New Franchise Rules Called 'Baby Steps'

Risks and rewards better explained before buying in

CHICAGO (Monday, May 07, 2007) - Jobless, but holding a big check from an employee buyout in 2005, Priscilla Taylor took the road traveled by thousands of downsized managers like herself: franchising.

In December, after a year of due diligence and construction, Taylor opened on West Jackson Boulevard the first Maui Wowi Hawaiian franchise in Chicago with a fixed location. She hired an attorney to help her decipher the coffee-and-smoothie company's franchise documents and talked with other franchisees. She came away with the knowledge that fixed locations didn't have a long company track record. Nevertheless, she now dons a Hawaiian shirt for work every day, having spent $34,500 for the rights to open up to three locations.

"I didn't want to go back into the corporate world," Taylor said. "It was a well-educated gamble. [Franchise] agreements, from what I understand, are clearly written in the favor of the franchiser."

New rules from the Federal Trade Commission, however, seek to correct that imbalance. The changes to the federal franchise rule, which had been in discussion for more than a decade, don't entirely correct the law's flaws, but they are baby steps in the right direction, say franchisee rights advocates.

"It's like they labored for 13 years and gave birth to a mouse. We got a little," said Susan Kezios, president of the Chicago-based American Franchisee Association. "The gaps, some of the largest ones, still remain."

The federal franchise rule had not been altered since it originally was written in 1978. Since that time, franchising has exploded as an industry. It continues to be viewed by existing businesses as a growth vehicle and by entrepreneurs as a means of being their own boss.

In the past three years, almost 900 business concepts began selling franchises, sending the total number of franchise systems to more than 2,500 companies nationwide, according to the International Franchise Association.

In Illinois, a state that regulates franchises, more than 200 new companies apply to sell franchises each year, and another 900 concepts renew their licenses, according to the attorney general's office.

"If you do your due diligence carefully, a franchise is a terrific way to do business because your risk is lowered," said Gerald Moriarty, Illinois president of FranNet, a company that links companies with franchisees. "The guy who started it has made most of the mistakes a start-up has made and fixed them."

Yet, not every franchise has a successful formula. A Wayne State University study of small businesses in the late 1990s found that five years after their start, 62 percent of franchise firms were still in business, compared with 68 percent of the independent companies studied.

It is those type of statistics that prompted calls to amend the federal rule to allow potential franchisees to make more intelligent decisions about the risks and rewards of buying a franchise. The amended rule takes effect on a voluntary basis July 1 and will become mandatory July 1, 2008.

Among the changes is the requirement that franchisers must disclose all lawsuits they file against franchisees and must detail any bankruptcy filing by any of its parent companies. They also must detail whether the franchiser can cut into a franchisee's territory by selling its products or services through alternative channels such as the Internet.

Additionally, the amended rule requires franchisers to disclose whether they have confidentiality agreements with current or former franchisees that would prevent them from speaking candidly about their experience with the company. It also seeks to make it easier for potential franchisees to pinpoint how frequently franchises were terminated, sold or transferred.

But, in other areas, franchisees lost ground. For instance, the rule no longer covers franchisees who are investing more than $1 million, are large franchisees or are considered "insiders" who already have business relationships with the company.

In Illinois, the new FTC rule will supersede some of the state requirements. One requirement that is now scrapped: a list of the risk factors of the venture that had been the first page of the offering circular that must, by law, be made available to potential franchisees.

Companies that work with potential franchisees say, despite the improvements, the new rule is not a cure-all for problems. It's still imperative to work with a franchise lawyer to help decipher document language, to talk with many current and former franchisees and to use the information obtained to best negotiate an agreement before any money changes hands.

"Our whole idea is not to tell you not to buy," said Robert Tingler, franchise bureau chief in the state attorney general's office. "Our idea is for you to take all this information we're forcing the franchiser to give you, digest it and make an informed decision. We see a lot of middle- to-upper-level executives who are getting tossed out and decide 'I've got this money' and say 'I was responsible for a department that had 500 employees; I know what I'm doing.' They don't know what they're doing. They are unwilling to accept that they may need to learn more before they jump into the fire."

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