Government regulation is meant to protect people. But when regulation covers most of the places where people make important financial decisions, and leaves one significant industry outside it, it can have an unintended effect. It creates unjustified confidence in the industry that has been left out. That is exactly what has happened with franchising in The UK.
Why franchisees assume they are protected
Regulation is almost everywhere. Government decides what must appear on food packaging. financial services and consumer credit are regulated. Estate agents cannot invent competing offers to push up bids. Over decades, this has taught us to expect that where serious money is at stake, important claims cannot simply be made up and somebody has set rules about what must be disclosed.
That expectation does not disappear when somebody considers buying a franchise.
A prospective franchisee may be investing £50,000, £100,000 or more. Often it is redundancy money, lifetime savings or money borrowed against their home. Yet the UK has no franchise-specific law requiring a franchisor to disclose how many franchisees have failed or left, what existing franchisees actually earn, or whether the financial projections used to sell the opportunity reflect real performance.
The buyer sees a recognised brand, a professional prospectus, a detailed operations manual and a lengthy legal agreement, perhaps with a trade association logo or an industry award. Every signal suggests legitimacy and oversight. What they are not told is that nobody is legally required to have checked whether the business actually works.
When appearance replaces evidence
Traditionally, a business became a franchise after proving itself. It refined its model, established reliable profits and tested whether someone other than the founder could run it successfully. Only then was it franchised.
Today that sequence can be reversed. Consultants can easily and very quickly supply an operations manual, a franchise agreement and the recruitment system. There is nothing wrong with that when it helps a proven business grow. The danger comes when packaging is mistaken for proof. A polished website and a professionally drafted agreement do not show that an ordinary franchisee can cover their costs and fees and still earn a reasonable return. The result can be an experiment paid for by franchisees.
The disclosure gap
The franchisor knows how previous franchisees have performed, how many have left, how many are struggling and whether its projections resemble typical results. The prospective franchisee may know none of this.
Instead, they are shown what the business could achieve. There is a big difference between potential earnings and typical earnings. If one franchisee has reached £100,000 in annual sales and twenty others have only managed £20,000, the £100,000 figure is technically achievable but it gives a false impression of the true position.
Minimum fees and the loss of shared interest
Most franchise agreements now include minimum monthly fees. Suppose the management fee is 10% of sales, with a minimum of £250 a month. At £5,000 of monthly sales the franchisee pays £500, and both sides benefit as sales grow. If sales fall to £1,000, the franchisee still pays £250. The effective fee is now 25 per cent of turnover, before any other costs. And the franchisor still gets paid.
Percentage royalties used to tie the franchisor’s income to the franchisee’s success. Minimum fees weaken that link. A franchisor collecting an initial fee and guaranteed monthly payments has less to lose when a franchisee struggles.
The problem grows when minimum fees are combined with non-territorial franchises. A territory can normally be sold only once, which gives the franchisor a strong reason to recruit carefully and help each franchisee succeed. Remove the territory and that restraint disappears. With online training and recruitment through social media, a franchisor can sign up hundreds of franchisees competing for the same customers. For the franchisor, each one brings another initial fee and another stream of monthly payments. For the franchisees, it means more competition and fewer customers each.
The exit trap
When a franchisee finally accepts that the business is not viable, they often cannot simply stop. Agreements commonly run for five years or more, so they face three choices: keep trading at a loss, try to sell a business nobody wants, or ask the franchisor to release them. At that point many discover that the remaining contract payments become part of the price of leaving.
They can lose their original investment, spend years working for inadequate returns and then face a further substantial payment to end the relationship.
The human cost receives far less attention. People invest years of their lives in these businesses. They work evenings and weekends, involve their families and give up salaries and careers. When the business collapses, the damage can include debt, strained relationships, lost confidence and years of financial recovery.
Children’s activity franchises are a good example. The investment is often modest and the idea simple, which makes them attractive to parents looking for flexible work. But venue hire, insurance, materials, advertising and franchise fees all have to be paid, while bookings rise and fall with cancellations, illness and competition. A model that looks profitable at full attendance can lose money at ordinary attendance. If fixed franchise fees continue regardless, the franchisee is effectively paying for the privilege of running an unprofitable business.
Good franchisors pay the price too
This is not simply a battle between franchisees and franchisors. Responsible franchisors spend years developing and testing their businesses, choose franchisees carefully and know that their own success depends on their franchisees’ success. They then compete for recruits against businesses that have incurred few of those costs, and both can call themselves franchises.
The public does not always distinguish between the two. Every failed franchisee damages confidence in the whole sector and raises recruitment costs for reputable franchisors. The lack of regulation gives poor franchisors a short-term advantage and imposes a long-term cost on good ones.
Why trade associations are not enough
The British Franchise Association promotes ethical franchising and has a code for its members. But a trade association is not a regulator. Membership is voluntary, and it cannot impose standards on businesses that choose to stay outside it. An accreditation logo can be reassuring, but it should never be confused with government regulation.
Other countries have already acted
The United States has had federal disclosure rules for decades. Under the Federal Trade Commission’s Franchise Rule, a prospective franchisee must receive a disclosure document covering 23 specified categories of information, generally at least 14 days before signing or paying any money. Australia’s mandatory Franchising Code of Conduct requires prescribed disclosure and sets rules for the franchise relationship.
The UK could learn from both. The aim would be to make sure investors have reliable information to judge a franchise for themselves. Deciding whether it is a good investment would remain their responsibility.
What UK regulation should require
This need not create a large new bureaucracy. A simple mandatory disclosure regime would transform the market. Before taking any money or allowing an agreement to be signed, franchisors should have to disclose:
- the size and history of the network, including openings, closures and departures
- successful resales and significant litigation
- all compulsory fees, including minimum fees and early exit liabilities
- the evidence behind any financial performance claims
- whether franchisees will have territorial protection
If a franchisor says franchisees can reach £100,000 in sales, it should say how many actually have. If twenty franchisees have left in three years, or a territory has seen several failures, the buyer should know.
None of this would guarantee success, and it should not. Franchisees must still do their own research and take professional advice. Regulation should not remove commercial risk buy it should make sure people understand the risk they are taking.
The cost of doing nothing
At its best, franchising works because the interests of franchisor and franchisee are aligned. The franchisee builds a profitable local business, the franchisor earns continuing income and both benefit from a stronger brand.
The danger arises when a franchisor can make substantial money from recruitment, minimum fees and exit payments whether or not its franchisees succeed. An unregulated market then allows unproven businesses to trade on the reputation of proven ones, selective projections to replace truly complete information, and appearance to replace evidence.
As one industry insider put it, “Franchising is a rocky road, full of broken hearts.” It does not have to be.
Government has built protections elsewhere because it recognises that an imbalance of information produces unfair outcomes. Having helped create the public’s expectation of protection, it should now close the gap. The question is how much longer franchisees, responsible franchisors and the reputation of UK franchising should be expected to bear the cost of its absence.
If you are thinking of buying a franchise, or you are in one that is not working, Franchise Problem Solutions offers a free initial consultation.