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Franchise Industry

Volume 450: debated on Tuesday 24 October 2006

Motion made, and Question proposed, That this House do now adjourn.—[Mr. Michael Foster.]

I welcome the debate this evening on the regulation of the franchise industry.

As you know, Mr. Speaker, you and I have similar backgrounds—you were an apprentice at Rolls-Royce Hillington, and I was an apprentice at Ailsa Shipbuilding in Troon. We both had jobs which were fairly secure, but others went into business, which is, perhaps, more difficult. I thought that there was some security in the franchise industry, but I have been proven wrong, as have a number of people, which is why I welcome this debate. Business people take risks to succeed in setting up businesses, but tonight I want to explode the myth that the franchise industry is a relatively safe industry in comparison with fully fledged business.

I want to mention the case of a business man in my constituency, Andy Walker, who has been self-employed for some 30 years, during 15 of which he operated a furniture company in Kilmarnock. He looked into the new venture to see exactly where it would lead him. He took his life savings, sold his furniture business and made his house available as collateral for setting up the business, which shows that he did not take the decision lightly. He researched the company involved long and hard by using the internet; he held discussions with the British Franchise Association; and he went to his bank. They all let him down, but those examples show the robust approach taken by Mr. Walker in trying to establish whether the concern would be supported.

The business was trading as 24 Self Video Ltd., but somewhere along the line that changed to RAS Partnership, which was part of a franchise network for renting DVDs. There were initially three directors of 24 Self Video Ltd., two of whom have subsequently been disqualified having hidden behind the front man—Michael Duffy, who was the managing director. He has a clear record and has intimated to me and to others that he took no part in the business. In other words, as I said, he was being used as a front man. The second director was one Tony Sacco, who, as Mr. Walker and I have subsequently discovered, has been disqualified from holding a directorship until 2009.

A third individual, Martin Reilly, has been disqualified as a director until at least the middle of 2007. The interesting fact about Mr. Reilly is that he changed the spelling of his name from Reilly to Riley for the purposes of the company. That is significant, because it is a first indication of evasion in the setting up of the franchise and the company itself. My first question for the Minister, whom I am glad to see in his place, is this: other than that disqualification, was any further action ever taken against Mr. Reilly? For instance, has he ever ended up in court on a matter related to this directorship or to the many more directorships that he has held, all of which ended over a period of years?

In the period from February 2003 to December 2005, some 30 outlets in the industry opened, 15 of which have closed with a loss in each case of some £120,000. That adds up to some £2 million that people have invested and lost. RAS Partnership has accrued an income, almost exclusively profit, of almost £4 million, yet of the 15 outlets remaining, none has reported any profits of any description. All those people thought that they were protected through the British Franchise Association, but all were let down. I say to the Minister and to those in the industry that it is time that much tighter regulation was considered.

The bank involved has also failed and is guilty of clouding the issue of the assistance that it gave when the franchise was being set up. It seems to me, to Mr. Walker and to the others involved that all the bank seems to care about is that the money loaned to the individuals—some £70,000—is repaid in full, and that it does not matter what form that repayment takes, even if it leads to an individual’s house being taken from them. The bank involved is the Royal Bank of Scotland and its associated bank in England, NatWest. Those banks, and their branches, lent money to the franchise although no other bank in the United Kingdom would do so, believing that something was wrong. Indeed, it is alleged that a Mr. Johnson of NatWest, who was a senior financial adviser in Warrington, was a drinking buddy of Mr. Martin Reilly. It so happened that the loan was subsequently arranged by the Royal Bank of Scotland.

What has been done by Mr. Walker and by my office? Mr. Walker has written to the Royal Bank of Scotland’s chief executive, Sir Fred Goodwin, who has sent three letters in response. He says that the bank takes absolutely no responsibility as it is not deemed to have given any advice on this occasion. What else are the banks there for in relation to this industry? We have also written to the BFA, which was initially most unhelpful in responding to any of my requests in connection with this case. It states that it takes no responsibility whatsoever and that

“the fact a franchiser is or was in the BFA offers only assurance that the business concerned succeeded in meeting our accreditation criteria at the time they were assessed.”

That is outrageous. The association should have regulations in place so that, at the very least, these companies are investigated and their financial returns examined; it should also be established that the directors have not been disqualified.

The fact remains that my constituent Andy Walker—and others, it has to be said—have been badly let down by the company, which bears a degree of responsibility, and by the BFA. The bank has done nothing of any use whatsoever for the individuals concerned, who stand to lose everything. The process needs to be examined and reshaped, so that individuals are in some way protected. If a more severe form of self-regulation cannot be introduced, the Government must introduce regulations. It must be mandatory that the BFA be advised of any franchisee closures, in order that prospective franchisers can be notified. According to my research, that is the system in the United States. I ask the Minister to look into that.

The BFA must make much more rigorous checks of its franchises and ensure that they are reviewed far more frequently. It is plainly wrong for an individual to be able to form a partnership while disqualified from being a director. Even the BFA was sufficiently concerned to write to the Department of Trade and Industry’s company investigation team about this issue. If the Minister cannot tell me tonight what the likelihood is of overcoming this problem, I would like him to write to me. I want the bank seriously to consider its position regarding the outstanding loans, and I want the BFA to be far more proactive, or to face imposed regulations. I look forward to hearing the Minister’s response.

I commend my hon. Friend the Member for Central Ayrshire (Mr. Donohoe) for securing this short debate and for the clarity with which he expressed his concerns, which arise from the sad experience of one of his constituents. It is worth setting out the context of those concerns, which is the practice of franchising.

