Franchise scams are usually pitched as an opportunity for investors to produce high returns with very little effort or an opportunity to be involved in a highly successful business model with guaranteed returns. In order to determine the legitimacy of a franch-ise system, prospective franchisees should conduct extensive due diligence before entering into any agreement or making a monetary payment. 

 

Potential warning signs that a franchise business may be a scam include:

The prospective franchisee is placed under significant pressure to make a quick decision to sign an agreement and pay upfront – many scams are sold on the basis that an offer is only open for a very limited short period of time. This should be a clear warning sign that the offer is a potential scam. The Franchising Code of Conduct requires that a franchisor give to the prospective franchisee a copy of the franchise agreement, a disclosure statement and a copy of the Code at least 14 days before the franchisee enters into a franchise agreement or makes a non-refundable payment. As a result, requiring a franchisee to quickly enter into a franchise agreement is prohibited under the Code.  

Minimal details are provided about the franchisor or the franchise system – if limited information is offered about the franchisor or the franchise system this should raise a red flag. For instance, the franch-isor does not provide details of its registered office, its ACN/ABN or details about existing franchisees. The Code requires franchisors to make disclosures about the franchisor, its directors and officers and existing franchisees, including the business address and business phone number of existing franchisees. Prospective franchisees are encouraged to contact existing franchisees to ask questions about the franchise system before entering into a franchise agreement or making a payment.  

A guaranteed high rate of return or weekly income – franchise scams are often sold on the basis that the franchisee will earn a certain income amount. However, in reality, particularly in the current economic climate, there is no guarantee that a business will perform to a particular level. Reputable franchisors generally shy away from giving any income projections to prospective franchisees given that there can be significant financial penalties if such representations are later found to be misleading and deceptive. Prospective franchisees should be cautious and seek financial advice when earnings projections are provided by a franchisor to encourage them to enter into a franchise agreement.   

 

Occasionally, franchisors do give income guarantees to franchisees for set periods of time to give the franchisee an income whilst the franchisee is establishing the franchise business, especially if the franchised business is a greenfield business. It is important that such guarantees should be reflected in the franchise agreement and any conditions for qualifying for the guaranteed income amount should be clearly spelled out. 

 

As a general rule a reputable franchise system should speak for itself without the assistance of fancy promotional deals and marketing puffery. Prospective franchisees should be aware that typically a franchise system is established not with the intent to make a new business successful, but rather to expand an already well-established and successful business. Buyers beware.