I don’t know of any lawyer who plans on working in franchise law while in law school. It just isn’t one of those areas that gets much consideration. I’m sure there are lawyers who strive to work in the legal department at McDonald’s or Subway. However, those lawyers want the security of working for a big company. For those attorneys, an offer from Wal-Mart or Anheuser-Busch (now Inbev) would be as welcome.
The point is that lawyers who now consider themselves as “franchise” lawyers somehow stumbled into this area of the law. My practice was forever changed when I took my first franchise case. That occurred 14 years after I was licensed. The one constant that I have seen is that those of us who practice in this area love it. I love the franchise work I do because I get to work on a national scale. The cases we investigate put us in touch with franchisees from all over the United States and, in some cases, all over the world. Unlike many attorneys I know, I love the time I spend talking with these clients. I learn something from them. I have learned that the entrepreneurial drive resides in every one of us. Unfortunately, that drive can leave us all vulnerable to high pressure sales pitches and business opportunities that we should never have pursued.
That leads me to the topic of this post. We are investigating tax preparation franchises. These include H & R Block, Jackson Hewitt, Liberty Tax, and any of the other copy-cat systems that are out there. My investigation started after I received an email from a franchisee of one of the big three (I classify the big three as H & R Block, Jackson Hewitt and Liberty Tax). This was not my first experience with the industry. I was previously one of three class counsel in a class action filed on behalf of the employees of one of the franchisees of Jackson Hewitt. That claim sought relief from burdensome non-compete agreements. That franchisee owned and operate 15 locations. Near the end of that case, I had the opportunity to talk to the franchisee. I learned that there were serious issues with that franchise system. That was shortly before the franchise sought protection through bankruptcy. It was with that experience and background that I approached the individual who had contacted me. I will refer to the individual as Pat so as to protect their identity, including their gender. I called Pat and we chatted for well over an hour. My style in speaking with clients is to just have an informal discussion. I do not fire questions at them. I have a conversation which allows me to get a feel for the client’s background, including family and social, their dreams, their experiences both positive and negative, and how they view the reality of their situation. By the end of the conversation, I have a feel for the client’s personality, their goals, and the claims they have in a potential case.
I learned Pat had been in the business world for a number of years and wanted the opportunity to slow down while still making a decent living. Pat was drawn to a tax preparation service because it would require hard work during tax season but leave 8 or 9 months out of the year to enjoy hobbies and other activities. That was the pitch used by the area developer who sold Pat on this franchise. The investment was affordable and would not require Pat to incur any debt. Pat was told by the area developer that no tax preparation experience was necessary because the company would provide all the training and software necessary to be successful. After what Pat thought was a careful review of the franchise opportunity, a decision was made to purchase a territory. In fact, Pat was told that there was a great opportunity because the franchise had two territories right next to each other and Pat could purchase both of them by paying the cost of the first territory and the company would finance the purchase of the second territory. Pat paid the money and signed the franchise agreements. Pat started looking for locations where he could put the franchises. This is where Pat’s business experience proved helpful but the lack of experience in the industry proved to be fatal to any chance of success. The franchise never explained to Pat that the target customers would be from the lower socioeconomic segments of society. These are not people who make much money. These are people who need help completing their tax returns because they need their refund. The average refund may be $300, $400 or $500. The other reason they are drawn to these services is that they offer Refund Anticipation Loans (RAL’s). For a fee, they could get their refund money immediately rather that waiting the few weeks it would take to get a check in the mail. To draw these customers, you must have a location easily accessible to them.
Pat found locations in more suburban, middle to upper-middle class neighborhoods. Pat told the franchiser where he was putting his locations. They did no demographic analysis of the area and never advised Pat to reconsider. The franchiser blindly approved the location. Pat was savvy enough to sign short-term leases of one year. That would prove to be a very smart decision. Pat went through training and then started hiring people to get ready for tax season. Pat had no prior experience hiring people. It proved to be much more difficult than the franchiser told Pat it would be at training. Nevertheless, Pat hired the people needed and opened the locations. After a week or two, Pat knew there was something wrong. The customers were not coming in the door in the numbers needed to be profitable. Pat had advertised and done everything the franchiser recommended but it was not working. After tax season, Pat knew that purchasing the franchise had been a mistake. Pat was paying about 20% of the gross receipts to the franchiser for ongoing fees and the advertising fund. In exchange, Pat was getting no assistance from the franchiser and there was little to no advertising. Pat wondered where all the money for advertising was going. With as many franchisees in the system, Pat figured that the franchiser would have more than enough to advertise the system. However, Pat had never seen a television commercial. In addition, there was no support from the franchiser. You know you made a mistake when you realize you would have lost a lot less money had you just opened a location and not bought a franchise location. Pat had that realization. You can imagine how sickening that must be after investing so much money. Pat was fortunate in that both of the leases for the franchise locations were only for one year terms. Most commercial leases require a personal guaranty and are typically for five-year terms. That means that Pat would have been required to continue paying the rent even though the franchise locations ultimately closed. Many others within the franchise system were not so fortunate. They are faced with lawsuits from their landlords seeking payment of the rent for the remainder of the lease terms.
The other major issue with the franchiser, is that the franchiser was aware that RAL’s were under close scrutiny by the Internal Revenue Service. Ultimately, the IRS, with the help of the FDIC who put pressure on banks, made it very difficult for the tax preparation companies to find lenders to keep the RAL system alive. H&R Block has announced they will not offer the loans this tax season. Liberty Tax tried to purchase its own bank to provide the funds. Not surprisingly, the government did not think that was such a good idea. These loans were very profitable to the franchisees and the franchisers. It appears that the franchisers were aware that changes were coming but failed to pass that information along to the prospective franchisees. How can a potential franchisee be expected to make an informed decision when the franchiser fails to disclose information it knows could negatively impact the very system they are trying to sell? The end of the RAL is in sight and that profit center will be forever eliminated for the franchisee.
When it comes to purchasing a franchise, I always advise clients not to believe that no experience is necessary. A franchise must be run as a business. That means there are taxes which must be paid, personnel issues, accounting issues, etc. I advise my clients to pretend as if the franchiser will not be there to assist you with anything. Would the client be able to survive? The franchisee must be able to access resources to assist in these areas. Many of the cases I investigate involve franchisers who claim no experience is necessary because they will teach you everything you need to know. The franchisee opens their location and then there is no support. The franchisee was depending on the expertise of the franchiser to assist in the operation of the business. When that doesn’t happen, these folks are left trying to compete with others that have decades of experience in the industry while the franchisee, who may have undergone a week of training at corporate, is simply trying to survive. They quickly learn that the “partnership” or “team” concept that was sold to them was nothing more than a salesperson playing on the franchisee’s lack of any real experience. There can be nothing worse that having your dream suddenly turn into a nightmare from which you cannot awake.
Have you had this experience? Have you bought a franchise after being told no experience was necessary only to learn that you get no help from your franchiser? We are interested in speaking to anyone who has purchased a tax preparation franchise. We would like to learn about your experiences, good or bad. We like to get as much information from current and former franchisees in any case so we can perform a fair evaluation. Obviously, people such as Pat do not contact us because everything is going great. They are in trouble. After I review the documents and get an idea of potential problems with the system, I have to continue talking to people who have experience with that system. Your experience may be 100% positive. I still would like to speak to you.
Jonathan E. Fortman
LAW OFFICE OF JONATHAN E. FORTMAN, LLC