Giants Are Known for Destruction: Franchisee Equity Hangs in the Balance

Editor’s Note: This article is the IFA’s response to Ron Gardner’s article in this newsletter.

While franchising has been one of the greatest tools for wealth creation in the modern age, it is far from perfect. No human construct is. But we should be wary of calls for one-size-fits-all franchise regulation as the challenges and their potential solutions are far more nuanced. Instead, franchisors and franchisees should seek constructive, collaborative solutions that foster shared success and illustrate a commitment to one another and to the proven success of the franchise business model.

The Federal Trade Commission (FTC) currently seeks information from franchise businesses to inform potential rulemaking that goes beyond its regulatory authority. As is increasingly the case with federal regulatory bodies, the tone and positioning of the FTC’s questions reflect a desire to establish a rulemaking record in support of its own regulatory agenda and make new policy, rather than use its existing statutory authority to enforce the law. This is to say, the questions asked of franchisees are designed to elicit responses critical of franchising.

Perhaps most troubling about the FTC’s recent behavior is its blatant coordination between the most hostile alphabet soup agency in Washington to the franchise model, the National Labor Relations Board (NLRB), which has perpetrated a brazen attack on franchising in its current proposal to hold franchisors and franchisees as joint employers under virtually any scenario.

Some have suggested the FTC (“the giant”) has awoken from a deep slumber because of persistent pressure exerted by franchisors on franchise owners across their systems.

Giants, unfortunately, tend to crush what’s in their path and leave a trailing wake of destruction. That’s not always their intent. Both cruel and gentle giants can be found in myth and legend. But giants are clumsy. They step on things without regard for good and bad.

As our colleagues in the franchise bar agree, legislative and regulatory corrections always pose a risk of over-correction. The FTC’s recent activity confirms the risk is significant and very real.

There always are a few bad actors—both franchisors and franchisees—and they need to be held accountable for engaging in deceptive sales practices or for not following the terms of their agreements. But there are thousands of franchisors and hundreds of thousands of franchisees who devote their efforts to improving their franchise systems collaboratively without the interference of the FTC. Could communications between franchisors and franchisees be improved and relationships be strengthened? Absolutely. Is the answer one-size-fits-all regulation for a model that supports hundreds of industries serving every community across the United States? Absolutely not.

While recent regulatory proposals claim to “protect” franchisees from bad actors, they actually threaten the hard-earned equity that franchisees have spent their careers building. This also comes at a time when Franchise Business Review finds that franchisee satisfaction is at an all-time high with 82% of franchisees supporting their brand’s corporate leadership.

Under the current model, franchisees are not the defenseless prey advocates of increased regulation depict them to be. Franchise owners are much more than branch managers of a corporate location. They are independent entrepreneurs, innovators, disruptors, and pillars of their communities who embody the grit and resilience that comes from building and owning a business.

One-size-fits-all regulation and legislation at the hand of lawmakers and federal agencies unfamiliar with—or who are motivated adversaries of—the franchise model will hurt all of franchising. While the intent of regulation to fight for the “little guy” may be laudable, regulation is a blunt instrument that rarely solves the identified problem.

Take Sarbanes-Oxley as an example. Passed in 2002, the law was crafted in response to a wave of corporate scandals that shook public confidence in financial institutions. Companies like Enron and WorldCom had engaged in accounting fraud, inflated their earnings, and misled investors, leading to billions of dollars in losses. Sarbanes-Oxley introduced a range of new regulations and requirements for public companies and their auditors ranging from stricter financial reporting standards and mandatory disclosure of insider transactions to enhanced oversight and corporate governance.

Don’t get me wrong: Fraud is inexcusable and should be prosecuted, but did the new Sarbanes-Oxley regulations truly increase consumer protections or decrease bad outcomes? Just six years after Sarbanes-Oxley became law, it was discovered that Bernie Madoff had been operating a Ponzi Scheme that defrauded thousands of investors out of billions of dollars.

On the flip side of the coin Sarbanes-Oxley increased the cost of doing business. When the law took effect, financial institutions had to make significant changes to their systems and procedures to comply with the new requirements. PriceWaterhouseCoopers found the average initial cost of compliance for a publicly traded company was $4.9 million. And a recent Protiviti survey highlighted annual compliance costs exceeding $2 million with an 18% increase in cost between 2021 and 2022.

Sarbanes-Oxley certainly had an impact, but did it have the desired outcome?

History is showing that to be unlikely, highlighting the failings of one-size fits all government regulation and legislation: motivated bad actors remain so, fraud continues, and costs increase for every company and consumer. The entire franchising community should be deeply concerned about the resulting adverse impact of agenda-driven policy formulation based on incomplete information.

There is another way, however. Franchisees and franchisors should—and do—work together to improve disclosures provided to prospective franchisees to ensure they are able to make informed decisions, establish educational requirements for franchisors and franchisees, provide pathways to positive communications and alternative dispute resolution when franchisors and franchisees are at an impasse, and collaborate to ensure the model never stops improving. The IFA has made investments in the post-Covid era to ensure we are doing our part to improve franchising from within.

The IFA has also supported improvements to the FTC Franchise Rule—the area the FTC should be focused on improving—that provide prospective franchisees better access to information about franchise systems and allow them to make fully informed decisions before investing in a franchise. These are welcome changes to existing regulation.

There also are non-regulatory solutions that will benefit the franchise business model. To find them, we need look no further than the Government Accountability Office’s (GAO) own recommendation to the FTC published on April 17, 2023. The GAO report recommended that the FTC enhance consumer education efforts for prospective franchise owners, increase publicity of its guide for franchise owners, and improve franchise owners’ awareness and understanding of the FTC’s complaint process.

At the IFA, we are creating and implementing those educational initiatives in addition to facilitating positive discourse among franchisors and their franchisees or franchisee associations through alternative dispute resolution programs and the IFA’s Ombudsman Program—available free of charge to any IFA member.

Awareness and understanding leads to better outcomes; better inputs yield better outputs. The IFA exists to protect, enhance and promote franchising—not just franchisors and not just franchisees. Making improvements to pre-sale disclosure is the best way for all stakeholders in franchising, including the government, to help franchise opportunity seekers better understand the business model, as well as their rights and the shared responsibilities of franchisors and franchisees. If we focus our efforts there, we see little need for additional regulation at the expense of the entire business model and the people it serves.

Matt Haller is CEO and president of the IFA. To learn more on this issue and to get involved in protecting the franchise business model, visit the IFA website, franchise.org.