How to spot franchise fraud

franchise-fraud

Franchising can be a relatively low-risk pathway into entrepreneurship – they get support and direction from the franchisor, and follow the structures laid out by the franchisor. However, sometimes, a franchise opportunity can seem too good to be true. Not all franchises are created equal, and you can’t necessarily buy into any franchise and wait for your riches to roll in.

How to spot a franchise scam

If you spot the following franchise scam warning signs, look elsewhere:

  • Overdressed salesperson trying to pitch a fast sale
  • Pressure for franchisees to sign gag orders
  • Insistence on cash transactions only
  • Exaggerated earnings
  • Promising a proven business model or proprietary technology that doesn’t exist
  • Promising training that never materializes
  • Forcing franchisees to spend money on so-called improvements
  • Failure to provide disclosure

How do you avoid franchise fraud?

To help you avoid franchise scam, you can choose to work only with a franchisor who is a member of the Canadian Franchise Association. Do your research. Be thorough, double-check everything, and get advice from trusted colleagues or professional advisors. And listen to your instincts!

Buying into a franchise can be a proven and relatively secure pathway to entrepreneurship, but it’s an investment in your future that shouldn’t be taken lightly.

Want to learn all the ins and outs of franchising in Canada? Check out our industry-leading small business training video program.

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What’s the difference between a franchise and a chain?

small business franchise

To many, chains and franchises can seem the same. However, they are quite different from one another. Here’s how to tell the difference between a franchise and a chain:

Characteristics of a franchise

Franchises are one pathway into entrepreneurship. With a franchise, a franchisee (the entrepreneur), buys the right to market and sell certain products and services from a franchisor (the person who owns the overall franchise) through a legal agreement. Fees and a share of the income are then paid to the franchisor over a specific period of time. The franchisee is in charge of operations, finances and HR for their specific location of the business.

There are several types of franchise agreements, all with different responsibilities, purchases, policies, procedures and rights. These terms are often outlined in the agreement and operation manual to make sure the franchise as a whole is consistent – a very important thing in franchising!

Examples of a franchise

Most of us think of fast food when we think of franchise. However, lots of industries that have them, including automotive, real estate, accommodations, business services and retail. Tim Hortons, 7-Eleven, and RE/MAX Canada are all examples of a franchise.

Want to know more? Check out our blog post about the perks and snags of franchising.

Characteristics of a chain

A chain is a business that’s usually under one main corporate ownership, which opens and operates locations itself. This is the vital difference from a franchise. Franchise locations each have different owners, reporting to the main franchisor. But each chain location doesn’t have a different owner – each chain location is owned by the corporate office.

Examples of a chain

Some popular examples of Canadian chain restaurants and stores are Mark’s Work Wearhouse, Swiss Chalet, and Sobeys.

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Costs of opening a franchise

franchise_costsThis may come as no surprise, but opening a franchise probably isn’t going to be cheap. But forewarned is forearmed, so let’s take a look at some of the common costs associated with opening a franchise.

Franchisors often charge a franchise fee that needs be paid at the start of the agreement – either in full or as a percentage – in the form of a deposit. You’ll likely have to sign a deposit agreement,and the deposit may or may not be returned to you if you decide not to go through with 
the franchise.

In Alberta, for example, this refundable deposit can be up to 20% of the initial franchise fee. Once you’ve made the agreement, however, the initial franchise fee can vary from as little as $5,000 to as much as $75,000 — possibly more.

The average initial franchise fee 
in Canada is $23,000. This fee covers costs like support, training, franchisee recruitment, grand opening launch, franchise development and site identification. In general, the initial fee is higher the more recognized and established your franchisor company is.

Royalties

Aside from initial franchise fees, royalties are often due, either weekly or monthly, to give the franchisor a portion of your sales. These can vary from 0–20% of gross (total) sales, depending on the level of support and services provided to you. Some franchises don’t charge an ongoing royalty fee, but the cost is often built in through rebates or mark-ups on products or services.

Additional costs

Aside from the franchise fee and royalties, you may have to pay other costs, like advertising fees. Depending on your franchise, you 
might have to make contributions to an advertising fund for the franchise system as 
a whole. This means that fees from all locations can be pooled into a much larger budget, allowing for cost sharing of national or regional advertising.

You’ll also need an equity investment – money to help keep your franchise location afloat until you’re profitable. On average, this investment amounts to around $160,000 in Canada. Other costs that you may run into could include research 
and development funds, leasehold improvements, furniture, fixtures, equipment, supplies and costs of employee training. Insurance costs are often included within the franchise agreement, but be sure you’re adequately insured before you open your doors. Like we said, not cheap!

