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OCTOBER 29, 1999

BOOK EXCERPT

Have I Got a Franchise for You! Be Your Own Boss, Easy Money...
Excerpt from Fraud! How to Protect Yourself from Schemes, Scams, and Swindles


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Tired of taking orders from your boss? You don't have to put up with any of that anymore. Now you can own your own day-care center, be your own boss, and collect your own big paycheck.

In 1995, some people accepted that opportunity from Tutor Time Child Care Systems. Investors were told they could be their own boss by operating a day-care center within eighteen months after paying their initial franchise fee. And, the promoter said most of the company's franchisees were earning net incomes of at least $100,000 annually!

Unfortunately, some of those people were sorry they got involved in this wonderful-sounding opportunity. In fact, they probably wished they were still taking orders from a boss. In 1996, the Federal Trade Commission (FTC) imposed a civil penalty of $220,000 against the company. You see, there were a few problems. The individuals running the company had criminal backgrounds. The company also failed to explain fully the terms of the franchise agreement and a few other details.

The classic franchise system is a company that for a fee offers individuals assistance in starting their own businesses. The franchisee has authority to use the company's trade name. Franchisees are also given location assistance, standard operating procedures, training, advertising, and a supplier of inventory. There's no standard method of franchising. The person who is buying (franchisee) is dependent on the representations and promises the seller (franchisor) offers. The key for the con artist is to promise whatever will get investors to part with their money.

The most common hook in franchise fraud is earnings misrepresentation. In the early 1990s, Tower Cleaning Systems, a commercial cleaning franchisor, promised potential franchisees that they'd achieve revenues as high as ten thousand dollars per month. The company, however, provided no documentation to back up that. The FTC filed a permanent injunction against it.

The second most common hook is training claims. In the early 1990s, a franchise company told investors they could operate travel agencies in their own homes. The company promised support from thousands of suppliers of travel services, including airlines. Investors would be licensed or certified as travel agents by some "official authority" and would receive free computers and free or deeply discounted travel opportunities. Investors were promised $250,000 in annual sales and were told that previous investors had a 100% success rate. When these investors tried to start their agencies, they got none of what was promised.

When checking out a franchise offer, the con artist may give you the names of current franchisees so you can ask about earnings claims, training, and other promises. The FTC has seen innumerable cases where the references are paid shills.

Con artists follow the headlines. Con artists are currently pushing Internet franchises, such as businesses that create Web pages, on-line malls, and other on-line endeavors.

PROTECTING YOURSELF. If you want to start your own business, a franchise gives you the opportunity to be in business for yourself but not by yourself. You do, however, have to take responsibility for doing your homework and ensuring that you're investing with a franchise system that is legitimate. There are several ways you can look for red flags that will pinpoint a scam:

— Disclosure document. All franchisors are required to supply potential franchisees with a disclosure document, called a Franchise Offering Circular, at least ten business days before the investor signs a contract or pays any money. If the franchisor has not offered a disclosure document or isn't aware of the requirement, there's a problem.

— Business background. Be sure the key executives have plenty of experience in franchising.

— Litigation history. Every company will have a lawsuit from time to time, but if one gets sued regularly, there's a problem. The FTC has seen disclosure documents with eight to twelve single-spaced pages of lawsuits, yet people invest. This section of the document also discloses criminal backgrounds of executives, if applicable.

— Turnover rate. If franchisees come and go quickly, the franchisor isn't doing what it takes to keep them in business.

— Earnings representations. Although a franchisor isn't required to make earnings representations to potential buyers, many do. Make sure those promises are substantiated. Get all earnings projections and other promises in writing.

— High-pressure tactics. The con artist will tell you the franchise offer is limited, or there is only one territory left, or this is a special one-time reduced franchise sales price.

Take your time, read the disclosure document, have an attorney or accountant read it, and do your homework. You should also visit the company's corporate headquarters. It's an investment in your future and certainly less costly than losing a complete franchise fee.

If you're a victim of franchise fraud, ask for your money back — although the chances you'll get it are slim. Complain to the FTC. It can get injunctions that stop companies from their illegal conduct. Report problems to your state regulators and attorney general, or hire an attorney and file a lawsuit.

Con artists don't usually hang around in one spot for very long. Take time prior to investing to ensure the franchise company you're doing business with is honest, trustworthy, and legitimate. When dealing with someone who wants to help set you up in your own business, don't fall prey to high-pressure sales tactics, the promises of exorbitant profits, claims of no risk, or unjustified start-up fees. Be sure your questions are answered clearly and fully, and to your satisfaction.

For helpful information on judging a franchise, visit the FTC's Web site at www.ftc.gov for news releases, business guidance, and consumer protection information. You can also call the FTC at 1-202-326-2222, or write to it at Public Reference, Federal Trade Commission, Washington, D.C. 20580 to order "Best Sellers," a complete list of the FTC's consumer publications.

Don DeBolt, president, International Franchise Association, Washington, D.C. recommends that anyone interested in a franchise attend a franchise show: "There are probably a couple of dozen expos across the country annually, most ranging in size from thirty to forty exhibitors. Every spring in Washington, D.C., IFA sponsors the International Franchise Expo, the largest in the country with approximately 350 exhibitors. Before a franchisor can exhibit at our expo, we prescreen them to ensure they're complying with federal and state disclosure requirements."


Marsha Bertrand is a writer specializing in investment, finance, and business topics. She is the author of The Consumer Guide to the Stock Market and A Woman's Guide to Savvy Investing. She has worked as director of shareholder relations at Allnet Communications Services and managed a portfolio of limited partnerships and publicly traded funds at a well-known investment firm.
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