A: I have reviewed and/or prepared hundreds of disclosure documents during my thirty-year legal career, so one could say that “I have nearly seen it all.” Ever since the Ontario government passed franchise disclosure legislation back in 2000, and before that, when the Alberta Franchises Act required disclosure (and even registration of disclosure documents), franchisors have been required to prepare disclosure documents. There are currently six provincial jurisdictions with franchise disclosure legislation in place.
The franchise systems offered to prospective buyers varied considerably, from established restaurant brands to home-based businesses, and everything in between; the use of the franchising model has become ever more popular, despite, or arguably due to, the regulatory framework that protects franchisees in their relationships with their franchisors.
I have noticed a trend in franchising in the last number of years, where newly established franchisors are offering franchises to prospective franchisees, well before the franchisors have a proven concept, or well before the franchisors have launched multiple stores with good to great financial results. It’s quite understandable that new franchisors will need a couple or more franchisees to take on the significant risk of purchasing the right to operate their franchises. After all, such franchisors will need to start somewhere and there are many entrepreneurial franchisees eager to assume the risk so they can be one of the first to operate such new concepts. However, it’s one thing if a franchisor has demonstrated evidence of success with their own corporately held units before they launched a franchise system, and an entirely different thing if the franchise has very little evidence of success to date.
Franchise lawyers are not typically equipped to provide franchise business advice, particularly when examining the viability of launching a franchise system with a concept that has yet to prove its ability to succeed once replicated. Thankfully, there are franchise consultants, some of whom have additional expertise in launching new franchise systems, who can be called upon to assist such prospective franchisors well before they launch their franchise systems. These franchise consultants play an integral role in examining the strengths and weaknesses of prospective franchisors’ businesses and systems and then providing business advice to assist their clients in launching their systems in a way that is profitable for both franchisors and franchisees. On occasion, these franchise consultants might conclude that the system is not profitable enough or capable of being franchised. Some of these consultants have the added expertise necessary to assist their franchisor clients to develop the infrastructure necessary to launch their systems and sell and support franchises on their behalf.
From the prospective franchisee’s standpoint, however, I recommend that caution be exercised when considering whether to purchase a franchise from a newly launched franchisor. Sometimes, new franchisors will present an opening balance sheet in their disclosure documents that doesn’t outline how the system will be viable in the long run, or shows that the franchisor is at risk of being undercapitalized to undertake franchise expansion. These same franchisors can also be reluctant to make financial performance representations to their prospective franchisees, so they will not include the financial results of their corporately held units; this is notwithstanding that the franchise legislation does not preclude them from so doing, if it’s done in accordance with the regulatory requirements and preferably under the watchful direction and guidance of their franchise law counsel.
All told, many prospective franchisees are willing to take risks, hoping that they too will succeed. Some will, no doubt, but the risk of failure is always present. Whether the allure of a new and exciting business that is being offered is too great to ignore, or there’s a desperate need to find a new source of income to support their families after a job loss, the prospective franchisee must be conscious of the warning signs that are often associated with such start-up franchise systems. Accordingly, it will often fall upon their franchise lawyers to alert them to the legal and business-related risks involved.[1] This is especially the case when such prospective franchisees have limited their due diligence to retaining a franchise lawyer and no other business consultants. However, franchise systems that are Canadian Franchise Association (CFA) members and that demonstrate a commitment to good franchising practices are arguably more likely to succeed, so prospective franchisees of such systems may have better reason to assume the associated risks.
Joseph Adler
Founding Partner
Hoffer Adler LLP
jadler@hofferadler.com
[1] Expert franchise lawyers are accustomed to addressing these business-related issues, though if they are not, they should (in accordance with their Law Society’s Rules of Professional Conduct) inform their prospective franchisee clients of their lack of business experience and direct them to qualified advisers who would be in a better position to give an opinion as to the desirability or otherwise of the proposed investment from a business point of view.