Last November, PlanetHopper Inc. unveiled plans to auction franchises on Internet auction site eBay. Though the future of this program is currently up in the air, PlanetHopper's announcement raises significant questions. Can franchises be auctioned online? Or, more important, should they? And how would auctioning franchises online affect the future of franchising?
To address these issues, Franchise Zone spoke with franchisor advocate David Kaufmann of the law firm Kaufmann, Feiner, Yamin, Gildin & Robbins LLP; and Robert L. Purvin Jr., chair of the board of trustees for the American Association of Franchisees & Dealers. Kaufmann and Purvin were eager to share their opinions on this potentially touchy subject.
Franchise Zone: What are the benefits to franchisors and franchisees of selling franchises online?
David Kaufmann: The obvious-indeed, probably the only-benefit of auctioning franchises over the Internet is the ability to address vast numbers of prospective franchisees at minimal expense. However, there is a world of difference between auctioning franchises on eBay and otherwise legitimately selling franchises over the Internet as part of a franchise marketing protocol.
Wise franchisors, whether they are start-up or mature, know that selling franchises to the highest bidder is not the way to proceed. Instead, such franchisors prudently calibrate their initial franchise fees to take into account anticipated returns on investment; a new franchisee's anticipated econometric curve (if the initial fee is too high and the resulting franchisee debt load is too heavy, the franchised business is virtually doomed to fail); the demographics, concept penetration and potential profitability of franchised territories; and competitive circumstances. Most franchisors actually try to keep their initial franchise fees as low as possible, such that it merely recompenses the expenses of marketing the franchise and does not cripple a franchisee's financial prospects from the start.
Conversely, a franchisor seeking to make its money from initial franchise fees rather than from ongoing fees, such as royalties that attach to a franchisee's operating business and rise or fall with the success of that business, is suspect and likely to end in failure.
You must remember that the federal and state disclosure laws, rules and regulations governing franchise sales activity apply in full force to Internet franchise sales. The federal government and several states have Internet-specific regulations regarding the subject. The Uniform Franchise Offering Circular guidelines still pertain and, as always, require a franchisor to set forth either its fixed franchise fee or, if that fee is variable, the circumstances under which the initial franchise fee varies. And the last time I checked, "We will sell our franchise to the highest bidder" has never been accepted by any federal or state government authority as an acceptable rationale for initial fee variation.
Robert L. Purvin Jr.: Buying a franchise is an important investment, which often involves the life savings of the prospective franchisee. Completing the purchase of a franchise on the Internet, or at an auction, is frankly unthinkable and almost certainly illegal under current disclosure requirements. If a franchise opportunity is offered on the Internet, it is almost certainly being offered contrary to prevailing law, and this offer, if only for this reason, should be avoided and reported to appropriate authorities.
On the other hand, the Internet can be of great value to prospective franchisees performing the research necessary to make an intelligent decision. But beyond doing research, an Internet purchase is antithetical to the building of a long-term relationship that requires personal communication, meetings, understandings and community building.
What effects might selling franchises on the Internet have on the sale of franchises in the future?
Kaufmann: The sale of franchises over the Internet, as opposed to auctioning them off on eBay, is a legitimate activity that's having a profound impact on the franchise sales process to the benefit of both franchisors and franchisees. Franchisees, with a few clicks of the mouse, can obtain a plethora of information that before could only be obtained by flying to various franchise trade shows, stopping at an endless number of booths and conferring with salespeople.
For franchisors, the advantages of offering franchises over the Web are many. First, it eliminates the time, expense and often-fruitless efforts of paying for print advertising and then flying around the country to appear at countless franchise trade shows. Through the Web, franchisors can now post their franchise marketing materials online.
Moreover, through electronic franchise application forms, franchisors can weed out, at virtually no expense, franchisee prospects who aren't suited for the chain. In addition, by enabling franchisors to immediately and electronically disseminate their franchise disclosure documents over the Internet, presumably [it will make it easier for] prospective franchisees to undertake investigative effort before applying for franchises.
