franchise doesn't have a track record, so you need [to find] information about how it's been tested in the marketplace, the experience of the people in the business, and what kind of training resources they offer," says Terry Hill, spokesperson for the International Franchise Assn., a Washington (D.C.) trade group that represents both franchisees and franchisors.

For the best advice, consult an attorney who specializes in franchising. These professionals will help translate a prospective franchise's UFOC and find the red flags often buried in its fine print. "The major problem is that nobody ever reads these," says attorney Webster. The UFOC contains a list of contacts for existing franchisees and ones who have gone out of business. Webster says it's worth calling current and former owners to hear their stories, as well as working in an existing store for a few weeks to help evaluate potential (see BusinessWeek.com, 4/12/05, "Extending the Front Lines of Franchising").

Performing this type of due diligence could take the edge off the new franchise gamble.

See our slide show for stats on franchise industries, and to get advice from franchisees.

MacMillan is a staff writer for BusinessWeek.com in New York.