Understanding Business Opportunity
Have you been laid off? Have you retired or do you have a severance or benefits check to invest? Are you a stay-at-home mom (or dad) looking for part-time work you can do from home? Maybe you’re tired of commuting to a boring 9 to 5 job with no prospects for advancement. Whatever the reason, the idea of starting your own business with someone else's expertise and support may appeal to you. But wait! Before you commit, investigate first!
What is a Business Opportunity?
A business opportunity is an arrangement where a third party (the seller) offers to sell you products, equipment, supplies or services to enable you to start your own business. In Connecticut, business opportunities are regulated by the Department of Banking's Securities and Business Investments Division. The law that covers business opportunities is the Connecticut Business Opportunity Investment Act.
In addition to selling you products or services, a business opportunity seller may make certain promises to you. For example, the seller may tell you that it will provide you with locations (or help you find locations) for the use or operation of vending machines, racks, display cases, other similar devices or currency-operated machines on premises that neither you nor the seller owns or leases. The seller may also tell you that it will buy any products you make, produce, fabricate, grow, breed or modify using the goods or services that the seller sold to you. Alternatively, the seller may conditionally or unconditionally guarantee that you will receive income from the business opportunity. The seller may also tell you that it will refund the price you paid or buy back any of the goods it provided to you if you are unsatisfied with the business opportunity. In addition, some business opportunity sellers say that they will provide you with a sales program or marketing program.
Business opportunity programs can include vending machine routes, distributorships, franchises and multi-level marketing arrangements. Before investing, think about what kind of business opportunity fits your personal experience, skills and interests. Can you see yourself operating the business opportunity for many years to come?
Vending machines and display racks typically feature food. To succeed, you must place them in public, high-traffic locations like restaurants, bars or malls. You are responsible for restocking the machines or racks, keeping them in good repair and collecting money. Your income would come from the product’s sales proceeds. The business opportunity seller may agree to find suitable locations for the machines or racks, relocate them as needed to more profitable sites, and fix or replace damaged machines.
Franchises have strong name identification with the franchisor. They feature a uniform marketing and quality control plan. A franchise that does not have a federally registered trademark that franchisees may use must be registered under the Connecticut Business Opportunity Investment Act.
Multi-level marketing ("MLM") programs involve the sale of products or services through various levels or "downlines." People become members of a downline after being recruited by other participants, called sponsors. The sponsor is in the new recruit's "upline." Sponsors are responsible for training, motivating and keeping in touch with their downline distributors. Sponsors earn bonuses and overrides based on the sales volume of their downline distributors. Recruits, too, have the chance to enlist still more participants, become sponsors themselves and receive a percentage of the bonuses and overrides going to their sponsor.
Sponsors do well if downline distributors enjoy heavy sales of the products or services and don't drop out. However, the dropout rate is often high. In addition, some MLM participants are so eager for bonuses and overrides or so pressured to meet sales quotas, that they order much more merchandise than the network can sell. The result? High out-of-pocket costs and a garage full of unwanted merchandise.
Sometimes, a recruit who has successfully signed up a substantial number of participants "breaks away" from his or her sponsor to form a separate network. Although the original sponsor still gets a share of the breakaway group's sales, the original sponsor can no longer count on the breakaway group's volume when building his or her downline. The two groups now have independent downlines. MLM arrangements are among the most complicated types of business opportunities to understand.
Pyramid schemes differ from multi-level marketing arrangements. In a pyramid scheme, people make money by recruiting others to invest. These other investors profit by recruiting still more participants and so on. Unlike bona fide multi-level marketing arrangements, any products or services you must buy in a pyramid scheme are incidental to the recruitment effort. Inevitably, the pyramid collapses as participants scramble to recruit prospects from an ever-shrinking pool in a given area.
Know Your Rights Concerning Business Opportunities
In Connecticut, the Connecticut Business Opportunity Investment Act regulates business opportunity offers and sales. Federally, the Federal Trade Commission (FTC) has a rule on franchise and business opportunity ventures which requires the preparation of a disclosure document for prospective purchasers.
Under Connecticut law, before a seller may offer a non-exempt business opportunity to the public, the seller must register the business opportunity. The Securities and Business Investments Division of the Department of Banking will review the seller's registration application, supporting documents and the disclosure document that the seller will give to you. The FTC, by contrast, does not review disclosure documents.
