Learn how to invest your IRA or 401k into a franchise penalty-free. ($50k min)
Franchisees and franchise sellers typically don't see eye to eye on whether more laws governing the business are needed. So before you decide to buy a franchise, it pays to learn more about how they're regulated and why.
According to new numbers from the International Franchise Association, franchising spans 1,500 concepts-franchise types-in 75 industries, and its 316,000 U.S. units reap $1 trillion in annual sales. Surprisingly, few laws regulate this business bonanza, and most regulations that do exist are relatively new-and owe their existence to the unlikely duo of Ronald Reagan and country entertainer Minnie Pearl. The main legal controversy shaking franchising today is whether more laws are needed.
Franchising started during the Civil War, when the Singer Sewing Machine Co. figured out a way to grow its retail operation without spending its own capital. Singer sold 'franchises' to local operators who then built and maintained their own stores while selling the manufacturer's products. In the early 1900s car manufacturers adopted the same system and sold franchised dealerships all over the country. They were followed by the oil companies, who franchised gas stations to fuel the cars. In 1924, two entrepreneurs named Allen and White gave all those new drivers a destination-a franchised chain of A&W Root Beer drive-in restaurants.
Fast-food franchising became the rage and outfits like McDonald's, Kentucky Fried Chicken, Dairy Queen and Hardee's grew quickly. In the 1950s the U.S. Congress passed laws regulating franchise sales within the auto and petroleum industries, but sales of food, retail and service franchises continued unregulated. "It was wide open, " says Anthony R. Pierno, an attorney in Palm Desert, Calif., who was then California's Commissioner of Corporations. "It almost seemed as if anyone who managed to open one restaurant or service business decided to franchise it. Of course, most of them failed."
Of these, a chain of fried-chicken restaurants named for Minnie Pearl caused the greatest scandal. Promoters had used the country singer's name to sell area franchise agreements, then reported millions in uncollected fees as revenue to drive up their stock price. The scheme collapsed into a mess of bankruptcies and lawsuits.
By 1970, the number of franchise complaints in California outstripped all other complaints to Mr. Pierno's office by a wide margin. He and his colleagues decided it was time to put on some legislative brakes. But just then California Governor Ronald Reagan was slashing away at government programs and spending. "We convinced him how important this was," Mr. Pierno says, "and his support was instrumental in passing the country's first franchise law."
To write the law, Mr. Pierno called in representatives from the IFA and attorneys from both the franchiser and franchisee sides of recent lawsuits. One of them was Lewis Rudnick, now a partner in the Chicago office of Piper Marbury Rudnick & Wolfe LLP, a leading franchise law firm. Mr. Rudnick says the California Franchise Investment Law he helped draft was patterned after the state's securities law, that is, it focused on disclosing what investors should know before putting their money into something, whether it's a new stock or a pizza parlor. Thus, the law requires that a franchiser reveal to each prospective franchisee a list of 22 items-from the franchiser's financial background and litigation history to what's expected of the franchisee in terms of facility, signs and product purchases-so he or she can make an informed decision before buying a franchise.
Seventeen states enacted similar laws (the others say that franchising is covered by their contract laws) and in the late 1970s the North American Securities Administrators Association incorporated the same basic list into the Uniform Franchise Offering Circular, or UFOC, the document all franchisers must present to prospective franchisees. In the early 1970s Congress turned the regulation of franchising over to the Federal Trade Commission and in 1979 that body issued its Franchise Rule, which also focuses on pre-sale disclosure issues.
Is this enough? Mr. Rudnick thinks so. "The disclosure laws have gotten rid of fly-by-night, poorly conceived business models, " he says, "and the UFOC has created a method by which a prospective buyer can compare information about competing franchise companies."
Franchisee advocates disagree. Susan Kezios, president of the 16,000-member American Franchisee Association in Chicago, says that current laws have no impact on the issues that hurt franchisees the most: encroachment (the awarding of a new franchise or the opening of a company store too close to an existing franchise); product sourcing-franchisers insisting that franchisees buy products only from them or their designated suppliers, often at inflated prices; and equity transfer. "Franchisees aren't allowed to sell the businesses they own," Ms. Kezios says, "because the buyer must be approved by the franchiser and must adhere to the franchiser's latest contract."
The AFA asked Congress to pass a new law governing the relationships between franchisers and franchisees. The cause has drawn support and a bipartisan coalition has twice introduced such a bill, called the Coble-Conyers Bill, to the House of Representatives.
But the Coble-Conyers Bill didn't made it out of committee, primarily because of even more vocal opposition from the IFA and the franchiser community, who said that the FTC was doing a good job of regulating franchising and nothing else was needed. In 2000, three U.S. senators asked the General Accounting Office to audit what the FTC was really doing about franchising.
The process took a year and when the GAO's report was released last summer, both sides claimed victory, probably on the assumption that no one else would read through the dense 73-page document (available at www.gao.gov). It states several times that "the extent and nature of franchise-relationship problems are unknown because neither the FTC, franchise trade associations, nor state regulatory agencies have readily available, statistically reliable data that would indicate the full scope of these problems." In other words, no one really knows if more laws are needed.
In the meantime, disputes between franchisers and their franchisees are being argued in state and federal courts and through a complex system of arbitration and mediation. Not much is heard about these disputes and that, too, is part of Minnie Pearl's legacy. Lawsuits, especially lawsuits that champion franchisee rights, can hurt a franchise system and, as evidenced 40 years ago, franchising in general-so they're usually settled quietly, out of the public eye.
That won't last, says Samuel Crawford, the AFA's director of public policy. He predicts that Congress will introduce, and pass, franchisee protection legislation this year. "More and more people in Congress have contacted us, asked for more information, and asked what they can do to help," he says. "When people become educated on these issues, they come over to our side."
Copyright Â© 2004 Dow Jones & Company, Inc. All Rights Reserved