Lewis Sovereign Public Hearing Testimony

Martin: You've basically laid out a new twist on "blame the franchisee." The franchisees somehow, in your view, in some instances - and perhaps it is true - don't disclose everything. They say they've got $350,000 and they only have $250,000. I would suggest to you that anybody who has had to go out and borrow a little to prop up the money that you have yourself, the financial institution that is going to lend you that money is going to find out everything about you.

LegislativeAssemblyofOntarioCostofArms.jpg

Legislative Assembly of Ontario
March 9, 2000

Public Hearing Testimony
London, Ontario, Canada
Mr. Lewis Sovereign, franchisor

Standing Committee on Regulations and Private Bills
1st session, 37th Parliament

FRANCHISE DISCLOSURE ACT, 1999
Consideration of Bill 33, An Act to require fair dealing between parties to franchise agreements, to ensure that franchisees have the right to associate and to impose disclosure obligations on franchisors

LEWIS SOVEREIGN

THE VICE-CHAIR (Mr Garfield Dunlop): Our next presenter is Mr Lewis Sovereign.

MR LEWIS SOVEREIGN: Thank you, folks. It's been an interesting morning. I just wanted to comment that my purpose for being here is that I am currently a franchise sales representative for a US company. In reading the article on this committee in the London Free Press, it's something that affects my livelihood so I thought it was my duty to come and make a positive contribution, if I could.

As far as the bill stands right now, the very limited scope that it's in right now, there is some boilerplate disclosure stuff that's very good. I see a bit of an interest here as to whether government should take some action. Maybe Mr Martin has the opinion that if we do, it somehow endorses franchising in general. There could be times when it would be interpreted that way and it could have an effect, so I suspect we do need to be careful as to what we do.

As far as disclosure and association, I believe that good franchisors welcome it. The one I currently work for encourages both. We use a disclosure document currently given to all Canadian prospects 14 days ahead. We encourage an association and in fact provide incentive. The difference is, what we need to look at are some of the fundamentals of the industry, of the buyer and the seller.

I made two recommendations here that were not related to disclosure or association. One of the recommendations was that people starting up in the franchise business be required to post some sort of bond, especially when there are tangibles involved, like equipment and delivery of goods. How this helps is that it can provide some recourse and it puts some of the research into the franchisor. It puts the onus on a person selling them a bond to do business.

Franchisors typically have an evolution in that they start out with a great idea and a concept, and maybe a guy has proven a great idea and like Henry Singer did in the 1800s, says, "Hey, the best way to get this out there quicker and faster is to franchise it."

In the beginning, a franchisor will be primarily capitalized by franchise fees. There is a curve, and sooner or later the return from his royalty or the retail sale of his product and idea starts to exceed his franchise fee. It's during that curve period that a franchisor needs to be scrutinized a little more in a bond process or some sort of-you saw these individuals who are up here who didn't have the ability to do their due diligence in the beginning. I did it myself. I sent US$4,500 across the border for a satellite dish franchise eight years ago, and the next month when I called them, they were out of business. So I know the experience of being stung.

This idea of a probationary period for new franchisors in our marketplace is valid, given the scope and size of the Ontario marketplace to franchise in.

The next recommendation was that a portion of fees allocated to tangible goods be held in trust. If you look at what's happening in the courts-and this is what concerned me-a newspaper article in the London Free Press said that there are 5,000 court cases related to franchising in Ontario. To somebody considering buying a franchise at the time, that might be an astonishing number. The unfair thing about that statement is that it didn't go on to say that there were probably 17,000 cases before the courts involving independent business people on the same types of issues.

I think some of the concern today is more related to the entrepreneurial spirit in North America, the increase in independent business people, and not specifically franchising related. But there certainly are some things that we can do to address and make this particular industry more viable, because the statistics are that the franchise structure in the business community in North America today is a valid structure and actually increases the chance of success of an independent business person. You wouldn't think that, sitting here listening to people this morning.

Disclosure documents and disclosure in general is not the be-all and end-all. I realize we're just starting here. The problem with the disclosure issue is this: This is currently the disclosure document that we give out to people considering a franchise. Franchise buyers are typically in a transitional period in their lives. I give it to people for 14 days. I ask them for a receipt for it. I phone them up and say, "Did you read it and understand it?" The first person who says yes to me, 90% of the time I know right away it's impossible. I've read it five times in three years, and I don't understand it.

So there needs to be some system in place - and I don't believe government involvement. I believe a mistake they make a lot of the time is that they take it to their lawyer or accountant, and perhaps that individual specializes in a specific field, and he's not particularly qualified, but we tend to take people's advice in a profession based on our perception of that profession. That's a situation for an independent body to help the person.

