Buying a small business or franchise only to have control of one’s career makes one an easy target for fraud, says Dr. Michael Webster, who has studied this form of fraud and decision theory. Read more on this topic in this article from Blue Maumau.
An expert says that buyers of small businesses who do so solely to have control of their career are easy marks. Dr. Michael Webster, a practicing franchise attorney who fights real-life hucksters in court and has a Ph. D in decision theory—a study that helps explain how we make such bad choices—seems well situated to explain how we so easily can be defrauded. Having studied economics and decision theory under Nobel prize economist A.K. Sen and other well-known scholars, he gives some profound advice on how to recognize when you are being cheated by a master.
With the economy seeing the highest unemployment figures in nearly four decades, Webster thinks once those unemployed have access to credit, there is the potential for record numbers to be ripped off. In order to avoid being swindled, his first piece of advice is to think of buying a business as one option among many investment opportunities.
Blue Maumau: What sort of path has taken you to be adept in recognizing the elements of fraud? That’s a very unusual area of expertise.
Webster: My academic interest has been in how people make decisions from an economic and psychological perspective. In studying decision theory, I found that sales techniques, persuasion by attorneys and calls to action by politicians use the same methods exploited by shills, con criminals and fraudsters. I went into law because I thought bargaining theory had a lot to teach lawyers about negotiations, theory and practice.
For the last twelve years of my litigation practice, I’ve seen a lot of fraud perpetuated by the use of simple psychological techniques. I write about this in my blog, bizop.ca.
BMM: What sort of franchise fraud have you seen?
Webster: One major fraud that I litigated involved a man named Paul Beaupre, who masterminded the single largest business opportunity fraud in Canada. The franchise owners of Universal Payphone Systems that I represented were defrauded in a pay phone vending scam. Franchisees were promised pay phones in the best locations in the world along with the residual money from them.
This was a fraud that spanned nearly four years. Beaupre was sent to jail. He was ordered to pay C$2.5 million dollars of the C$10 million he had defrauded from his franchise owners. My litigation involved a plus and a minus. I was happy to get him jail time, but unhappy that he didn’t have to pay a dime in restitution for his crime.
BMM: Fascinating. Was there a way for the franchise buyer to recognize early on that they were being duped?
Webster: It doesn’t take but a moment to realize that if Beaupre could actually secure a good location to put a pay phone, he wouldn’t need the franchisee’s money. He would be able to borrow money more easily from a bank than build the infrastucture to obtain it from a franchisee.
But people don’t normally think that way. They don’t think that when they are purchasing these assets that they are essentially loaning money to the distributor. The biggest problem with people buying a distributorship or a franchise is that they don’t think like a lender. They don’t engage in economic reasoning of why such a purchase makes sense for both franchisee and franchisor.
The franchisee must have some local expertise that will offer value to the deal.
BMM: Not just franchise fraudsters talk about sweat equity. Many sellers explain to buyers that besides buyers providing money in the investment, they also provide benefit to the relationship via sweat equity. That is to say that they provide labor like no company manager would be willing to match. Since the franchisee’s own money is at stake, owners work much harder than company managers.
Webster: Sure. But you can always talk about working hard with sweat equity. If the franchisee can only offer being able to execute better and with longer hours than a hired manager, then the franchise deal doesn’t make economic sense.
Besides, working hard in a crappy concept doesn’t mean a thing. You could sell me a bad ice cream concept in a frozen fishing village in Alaska and although I work harder than a sled dog, I’d still be out hundreds of thousands of my hard-earned dollars.
BMM: What is a buyer’s best alarm that they are being bamboozled?
Webster: When you are being defrauded, your gut whispers to get out and to get out fast. But many people want to “investigate just a little further” because the criminal has painted such an attractive picture of how this economic activity will solve important problems. For example, one of today’s pressing problems is control over employment. The con artist doesn’t even need to know the details of the individual prospect’s problems since they can draw on a large menu of problems that are common to most.
People will convince themselves of bad choices without even knowing they are doing it.
BMM: You speak of a voice that tells a business buyer that the decision is folly and that we need to tune into it. But doesn’t every business investment decision essentially have a little voice inside cautioning that there is risk and uncertainty about a future that cannot be known? If we listened to only that voice, we’d never do anything except cower in our room all day.
Is there something else about our risk-averse voice of caution that especially marks fraud?
Webster: The world is full of risks and uncertainty. But in frauds, there is something that lets buyers recognize at a gut level that the people and concepts that they are dealing with are untrustworthy. They recognize the light is red, but drive through it anyway.
Buyers need a healthy dose of skepticism from the beginning—that all is not as portrayed. The problem with many franchise buyers is that they often forgo serious investigation until after Discovery Day [a day the franchisor invites prospects to come visit the head office for the purpose of buying a franchise]. They go to an attorney with 10 or 14 days left [before the purchase] and ask the lawyer to help them review the franchise disclosure document.
This is pointless. It is pointless because the buyer is already in an enamored state of being, having ignored all the warning signs long ago. After becoming franchisees, these same buyers become surprised and angry when they discover that they have been dealing all along with sharks and thieves.
BMM: I understand what you mean. Many of us have read news stories of franchise owners who feel they’ve been taken in and are particularly angry. These are not stories of unsophisticated investors. It could be any of us. So, how come we are so easily conned when it comes to investing in a business?
Webster: There are times in our lives when for whatever reason we want our aspirations to be achieved immediately. For many, the most compelling overriding value is the need to be in complete control of their economic lives. Simply put, they never want to be fired again.
Those people are sitting ducks.
The con criminals know this and wave phrases like “be your own boss” and “in business for yourself but not by yourself.” Prospects pick up on such words of puffery. Buyers blow it up into full-scale fantasies of business ownership. And then to compound the problem, they perform bad due diligence by sloppily selecting evidence that only confirms they are making a good decision.
They know that they need this investment.
BMM: Hang on. Being your own boss is a strong motivator for just about anyone. People do want to take control of their career and their destiny. They want a greater degree of autonomy and are often willing to take cuts in their old company wages to do so. I know of an investment banker who made millions in a year, but realized he was cutting his life short from the stress of his job. He wanted a business of his own, even at a much reduced salary, in exchange for more years to his life.
Webster: That’s true. People need to make trade-offs between autonomy and working for others. But the main issue we are discussing is avoiding fraud. We need to remember that we can’t let one value, autonomy, trump all other values—like the need for survival and making a reasonable return on your investment. It makes no sense.
A buyer should take their time—some six to eight months. Read the franchise disclosure document. Get the best professional help to explore the opportunity and its accompanying documentation. Ask questions. Do not jump! Get a part-time job doing anything if you need to so that you don’t feel like you have to buy this franchise. If the opportunity is any good, you’ll figure it out.
Time will trump all frauds.
This article has been reposted from Blue Maumau. View the article on Blue Maumau’s small business and franchise news website here.