The Division checks the seller's disclosure document to see if it contains enough information to enable you to make an informed decision on whether to buy the business opportunity. The Division also looks for misleading or fraudulent statements in the materials. By law, the Division cannot substitute its judgment for yours or endorse any particular business opportunity.
If the Division considers the materials complete, the business opportunity will be registered. The seller may then begin to make offers or sales in Connecticut. Offers may be made through classified advertising in Connecticut newspapers, direct mail, radio station announcements, business opportunity trade shows, Internet web pages and postings or other means.
Under Connecticut law, you are entitled to receive a copy of the disclosure document at least 10 business days before you sign a business opportunity contract or at least 10 business days before the seller receives any money from you for the business opportunity. This 10 day "cooling off period" gives you time to look over the disclosure document before you make a legal commitment or hand over any money to the seller.
If you buy a business opportunity and the seller uses untrue or misleading statements in the sale, doesn’t provide you with a disclosure document, fails to deliver the goods or services needed to begin substantial business operations within 45 days of the delivery date stated in the contract or fails to provide you with a contract that complies with Connecticut’s business opportunity statute, you can void the contract.
If you void the contract, you can recover those sums you paid to the seller. However, you must return to the seller all products and supplies in your possession. If you are able to prove that you have been damaged by a violation of the Connecticut Business Opportunity Investment Act, you can also sue the seller in court for breach of contract and recover damages plus attorney's fees. The statute of limitations for breach of contract actions is six years.
Be on the lookout for these signals that something may be wrong.
High Pressure Sales:
Does the seller badger you with constant phone calls or e-mails – or demand that you make a quick decision? Do you feel forced to pay on the spot, whether via credit card, overnight courier service or otherwise?
Sellers with good offers don’t have to use sales pressure. Give yourself enough time to investigate the business opportunity. Talk to an attorney or accountant if necessary.
The High Profit Promise:
Beware of claims that you’ll achieve high profits – especially if the profits are “guaranteed.” Ask the seller to verify the income projections and profit claims in writing. The seller should give you specific figures on how many purchasers actually earned such profits.
Just because you see a profit claim on the Internet or in a print advertisement doesn’t mean that it’s valid. Newspapers, radio and television stations don’t have the time and resources to carefully screen and verify every advertisement they run. In addition, there are no controls over what a seller can publish on its own web page. If you hear promises of high profits at a trade show, seminar or during an "infomercial," be a critical listener and treat the claims with skepticism.
If you’re dealing with a multi-level marketing company, ask the seller to give you specific figures on how many people have actually reached the most advanced status levels. It’s not uncommon for the vast majority of distributors to be concentrated at the bottom of the status ladder.
The No Risk Promise:
Watch out for remarks like "you can't go wrong" or "this is a ground floor opportunity." Understand that small start-up businesses are riskier than more established ones, and that different types of businesses involve different risks.
High Start-up Fees:
Are you getting your money's worth in terms of the inventory, training and other services you will receive? Sales jobs, for example, shouldn’t involve very high start-up fees. In addition, if you will be selling a product, will you be able to retail the product at a profit given your costs?
Avoid multi-level marketing arrangements with high sign-up fees, substantial inventory quotas and no product repurchase policy. Most important, if a multi-level marketing company makes you buy a lot of products just to join (front end loading), think very carefully about signing up.
Missing Disclosure Document or Evasive Answers:
If the seller fails or refuses to provide you with a disclosure document, don’t buy the business opportunity. In addition, if the seller will not give you straight answers on the business opportunity arrangement, it may not be in your best interests to invest.
The “Red Carpet” Seller:
You've never met the seller, but he sure sounded smooth when you called his international toll-free number. How nice of him to take time out from his busy schedule to fly in and quickly sign you up – at the airport’s premier motel lounge. Don't let flashy appearances fool you. This “Red Carpet Seller” will leave your wallet in the red. Unless you're dealing with a highly reputable out-of-state company, if there's trouble down the road, it will be a lot easier to collect from a Connecticut based seller.
Glowing References and Testimonials:
The seller’s website and promotional materials feature countless references – all glowing. Many of the people are halfway across the United States or perhaps in another country. Should you care? Absolutely. The seller could be paying these folks to give you a rosy picture, or they could be the seller’s close friends. In one extreme case, the seller’s staffers manned an answering service and posed as delighted purchasers when new investors tried to question them on whether the business opportunity was profitable.