The problem with disclosure is that it needs to be reciprocal. By "reciprocal," I mean that we also need to encourage franchisors to have their buyers offer proven disclosure as to their capabilities. It's an unfortunate old salesman's adage that buyers are liars. What happens to us sometimes is that we make a sale and somebody tells us they have a particular net worth or access to funds. Then, when I've taken their deposit and they've made application for the franchise and we start to go into the development process, I find out that they indeed did not have those funds, or access to them. Now, all of a sudden I'm in a tough spot as a franchisor. I've taken a deposit, I bore expense, I've maybe flown them somewhere for training or flown my engineers out to look at their sites and do site calls. Then we say to the person, "Gosh, you told us you had $400,000, or access to it, and now you really only have $250,000." Maybe we need to encourage franchisors to look a little more closely at the qualification of the people involved.

All the laws or things we do or pass are not going to prevent the people who enter the industry with ill intent. They don't care whether the guy is qualified or not. A thing I heard years ago: As long as they pass the mirror test, you could sell them a franchise, or sell them anything; it wasn't particularly franchising. It was that if you held a mirror up to their face and they fogged it up, if they were alive, you could sell. That mentality exists at all levels of the selling profession, in the business community in general. That mentality exists out there. So encouraging franchisors to better qualify their leads can still-again, this isn't disclosure. Disclosure is a benefit. If you're considering giving a large amount of money to someone who cannot get a bond in your business community, based on the delivery of goods or something, do you really want to give that person a lot of money? The primary benefit, to me, of disclosure is that it slows the person down.

People who are buying a franchise, who are in a transitional period in their lives, are making life decisions here. They're changing their whole life. Maybe they're getting the golden handshake from a bank or whatever institution they were involved in before. This is a life decision that should not be susceptible to urgent closing tactics of professional salespeople, or susceptible to just them following their dream. Gosh, I hear it all the time: "My wife and I have been working away at such-and-such jobs all our lives, but we always wanted to be in this industry. So we're going to buy into it. This seems like a shortcut way for us to do it." Of course, in many instances they are qualified, they do have the money in funds.

The other situation is that, like any other product we buy, we sometimes grow tired of a franchise. One of the problems with the franchise structure in that case is that all of a sudden you're an independent business person and you start up on your own and you go out there and take that hard role, and if you succeed, wonderful; if you fail, you take responsibility, and that's it. You did it, you failed, you go on with something else. But if you do that in the same context with a franchisor relationship, then all of a sudden you don't look in the mirror as much any more. You have a big corporation there maybe, that you perceive has deep pockets that you can now have legal recourse against to help you with your losses. Certainly there needs to be some mediation process in place.

I've been hearing Mr Martin say that this is part of the legal process and that you're stepping them into the courts. But I think it's valid to have something in place to prevent half of these scenarios from going to court, primarily because these people are telling us they don't have the resources to go to legal battle. In some cases, we all know they're walking into court, having made commitments and signed documents and put themselves in a position where legally the courts are going to have no recourse but not to find in their favour. By getting to that in-court position, all they are is further in the hole and maybe more deeply hurt by the fact that they went the extra step, prolonging the agony.

I'm always pro prevention in all objections. One of the things I noticed from one of the ladies who was up here prior-I notice in dealing with franchisees that in the beginning, like in any business prospect in the beginning, they have a different mentality and perception than they do after they've had to get into it and roll up their sleeves and go to work. We need to encourage them more to realize what is happening in the beginning and to test them: Do they understand their payment process? Do they understand that they're putting up a $10,000 or $20,000 fee but their capital requirements are $250,000? That's what they're going to have into it over a time period. I've always been amazed at the fact that I've told people that, and they come back and tell me they can do it better. I say, "Gosh, we've had a thousand people do it in the past 35 years and they couldn't do it better, so when you can do it better, please show us how." We need to ingrain in them that this is what it's going to take and then provide some step where the franchisor also has a better chance to look at them. We get them to fill out credit applications sometimes and they're not obligated to fully disclose. We are. We tell them, "Here's who's sued us, here's who's been with us for years, here's who's left." We give them full disclosure. They know everything about us, but sometimes we're at that position where we enter into business relationships with buyers that we don't know as much about as we'd like to.

It all leads to this: What is the committee going to do or what is Bill 33 or 35, or whichever ones we implement, going to do to prevent the franchise buyer-protect the consumer, not hinder business development, because we want global franchisers to come into our marketplace and bring their ideas and create employment, all those things. But there needs to be more depth to the bill than exists in its current state to make it something valid to the consumer and to the business marketplace.

Those are my comments. Any questions?

MR TONY MARTIN: I must say, I appreciate your last statement, which is that the bill needs to be deeper and it needs to be developed further. I couldn't agree with you more. Anything that we can put in place today to prevent franchisors and franchisees from taking advantage of each other I think is going to be better in the long run for everybody concerned, particularly for the health of our economy. We've heard stories over the last three days, and some of us have heard them over the last five or six years. Some of us have experienced them ourselves in the lives of friends and neighbours. I came to this piece of work from my own constituents who brought me to a meeting back in 1995 and shared with me what was going on.

