Every business owner or prospective business owner who is contemplating buying a franchise needs to be very wary of entering into such an arrangement without adequate professional assistance to evaluate whether it is, in fact, a beneficial arrangement. The recent Brooke Insurance bankruptcy, and the events leading up to that, serves to demonstrate this point. Over three years ago our firm was hired to represent a Brooke franchisee in Florida who had purchased a Brooke franchise and borrowed money from a sister company of Brooke to finance the purchase. In spite of being a seasoned insurance professional, the agent, under the constraints of the Brooke system, could not make a sufficient income to pay the debt service and the expenses necessary to keep the office open. Our firm was able to negotiate a buy back of the agency allowing the agent to get out of debt and actually walk away with some additional cash. What followed was three years of representing Brooke agents from around the country who had similar, if not identical, problems.

While the problems these agents encountered may have been unique to the Brooke system and would not be general issues faced by all franchisees, there were a lot of “red flags” in the agency documents that a competent legal advisor should have been able to see and advise the prospective franchisee of the consequences of such an arrangement. While your attorney, accountant, etc can point out these potential problems only you can make the decision as to whether or not you are comfortable with the arrangement. It is the job of the hired professional to make you aware of these concerns but, of course, in some instances the business person will decide he is willing to take the risks involved in spite of these potential issues.

Some of the “red flags” that might be of some concern to a potential franchise owner include inadequate access to financial information, both regarding the overall franchise system as well as the actual franchise itself. In the Brooke system, for example, the insurance carrier paid all commissions directly to Brooke who then took out their portion and remitted the balance to the franchisee. This was done with entirely inadequate backup documentation and the franchisee was often unable to tell without extensive additional research whether the amount remitted was correct. Brooke made it difficult if not impossible for the franchisee to review the record of commission payments by the insurance carrier to ensure that the payments remitted by Brooke were correct.

Some of the other factors that might make you question the wisdom of entering into such an arrangement include financing of the franchise purchase by the franchisor or a related entity, whether the franchisor or related entity is the party that does the due diligence for the transaction (often for an additional fee), whether the franchisor “helps” you locate an attorney to issue an opinion letter as to the details of the transaction. Look closely at what specific support the franchisor promises to give. Often these obligations are vague or specify that the support will be that which the franchisor determines is appropriate. That doesn’t give you much of a basis for insisting that they give you any assistance at all. There are a number of other such concerns that may arise in such agreements that your attorney or other professional can point out and on which they can give you advice.

It is normal to be excited by what one sees as a great opportunity. Most of us have made a purchase or entered into a contract in spite of concerns that it might not be the wisest course just because we really want to do it. Obviously that is not the best course of action when an investment of your time and money is involved. In spite of your enthusiasm for a business venture take a step back, hire the necessary competent professionals and seriously consider what the ramifications of entering into the agreement really are.

At The Law Offices of Smith/Coonrod we are happy to assist you in any business transaction and will work with other professionals of your choosing, or which can recommend, to ensure that you get the best possible advice and counsel BEFORE entering into a new business venture.