Want Franchise With That?

Getting It Right

Beginning in the early '70s, states began enacting franchise disclosure and registration laws. This action led to the Federal Trade Commission's Franchise Rule in 1979, which required all franchisors to furnish potential franchisees with information about the franchisor, the franchised business and the franchise relationship. The Uniform Franchise Offering Circular (see "Tell Me More") now satisfies the FTC's disclosure requirements. Twenty-one states regulate franchises with additional registration and disclosure requirements.

But some say regulation by the states and the federal government doesn't do much to give franchisees fair treatment. The new changes "created an enormous seller's market, and franchisors were able to drive tough bargains in terms of fairness of their franchise agreements," says Robert Purvin, chair of the American Association of Franchisees and Dealers, a San Diego, California-based franchisee advocacy group. "In 1977, the typical franchise agreement was beginning to change in that you no longer got substantial territories, didn't have the right to terminate your franchise if the franchise wasn't delivering you value and couldn't determine who you were going to buy your product sources from."

Reform on this front was slow. There was an industry-wide belief that 95 percent of franchises succeeded while 80 percent of independent businesses failed. No one was really interested in tampering with a system boasting those numbers.

But in the early '90s, two major studies debunked the myth that franchising guaranteed success. In 1996, Timothy Bates, then a professor at Wayne State University in Detroit, authored a study that revealed 61.9 percent of the franchised businesses studied succeeded, compared with 68.1 percent of the nonfranchised firms.

"The shock wave regarding the whole area of franchise success rates has caused a lot of us to stop [and re-examine it]," Purvin says. "We found a lot of franchises were being sold under the false premise-an industry-wide false premise-that you couldn't lose."

Around the same time Bates was conducting his study, Scott Shane, professor of entrepreneurship at the Robert H. Smith School of Business at the University of Maryland, began researching the survival rates of franchisors. In his study, Shane discovered that within 10 years, one quarter of all new franchisors fail, and that the failure rate is highest within the first four years.

As with the Bates study, there was a preconception that franchising meant successful expansion for businesses. "The popular notion was that franchisors are just well-established organizations like McDonald's," Shane says. In reality, he adds, "The typical [franchisor] is new because most of them fail in a short period of time."

TELL ME MORE

Since going into effect in 1993, the Uniform Franchise Offering Circular has provided prospective franchisees with the essential information they need when choosing the right franchise. "A franchisee that's more informed about the risks associated with the offering is an absolute benefit to the franchisor as well," says Dale Cantone, chair of the franchise and business opportunities project group of the North American Securities Administrators Association, developer of the UFOC guidelines.

"Any franchisor would admit that they want a franchisee to be fully informed about the risks associated with the offering before the franchisee decides to invest," adds Cantone.

The UFOC currently satisfies the Federal Trade Commission's Franchise Rule, but a new rule is being proposed that may make the UFOC obsolete. "The UFOC is going to be used by the FTC as the basis for a new disclosure document," Cantone says.

"Basically, the FTC's proposed format is the UFOC with a couple of slight revisions and a couple of additional requirements. In effect, it will replace the UFOC as the required disclosure document for franchising."

Regardless of whether the UFOC will be replaced sometime in the future, Cantone is proud of the document. "The UFOC," he says, "has held up fairly well for 10 years."

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This article was originally published in the May 2002 print edition of Entrepreneur with the headline: Want Franchise With That?.

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