Franchising, which is of course a well known form of relationship between businesses, is essentially a matter of packaging an existing brand or business identity. The brand owner licenses the use of the brand, trademarks and know-how to another person, in return for payment. The franchising model is extensively used; indeed, the Financial Times has estimated that if sales by US franchise businesses were translated into national product, they would rank as the seventh largest economy in the world. That gives some idea of the scale. It is estimated that some 330,000 people are employed in the United Kingdom as a direct result of franchising, and the turnover of these businesses is in excess of £10 billion.

From the brand owner’s point of view, franchising offers the opportunity to develop the business more rapidly than they could with their own resources. For the prospective franchisee, there are some clear advantages. Buying a franchise offers the benefits of an established brand and a proven business model, rather than having to build a business from scratch. The franchisee benefits from the brand owner’s own promotion of the brand, and the brand owner provides support in the form of training, marketing assistance and know-how of various kinds. Given that the business concept is already proven, it can be easier to raise finance.

However, there are of course disadvantages, too. There are payments to be made to the brand owner, which reduce the potential profits. The franchisee is obliged to adhere to the established model and obtain approval for any changes. The business can be sold only to someone approved by the brand owner, who can go out of business.

On balance—of course, I generalise—franchising appears to offer an effective way of starting a business. The annual franchise survey by NatWest shows that a large majority of franchisees are satisfied with the business relationship and would recommend it to someone who was considering buying a franchise. It is often claimed that the failure rate for new franchise businesses is less than that for new businesses generally. There is some economic evidence for this, although I am cautious about it because it is not conclusive.

We have all however learned the lesson that, where there are opportunities, there are also risks. Anyone considering buying a franchise needs to assess the opportunities and the risks with as much care as if he were buying an independent business. There is a good deal of help available for that. The Business Link network, which the Department supports, offers helpful advice to anyone who is starting a business, including specific advice on buying a franchise. However, that and any other general advice is not enough on its own. Anyone considering a franchise opportunity is strongly advised to take independent professional advice on the specific opportunity in relation to his particular circumstances before making financial commitments.

It appears that my hon. Friend’s constituent took the plunge, and that things have gone very wrong. I heard the constituent’s story with much sadness, as anyone else would. Many factors may, of course, be involved, but one point in my hon. Friend’s speech is of immediate concern to me. He said that two people closely connected with the brand owner are disqualified directors. That is, of course, a serious matter. Anyone disqualified from acting as a director is also disqualified from any direct or indirect involvement in the management of a company or limited liability partnership. Any breach of those restrictions is a criminal offence. The Department maintains an enforcement hotline so that anyone can report evidence of such breaches promptly. I assure my hon. Friend that those matters are treated very seriously. I hope that he will encourage his constituent to report the evidence as soon as possible so that it can be investigated. He could help facilitate that.

I am happy to discuss the specific case further with my hon. Friend, but let us move beyond it today. My hon. Friend suggests that there is a need for some specific regulation of franchising. I have to say that I am not at this stage convinced that that is necessary or desirable. A franchise business is, in most respects, a business like any other. If the brand owner has a sufficiently attractive business offer in the first place, and conducts his affairs well, he may prosper. If his franchisees are prudent and conduct their businesses competently, they may prosper, too.

To be sure, things will not always work out. If businesses are to be allowed the freedom to prosper, it follows that they are also free to fail. In a dynamic market economy, the Government cannot insure businesses against the possibilities of failure. Of course, my hon. Friend does not ask us to do that. We can and should maintain controls against fraud, deception, anti-competitive practices and irresponsible behaviour by those who manage companies. I have already mentioned the controls that exist on disqualified directors.

To go beyond those general regimes and institute special controls on franchising, however, it would have to be shown that those businesses are especially risky or hazardous. There are undoubtedly risks, and some are specific to franchising. Anyone who considers buying a franchise needs to consider them carefully and seek advice, as I have stressed. As I have also said, our Business Link website provides helpful advice to anyone who is starting a business, including specific advice on buying a franchise. That highlights the advantages and disadvantages of franchising, and points to further sources of advice, including the banks and the BFA.

To make a special case for special controls on franchising, however, it would have to be shown that those businesses are especially risky or hazardous. The evidence, such as it is, does not support that idea. Although it is not conclusive, it does not suggest that franchises are more risky than other forms of business start-ups. Of course, any deception or fraud must be properly tackled, and it will be. But at the end of the day, the Government cannot insure businesses against the possibility of failure. I hope that this evening’s short debate, and the painful experience of my hon. Friend’s constituent, will serve to draw attention to some of the downside risks involved, and those should not be underplayed. I do not want to end on such a downbeat note, however. We should not lose sight of the fact that new business start-ups are a vital seed bed for future growth and prosperity in our economy. They are a source of innovation, competition and new ideas, and they create more jobs than established business at all points of the economic cycle.

The Department of Trade and Industry works closely with the regional development authorities to ensure that start-ups are offered appropriate business support. Those who wish to start new businesses should of course think carefully and weigh up the risks as well as the opportunities, but they should not be unnecessarily put off. As I have said, there are sources of advice available for anyone considering starting a business.

I again thank my hon. Friend for raising these important issues this evening. I hope that he will understand why I have not responded directly in regard to the individual circumstances that he has described, but I shall be more than happy to discuss the matter with him in due course.

Question put and agreed to.

Adjourned accordingly at nineteen minutes to Eleven o’clock.