A Franchise Investment Gone Bad

Everybody’s looking for the right investment, a way to get ahead. For a former investment banker in Arizona, that meant purchasing a franchise from a New Jersey-based chain of educational service centers. In just two years, he learned that it wasn’t the right investment after all. He closed his struggling tutoring center. But that wasn’t the end of his travails. The franchisee also filed a lawsuit alleging that the franchisor had engineered the sale by misrepresenting the financial health of its franchise network. Specifically, he claimed that the franchisor used written correspondence, marketing collateral, and digital and in-person presentations to falsely inflate projected first-year revenue numbers in a deceitful effort to sell him the franchise.

 

By the time the franchisor had filed his suit, the Inspector General of the U.S. Small Business Association (SBA) had already investigated loans issued by an Illinois bank to other franchisees of this company. Ten other SBA-backed franchise loans had failed. In his report, the Inspector General concluded the first-year revenue forecasts were not realistic, but inflated. Further, if the projections were realistic, the bank would not have issued the loans.

 

The franchisee’s filing cited the Inspector General’s report. Had the franchise’s forecasts been realistic, the franchisee would have evaluated this franchise opportunity negatively. Furthermore, he wouldn’t have been able to obtain a loan. Under these circumstances, the franchisee would not have purchased this franchise.

 

The franchisor maintained that the problem wasn’t in the reporting but with unscrupulous brokers, suggesting that the brokers padded applications to help potential franchisees get loans. So who was on the winning side? The franchisee and franchisor agreed on a settlement whereby the franchisor would pay the cost of materials and inventory purchased to open the center. Nothing more. In the end, no one came out ahead.

 

Learn more about franchise lending in Who’s Loaning to Franchisees

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