Full and thorough disclosure upfront, which is particularly accelerated by the Internet, leads to fewer pipe dreams and fewer unrealistic expectations down the line, such that subsequent conflicts, which so often arise out of unrealistic franchisee expectations, can be avoided to the benefit of both the franchisor and its franchisees.
Purvin: A franchise is not a commodity that can be placed on an auction block. In most instances, the franchise fee is a small part of the cost of starting a business. Selling a franchise by auction or on the Internet is quite simply not in the best interests of any franchisor or franchisee.
Could this impact the selling price of franchises?
Kaufmann: Perhaps for smaller or start-up franchisors, much of whose initial budgets are devoted to the franchise marketing process. Given the reduced costs of marketing franchises over the Internet vs. the traditional method of attending trade shows nationwide, perhaps these smaller or start-up franchisors can make their offerings more attractive by concomitantly reducing their initial franchise fees. For larger franchisors, the franchise marketing budget is so relatively minuscule to their overall operating budgets that I don't see the cost savings associated with offering franchises over the Internet as having any profound effect, or any effect at all, on those initial franchise fees.
Purvin: Traditionally the price of a franchise is driven by the cost of qualifying and training prospective franchise owners. Internet sales will not appreciably affect these costs.
Would the level of franchisees be affected?
Kaufmann: An Internet-driven franchise sales process will enable franchisors to quickly weed out unqualified prospects-those who have insufficient funds, insufficient experience or education, or the wrong attitude. Through the use of an electronic application form, this weeding-out process can be vastly accelerated, saving the franchisor much time, effort and money. Given the vast population of prospective franchisees yielded by the Internet and their ability to investigate the investment in great detail from the comfort of their homes, I predict the Internet will give rise to more and better franchisee prospects at vastly lower cost.
Purvin: Quality, ethical franchisors will still thoroughly screen and train their franchisee prospects. Those franchisors would never consider blindly selling a franchise on the Internet. Fraudulent opportunities, on the other hand, wouldn't care [potential franchisees] found their franchises, so long as their franchisee checks clear the bank.
Legal And System-Wide Considerations
Does auctioning off new franchises online raise any legal issues?
Kaufmann: You bet it does. Both the federal government and several states have enacted Web-specific regulations that franchisors must adhere to when offering franchises over the Internet.
A franchisor's Web-based franchise marketing campaign is considered to be franchise advertising, which is regulated and, in certain states, must be filed with franchise administrators unless the franchisor makes it clear on its Web site that it's not offering franchises in a particular state and does not take any application from that state.
Moreover, the antifraud provisions of federal and state franchise laws apply to all Internet franchise sales activity. While franchisors are now free to post their franchise disclosure documents on their Web sites, no jurisdiction, either federal or state, has yet permitted franchisors to fulfill their disclosure obligations through electronic means. Paper disclosure documents must still be disseminated and paper receipts must still be collected.
Purvin: Current law requires lengthy disclosure of franchise opportunities, plus a [10-day] period following disclosure before a franchise agreement can be signed and any money can exchange hands. Under the current law, legal sales of franchises over the Internet are quite questionable.
How could auctioning franchises online affect a company's franchise system?
Kaufmann: Auctioning franchises on eBay is not only suspect from an econometric perspective, but it may violate federal and state laws governing franchise sales activity. Those laws require franchisors to set forth in their disclosure documents just what initial fees they charge-and, if the initial fee varies, the circumstances under which such variation takes place. "We will sell to the highest bidder" is not the type of justifiable circumstance that any franchise-regulating authority has ever accepted as lawful. I would suggest to any franchisor considering auctioning its franchises to first consult with competent franchise counsel to determine if such conduct could lead to the collapse of that company's franchise sales program in the wake of federal and state enforcement actions.
Purvin: Quite simply, this would be a certain path for disaster. A franchise relationship should be built upon careful planning and screening. We are not selling computers or commodities here, but rather a very high stakes Internet dating, one with dire consequences if the relationship doesn't work.
American Association of Franchisees & Dealers
(800) 733-9858, http://www.aafd.org
Kaufmann, Feiner, Yamin, Gildin & Robbins LLP
(212) 755-3100, firstname.lastname@example.org