The Big Bang

A New Day

Certainly, federal and state franchise laws and regulations are largely responsible for facilitating franchising's explosive growth and success over the past 25 years. Many folks forget that, by the late 1960s and '70s, the words "franchise" and "fraud" had almost become synonymous.

What happened was simple. As franchising exploded on the scene in the 1950s and '60s, story after story appeared in newspapers and magazines about how franchisors and franchisees were growing wealthy in this burgeoning arena. That's when the criminal community-including organized crime-jumped in on the action. Tens of thousands of people nationwide collectively lost millions of dollars through criminal franchise enterprises-enterprises which, by using slick brochures and outright fraud, sold phantom, nonexistent franchises to hapless victims.

Indeed, the situation was so bad that, just a year before Entrepreneur published its first Franchise 500® edition, even 60 Minutes did a "takedown" piece on franchising, featuring a scam perpetrated by an outfit known as "Wild Bill's Family Restaurants," the principals of which were ultimately indicted by a federal grand jury.

California took the lead in fighting against franchise fraud, enacting its revolutionary Franchise Investment Law in 1971. It required a franchisor to register itself and its franchise disclosure document and to distribute that document to prospective franchisees prior to accepting their money or signing any contract, lest the franchisor expose itself to both criminal and civil liability. Other key states have also followed suit-Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington and Wisconsin.

In fact, as Entrepreneur was publishing its first Franchise 500® edition, I, then special deputy attorney general of New York, was putting the finishing touches on New York's franchise statute, the New York Franchise Act, which was enacted in 1980. Also at the time of Entrepreneur's first Franchise 500®, the seminal FTC Franchise Rule was promulgated, requiring franchisors nationwide to engage in the disclosure protocol pioneered by California (but unaccompanied by state franchise law registration requirements).

The goal of these federal and state franchise laws was to eradicate fraud and to eliminate criminals and organized crime from the franchise arena. And guess what? It worked. Due to the diligent enforcement of these laws by federal and state regulators-who, at the same time, grew increasingly aware of the legitimate franchisor community's needs and wants-there hasn't been a major franchise scandal in this country in decades. Not that there haven't been improprieties, mind you, but no large-scale and massive fraud visited by a criminal franchisor.

And franchisors recognize the laws' effectiveness. "Probably the best thing I've seen is a requirement of having a disclosure document for franchising," says Subway's DeLuca. "It helps to clarify and spell out the details of the relationships, so there's less likelihood of miscommunication or confusion. The fact that everybody gets a disclosure document is really important."

Harrington certainly notices the change at the FTC. "We see fewer things going wrong, less deception, certainly a lot less outright fraud in connection with franchising," she says. "We see a lot of fraud in connection with the sale of business opportunities, but not in franchising. The environment is a lot cleaner than it was."

Even crusading New York Attorney General Eliot Spitzer, who almost single-handedly took on massive Wall Street fraud and deception last year, notes the contrast between the slew of corporate fraud that's come to light of late (Enron Corp., Global Crossing Ltd., WorldCom Inc.) and franchising's relatively clean slate. "Interestingly, many of the protections we are now building into the traditional securities marketplace have been in place for a great number of years in the franchise marketplace," he observes. "And that may explain why, in recent years, we have seen fewer scandals in franchising."

So, yes, it's been quite a run for franchising since Entrepreneur published its first Franchise 500® edition. Meteoric growth, consolidation of both franchisors and franchisees, the maturation of relationships between them, and the still-growing public demand for franchising's brands (and the products and services sold under those brands) have yielded a situation where rarely a day goes by that any of us-either in the United States or most of the industrialized world-does not encounter or frequent a franchised establishment on a daily basis.

Special Effects

Franchisors sound off about what's shaped the face of franchising today:

Top four factors that have improved franchising:

  1. The Internet
  2. Government/FTC regulations
  3. The economy
  4. The UFOC

Top four factors that have hurt franchising:

  1. State and federal regulations
  2. Lawyers/litigious society
  3. Bad franchisors entering franchising
  4. 9/11

SOURCE: Entrepreneur magazine

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This article was originally published in the January 2004 print edition of Entrepreneur with the headline: The Big Bang.

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