Brokers offer a peek behind the curtain
Jania Bailey, FranNet
Franchise development is not exactly the Land of Oz, but nonetheless, some players in the industry are trying to pull back the curtain on the inner workings of the industry in an attempt to promote transparency and raise the bar on industry best practices.
Franchise development consultants (aka franchise brokers) have seen a big shift in the past decade. The sector has become increasingly competitive with new players entering the space, while some of the rules governing that participation have eased a bit.
A key part of the back story dates to 2007, when the Federal Trade Commission approved an amendment to the Franchise Rule, effectively eliminating the requirement to include broker disclosure information within the franchise disclosure document. Generally, individual states went along with that ruling. Only two states—New York and Washington—require any franchise broker working in the state to file a certified disclosure document.
The move was well intentioned, as broker disclosures added extraneous information to what was already a cumbersome document. In some cases, franchisors were working with multiple brokers, and anytime one left or was added, it required changes to the FDD.
“It was very complicated and became an unwieldy document, although it provided good information to prospective franchisees,” says Michael Seid, managing director of MSA Worldwide, a franchise advisory firm.
Yet removing that requirement has since highlighted a new problem. “One of the things that is somewhat concerning is that we have had a lot of competition jump into the business over the last several years,” says Jania Bailey, CEO of the franchise consulting and brokerage firm FranNet. The growth within the franchise brokerage industry has created some confusion with prospective franchisees, who may not fully understand the differences between brokers and other referral sources and what they are offering in terms of services, she says.
“Most of these newer brokers have entered the market by purchasing a package from business opportunity organizations selling a quick and easy program that they purport will turn someone with no franchise experience into an ‘expert franchise consultant’ in a matter of days, which is a very questionable claim at best,” adds Jeff Elgin, CEO of FranChoice. “A number of us who have spent many years in the franchise business have become increasingly concerned that there is almost certainly a wide variance between the level of professional conduct, franchise experience, training and ethical standards among brokers from one referral network group to another.”
Jeff Elgin, FranChoice
Voluntary broker disclosures
FranNet is working to bring more transparency to the franchise development industry. As Franchise Times reported in September, the firm launched its own broker disclosure document last year. The goal of the document is education and helping people gain a better understanding of the broker’s role, what brokers do—and don’t do—and also understanding the fees and who is responsible for paying them.
For example, FranNet consultants were hearing anecdotally from potential franchisees that other brokers were providing them with the franchisor’s earnings claim.
“Franchisors need to understand if the broker they are working with breaks the law, it doesn’t only pull that broker into a potential lawsuit, it also brings in the franchisor,” says Bailey. Overstepping boundaries can have big ramifications. That’s why the education piece is so important, she says.
FranChoice requires its consultants to file certified disclosure documents in those states where it is required, even if they don’t intend to operate in those states, as a precaution to make sure there is no chance of violating the regulations in those jurisdictions, says Elgin. These filings provide a legally binding public disclosure of the broker’s background information, which is then available to any potential franchisee who would like to request it, he adds.
FranChoice also completed a draft of its own broker disclosure document, which it submitted to the International Franchise Association last year as part of a discussion to potentially create a common industry format for disclosure documents. FranChoice is waiting to distribute its BDD until that process plays out, notes Elgin.
“IFA is supportive of increased transparency among franchise brokers and commends companies that have taken additional steps to ensure that prospective franchisees have a full picture of the risks and responsibilities of the franchise relationship,” says IFA spokesperson Stephen Worley.
Others in the industry agree the franchise world would benefit from greater transparency.
“I would like to see the broker disclosure document have some of the similar attributes of a franchise disclosure document,” says Seid. For example, it is important for the franchisee to have a clear understanding of any potential conflicts of interest and what the broker relationship is with the franchise. Who is the broker’s client and who is responsible for paying the fee—the franchisor or the franchisee? And similar to an FDD, it should be required to also include any bankruptcy or litigation history, he adds.
Being completely transparent on fees and clients can be problematic for brokers due to client confidentiality. One way FranNet has resolved that is by using SIC codes to show the sector and then lists the number of clients in each of those different SIC codes.
Leveling the playing field
Franchise broker networks that operate as a franchise business are required to offer FDDs the same as any franchise business. So, it is no surprise to see franchise consulting and brokerage firms such as FranNet and FranChoice leading the charge behind the push for greater transparency.
“Helping to shine more light on the whole industry and what the differences are is important for everybody involved in that sales process,” says Bailey. “This is the right thing for us to be doing as an industry. It’s the right thing for us to be doing for the clients, and I would challenge them all to make this a priority in first quarter 2019.”
Bailey, Elgin and Terry Powell of the Entrepreneur Source also have approached the IFA to discuss ways to increase the transparency of broker operations in the marketplace.
“Specifically, we wanted to create a mechanism that would allow consumers to have ready access to information that would indicate the caliber of the franchise broker they were contemplating working with,” says Elgin.
One of the ideas on the table is creating an IFA certification process that would clearly identify brokers that follow a set of professional standards and requirements that, among other things, would require certified brokers to create and distribute a voluntary BDD to clients. Other proposed conditions to achieving the IFA certification would be agreeing to a code of ethics commitment, following a degree of public transparency concerning the brokers in any network and making certified disclosure documents publicly available for each individual broker in each broker network.
“Frankly, these are all requirements that can be fairly easily met by any legitimate referral network,” says Elgin. The group is continuing to work with the IFA on creating a certification program. “Our hope is that a certification program with requirements such as those we have suggested will become a reality in 2019.”