There are some things, though, that you've said that cause me to worry a bit. You've basically laid out a new twist on "blame the franchisee." The franchisees somehow, in your view, in some instances-and perhaps it is true-don't disclose everything. They say they've got $350,000 and they only have $250,000. I would suggest to you that anybody who has had to go out and borrow a little to prop up the money that you have yourself, the financial institution that is going to lend you that money is going to find out everything about you. I know in my own experience I've had to go to the bank to borrow. They knew the size of my shorts. It's amazing the things they know about me.

To suggest for a second that there's an imbalance there and that the franchisee is somehow to blame in terms of disclosure or is the cause of their own demise because they didn't disclose, I think is stretching it a bit. Nevertheless, I'm willing to give that in some cases it does happen.

But what I wanted to talk to you about even further is, you sell franchises. American franchises?

MR LEWIS SOVEREIGN: We are a Canadian registered company as well, but yes, it was a company that started in the United States.

MR TONY MARTIN: It seems to me, from listening over the last few days, that you're selling Canadians the American dream.

MR LEWIS SOVEREIGN: OK.

MR TONY MARTIN: And some of them have experienced what that's about-and we heard some stories here this morning-without the attendant regulations that many American jurisdictions have developed over some 30 years now. It was 30 years ago that California brought in a fairly comprehensive franchising regulatory regime. Here we are, entering the new millennium, and we're looking at what I would consider a very primitive limited disclosure, right-to-associate piece of legislation. You suggested at the end of your presentation that it needs to be fuller. Could you expand on that a little bit for me?

MR LEWIS SOVEREIGN: Again, the disclosure - interesting comment - return on investment, those types of things, more depth as to what people disclose. I realize there are financial statements needed in here. There are some other areas to address.

What I wrote down was that the issues that come before the courts have some common denominators. There are some issues that come up in franchising that are common problems. There's lack of capitalization, lack of management experience, non-delivery of goods. I think non-delivery of goods and people entering into the business and agreements with people they shouldn't be are part of the problem.

I didn't mean to put the onus or do a blame-the-franchisee thing, Mr Martin. I'm just bringing to light that in some instances that is the case. Although you say the financial institutions will find out everything about you, what happens in many instances in franchise structures where it's land- or finance-based, the financial institution also becomes part of the culprit. The reality in life is that the 80-20 ratio exists in all industries and businesses. Franchising in this world didn't change that; 20% of the people produce 80% of the productivity. That's just the way life is.

By expanding on what more needs to be in it, there are other issues and common problems that come up to franchise buyers. In the beginning they don't have the necessary resources to research the franchisor properly. They can't understand these large disclosure documents, or even smaller ones in many instances. I like the fact that there is a clarity requirement in this bill. I don't know who determines it. I found it rather amusing, a government bill that wanted to encourage clarity in the written form, and there are parts of it that were a little confusing to me. That's OK. It's a good thing.

There are common issues. If you look at all the franchising problems that have come before us, association with lease agreements - third party involvement with a franchisor is an issue. In the beginning, some of these people simply need advice to put some "subject to" in their other clauses. If there's a third party lease agreement, make a "subject to": "Should my franchise fail, or if my franchisor goes out of business and folds up and leaves me out of business, I need a 'subject to.'" I need an opportunity to get out of here, because this person is now in a jam with the third party. They signed a lease agreement but not a franchise - it's nothing to do with franchising. All kinds of business people in retail and any other thing get involved with lease agreements that sometimes they'd like to break and get out of. They need some better guidance in the very beginning to give themselves some flexibility.

In dealing with franchisees at the end, when they're coming to the end of their term, it always astounds me that these people have been involved with my organization for 20 years, and when I ask: "Have you read the termination clause? Do you know we have first right of refusal? It's 20 years ago that you bought it, so would you take a moment to go and read that?" they say, "Gosh, I didn't understand that." They need business planning in any term agreement. It's almost like estate planning. A person has to be prepared for what can happen at the end. What can happen at the end is that the guy might have designed and wanted the ability to shotgun you out of there, so you need to know that up front. You need a little bit of testing when you go to buy a franchise. We used to give them tests: "Please provide us in handwriting what the payment structure is for our franchise fees." They'd had the disclosure document for months, they had the franchise agreement for months, but they couldn't copy out of it and put it back to me. So they didn't know; they didn't understand it. So you reiterate and try to educate.