So how much do I need to pay to open a franchise?

Estimated overall costs to opening a franchise can range anywhere from $50,000 or less for service franchises to as much as $500,000 or more for more sophisticated franchises. For more information, visit the Canadian Franchise Association‘s website.

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The warning signs of franchise fraud

small_business_sales_proposalIn the Ask a GoForth Expert section of our website, an entrepreneur wisely wanted to know about the warning signs of franchise fraud. Sometimes, a franchise opportunity can seem too good to be true. Franchises have a high rate of success compared with other types of small businesses, but that doesn’t mean you can buy into any franchise and wait for your riches to roll in.

Scam franchisors can pressure their franchisees into signing gag orders, promise a proven business model or proprietary technology that doesn’t exist, promise training that never materializes, even force franchisees to spend money on so-called improvements.

Our GoForth Expert Samir Dandekar offered these tips to avoid franchise scams:

Firstly, you can choose to work only with a franchisor who is a member of the Canadian Franchise Association.

Secondly, you can be wary of the following franchise scam warning signs:

  • Over-dressed sales person trying to pitch a fast sale
  • Insistence on cash transactions only
  • Exaggerated earnings
  • Failure to provide disclosure

As always, do your research. Be thorough, double-check everything, and seek the advice of trusted colleagues or professional advisors. And listen to your instincts! Buying into a franchise can be a proven and relatively secure pathway to entrepreneurship, but it’s an investment in your future that shouldn’t be taken lightly.

For more Ask a GoForth Expert questions and answers about franchising, visit us here.

 

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The perks and snags of franchising

Franchising is a great pathway to entrepreneurship. Did you know that there are about 75,000 businesses in Canada available for franchising? That’s one franchise opportunity for every 500 of us! And approximately $1 out of every $5 spent by consumers in this country is done so at a franchise.

Great!, you might be thinking, Give me the papers to sign and let’s get started! Not so fast. Franchising sees higher success rates than those of buying an already-existing business or starting from scratch, but there are some downsides, too. Let’s review the perks and snags of franchising:

Perks of Franchising

  • Ongoing support. Most franchisors help out with things like bookkeeping, national advertising, updated training, purchasing equipment and acquiring supplies.
  • You have the use of a well-known trademark or trade name behind you. You won’t need to work hard on brand recognition and marketing strategies.
  • Franchises often spend a great deal of resources on proper education and training. Franchisees are usually trained to help you establish, run and expand your business, covering a wide range of topics from hiring to financial issues. Employees at your location are also often required to participate in comprehensive training.
  • The franchisor’s experience and knowledge helps you reduce risk. Buying into an established, tried-and-tested concept reduces your chances of failure as a small business owner. Statistics show franchisees have an 80-95% chance of success. Wrinkles have already been ironed out, so you have less to worry about.
  • Most franchises spend lots of time and money on research and development in order to find new ideas, new products and new variations to existing products and services. You get to enjoy the benefits without having to spend any of your own resources on research.
  • Often, franchisors will offer financing options to their franchisees. This saves a lot of stress and time in looking for money from banks, angel investors, venture capitalists or friends and family. Banks are also often more willing to lend to someone who has a large, well-known franchise backing them. That’s pretty convenient!

Snags of Franchising

  • It can sometimes be very difficult to keep track of all of the additional fees and costs associated with franchising, even after the initial franchise fee has been paid. Royalties are a percentage of sales to be paid to the franchisor on a regular basis. Not to mention the advertising fees, debt service fees, equipment and merchandise costs, rental rates and other costs that show up along the way. Your ability to expand is in the control of the franchisor.
  • Requirements for franchisee consideration can be very specific and demanding. The franchise application process and research can be long and tedious. You may spend a great deal of time researching a particular company only to find out that you won’t be considered as a potential franchisee.
  • Any difficulties or issues that come up for the franchisor will also get passed down to you, no matter where in the franchise the issues happened. You are not only tied to the franchisor by contract, but also by the brand – its concept, name, services and products. Any unfortunate incidents inevitably affect business not only for the franchisor, but franchisees as well.
  • You’re not totally independent. The hard work that you put in doesn’t really reflect on you personally. Instead, it’s the franchise name that gets the reputation. You also can’t make all of your own decisions with this form of entrepreneurship. You have policies, procedures, rules, guidelines and responsibilities that must be followed for consistency’s sake.
  • Although you run your own business, you may not get to experience the benefits of flexibility and setting your own hours. You’ll have to stick to strict hours of operation and deal with reporting and administrative work required by the franchisor.

Do you have further questions about opening and operating a franchise in Canada? Our GoForth Experts may have already given the answer at our website – read more questions and answers about franchising here.

 

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