• Virtual Franchise

Pyramid Schemes, Multi-Level Marketing, and the “Virtual Franchise”

by Noel Bagwell
for ExecutiveLP®

December 14, 2016

Once the public learns that a certain “business venture” is actually a scam, the scammers tend to either scurry like cockroaches into the shadows or reboot their scam under a different name or brand. You don’t hear that much anymore about “pyramid” schemes, because the schemers rebranded themselves as “Multi-Level Marketing” or “MLM” businesses. Now, even the “MLM” label is becoming toxic; so, the schemers and scammers are rebranding, yet again.

This time, however, they’re using the term “Virtual Franchise”, which is dangerous, because using the word “Franchise” in connection with what is actually not a franchise business at all is materially misleading–an element of fraud.

Startup Opportunity by xkcd

All credit for this comic strip goes to xkcd. See this image in its original location at: http://xkcd.com/1772/

Try searching Google for “Virtual Franchise” Scam. As of the time of this writing, there is one company that dominates the first page of search results. Now, I’m not going to accuse any business of being a scam, per se, but I do want to talk a bit about what a franchise is, and–perhaps more importantly–what a franchise is not.

A franchise is not an independent contractor (an “agent”) who merely sells products or services on behalf of a person or business entity (the “principal”), or who recruits other people to do so. According to Black’s Law Dictionary (10th ed. 2014), a “Principal” is “someone who authorizes another to act on his or her behalf as an agent.” An “Agent” is “someone who is authorized to act for or in place of another; a representative.” Id. The relationship between a franchisor and a franchisee has important differences between a Principal-Agent relationship.

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These are my Google search results from Dec. 14, 2016 when I searched for: “Virtual Franchise” Scam

In the context relevant to this article, a “franchisor” is someone who grants a commercial franchise. A “commercial franchise” is “a franchise using local capital and management by contracting with third parties to operate a facility identified as offering a particular brand of goods or services.” Id. A “franchisee” is the person or entity to whom a commercial franchise is granted.

Words matter, because when one changes the words he uses, he conveys different meanings, ideas, and impressions to whoever hears or reads his words. Fraud necessarily entails materially misleading the victim of the fraud; the chief way in which that is done is by intentionally or negligently using materially misleading words when discussing what a business does or the way in which it operates. When one refers to a business as a “franchise”, even a “virtual franchise”, when it is not a franchise, such a reference is materially misleading.

The most important difference between a franchisor-franchisee relationship and a Principal-Agent relationship is that, in the case of the former, the franchisee is an autonomous business that directly provides goods and services to consumers, whereas, in the case of the latter, an “independent contractor” serving as an agent merely offers goods and services on behalf of the principal. In effect, the “independent contractor” / agent is nothing more than a salesperson working on behalf of the principal. On the other hand, a franchisee is an autonomous business that licenses intellectual property from, uses a business model prescribed by, and may obtain some goods and services from the franchisor.

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If, for example, a franchisee organized as a limited liability company (“LLC”) opened up a fast food restaurant as a Wendy’s® or Burger King® in a building owned by the franchisee, in theory, that same LLC could end its agreement to be a franchisee and continue operating a fast food restaurant out of the same building.

The branding (and supply of branded materials or brand-specific goods) is part of–actually, the essence of–the franchise relationship, but the actual business–the people involved and the type of goods or services provided–is separate and autonomous, to varying degrees, from the franchise. Franchise companies sell franchises–branding, systems, access to distribution networks, etc.

Ultimately, it’s the franchisees who sell whatever goods and services are offered under the franchise’s brand; it’s the franchisees who bear the lion’s share of the legal and financial liability for the success of their business; and it’s the franchisees who receive payments from the customers, who employ the employees, who have the contracts with the vendors and distributors, and who realize the profits of the business at the local level.

In a contrasting example, if a business engaged an independent contractor to be its sales agent, the very essence of that relationship is that the agent acts on behalf of the principal, not on the agent’s own behalf. The agent acts as the principal, and represents the principal to the principal’s customers.

Calling an “independent contractor” a “virtual franchise” or “virtual franchisee” or whatever does not make them more than an independent contractor, an agent of the principal, basically an arm’s-length employee or representative of the business / employer / principal. Furthermore, doing so is materially misleading, and might be an element of fraud. Calling an “independent contractor” a “virtual franchise” or “virtual franchisee” might even be an element of fraud.

A wise businessperson would do well to be extremely cautious, skeptical, and wary of any business that engages in Pyramid / Multi-Level Marketing / MLM / or structuring of their business relationships–even if they’re called something else that seems innocuous, like a “Virtual Franchise”. Under federal law, franchisors have to meet certain legal requirements, including offering a Franchise Disclosure Document (“FDD”) to franchisees. If you don’t receive an FDD, odds are you’re not dealing with a real franchise, and the business might be a scam.

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2017-01-26T15:23:52+00:00