The same with the end: "Do you understand what happens at the end of your agreement?" They need to know that up front. They need some clarity and they need some guidance because of the nature of both the franchisor and the franchisee. The typical franchise buyer is a person in a transitional period in their life. I think the longer I've been in the industry and the longer I've been in the sales profession, as with anything in life, you tend to get exposure to more situations and you start to see these things happening. "Gosh, here's a government committee coming to town that's going to do something about franchising in Ontario now." I welcome it and hope that we can make some positive contributions.

THE VICE-CHAIR: A couple of quick questions here from the PC caucus.

MR WOOD: Do you have any sense of the rate of return on investment that your franchisees get?

MR LEWIS SOVEREIGN: Yes, a little bit. It's an interesting case. In the particular product that I'm marketing right at this moment, is that what you're referring to?

MR WOOD: Yes.

MR SOVEREIGN: There are a number of ways to look at return on investment. What we advise people is that typically this particular product will outperform the rate of return on, let's say, a golf course, whether it's a 5%, 6% or 7% return. What we shoot for in one component of our investment, if they're getting into our industry in a particular manner, by converting a property or buying an existing property, is a 20% return on their initial investment, on their down payment.

The problem, Mr Wood, with a land-secured, equity-building lifestyle investment with my particular product is that part of the return on investment is based on equity. If we design their business on a five- to 10-year growth program and they watch it evolve from a particular low-end or start-up operation to a high-end operation, their property becomes more valuable. It's always easy for the salesman to provide a best-case scenario.

MR WOOD: Maybe I should have given you some guidance. You've raised some important considerations. In terms of the money they put in-not what it's worth today-what kind of return would they expect and what kind of return would they get?

MR LEWIS SOVEREIGN: It's probably going to run around what some bonds and lower-end investments do, somewhere between 2% and 6%.

MR WOOD: That's 2% and 6% of the money you put in?

MR SOVEREIGN: On average. Again, that's not a true case of return. If you look at land criteria and what they do-I've got an individual who advised me. He did three of them in 21 years and made a $1 million on every one at the end when he rolled them over, because we instill some land criteria that cause the property investment to increase in value. So, what do you say to an individual up front? The fellow before me said, "Hey, these people buy jobs." Typically, to get involved in a franchise investment, they quite often have to buy a lower-paying job. "We're going to ask you to put up a quarter of a million dollars to make less money than you have for the last 10 years."

MR WOOD: The $1 million comes on land appreciation?

MR SOVEREIGN: Land and business appreciation. Yes.

MR CROZIER: Thank you for your comments this morning. I think you've made some interesting recommendations in your proposal. The real test of committee hearings is to listen to suggestions and for either the government to accept recommendations and amend their legislation and/or for us in the opposition to propose amendments. I found all three of your suggestions rather interesting. Perhaps you and I can keep an eye on this to see if they make it into the legislation. Thanks for coming today.

THE VICE-CHAIR: Thank you very much. It was a pleasure to have you here.

Later that day Mr. Sovereign asked to clarify his answer…

THE VICE-CHAIR: Gentlemen, thank you so much for your time this morning, and thanks for moving your time ahead.

If I could have the committee's indulgence for just a moment, the previous speaker, Mr Sovereign, made a statement and he'd like to make a clarification. Would anyone mind if he took a minute to do that? Mr Sovereign, you've got a minute.

MR SOVEREIGN: I just want to take a brief moment here. I was asked by a committee member as per a specific return on investment, and I'd like the opportunity to retract that statement. I gave you a percentage number based on a recent conversation with someone else involved in the company. A more honest and accurate answer is, I don't know, sir. I don't know what the exact returns on investment are. The proper and ethical thing for a franchise salesperson to do when asked questions specifically pertaining to return on investment is to refer the person asking the question to the uniform offering circular, which I do have a copy of here, and if Mr Chairman would like, I will leave a copy for the committee for copy and distribution, or if Mr Wood would like, I can leave it for him. Is that OK?

THE VICE-CHAIR: That would be fine.

MR SOVEREIGN: Would you like this, sir?

MR WOOD: Well, just give it to Ms Stokes.

THE VICE-CHAIR: Thanks for that clarification. We'll now adjourn until 12:55. That should get us here by 1.

This document is a verbatim copy of this witness’ oral testimony. To review the original transcript: http://www.ontla.on.ca/web/committee-proceedings/committee_transcripts_details.do?locale=en&Date=2000-03-09&ParlCommID=1&BillID=&Business=Bill+33%2C+Franchise+Disclosure+Act%2C+1999&DocumentID=19723#P320_96668

Copyright (c) 2000
Office of the Legislative Assembly of Ontario
Toronto, Ontario, Canada


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Risks: Ontario Public Hearings, Canada, 2000, Rate of return on investment, 5,000 new lawsuits per year in Ontario, Canada, Bonding, Blame the franchisee, American Dream, Buying a job, Sold during time of psychological vulnerability, especially unemployment, Commission with investigation, publication and enforcement powers, Canada, 20000309 Lewis Sovereign

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