Even if the references the seller gives you are genuine, they may be too new at the business to say for sure what lies ahead. Your best bet is to meet the purchaser in person and carefully look at first year costs and break even sales computations. Stop by the purchaser's place of business and examine for yourself the volume and type of business that is being conducted.
Skimpy or One-Sided Contracts:
Business opportunity and franchise relationships seldom involve a complete balance of bargaining power. Many agreements are lengthy, comprehensive documents that cover almost every aspect of the relationship. Others involve nothing more than a boilerplate purchase order or one page form with fine print on the back. If your contract takes only a couple of minutes to read or looks incomplete, and the seller makes promises not covered by the agreement, watch out. Your success depends on the seller honoring its part of the bargain. If the contract doesn’t spell out what goods or services the seller will supply, you will have a hard time if there is a dispute. Regardless of whether your contract is skimpy or comprehensive, read it carefully to make sure it's not drafted entirely in the seller's favor. Take the contract to an attorney before you buy so he or she can make sure your rights are protected.
The seller's name isn't a household word, but according to the seller’s website and glossy brochure, you could start a business stocking racks with brand name merchandise. There is even a picture of the product’s trademark and logo. A good deal, right? Not necessarily. The seller may not be legally authorized to use the trademarks and logos. If a third party (such as a trademark holder) is an important part of the business opportunity's operations, check to make sure that it really does have a role in the business and that it is legitimate.
Irregular Business Practices:
Does the seller require you to leave Connecticut to sign up for the business opportunity and make payment? If so, the seller may be trying to escape the jurisdictional reach of Connecticut's business opportunity laws and avoid having to give you a full disclosure. Does the seller require that you make your check payable to "cash"? This may be an attempt to prevent you from tracing where your money went if a problem develops later on. At any sign of irregular business practices, put away your checkbook or credit card and head for the nearest exit.
Pyramid Scheme Warning Signs:
Be wary if the start-up cost for the investment is high. Will the seller buy back inventory? If not, the sale of inventory may only be a smokescreen for the true nature of the business. Is there a consumer market for the product? If the seller seems to be making its money from recruiting alone, stay away.
A Checklist for Investors
Before you buy, read the business opportunity disclosure document and contract carefully. Talk to an attorney or accountant, preferably one with experience in this area, before you pay any money or sign any document. Even the most experienced entrepreneurs - who perhaps can afford to lose more than you - never enter into an important business relationship without consulting a team of professional advisers. There is no reason why you should not do the same.
- Check to See if the Business Opportunity is Registered
A list of registered business opportunities, including federally registered trademarks or service marks, is available on the Department of Banking website.
- Financial Statements
Carefully review the seller’s financial statements in the disclosure document. An accountant or lawyer can help you to analyze them and tell you about the seller's financial strengths and weaknesses. If the seller is in a weak financial position, it may be selling business opportunities as a way to raise cash just to stay afloat and won't be able to provide you with effective support. Current financial statements will also tell you if the seller is really a one person operation or if the seller will be able to refund your money if there is a problem.
- Risk Factors
The disclosure document will summarize any factors that make the business opportunity highly risky or speculative. Here are some examples of risk factors: 1) the business has had no profitable operations within the past 3 years; 2) the seller’s financial position is erratic; 3) the seller’s business type presents specialized risks; 4) the seller’s executive officers and directors were convicted of a crime or adjudged bankrupt; 5) the seller’s management lacks experience; and 6) the seller relies on key customers whose departure would have an adverse effect on the seller’s business.
- Prior Business Experience of the Seller and its Partners, Officers, Directors and Affiliates
How long has the seller conducted a business of the type you will be operating? Has the seller or its principals or affiliates had any prior business experience in related areas? Which ones?
- Seller's Prior Business Opportunity Track Record
The disclosure document will give you information on how many business opportunities have been operating within the preceding calendar year; the names, addresses and phone numbers of existing purchasers closest to you; the number of business opportunities that were voluntarily terminated or not renewed; the number of business opportunities that the seller reacquired by purchase; the number of business opportunities the seller refused to renew; how many business opportunities the seller cancelled or terminated during the term of the contract and after it expired; and the reasons for any reacquisitions, terminations and refusals to renew. Pay special attention to the number of business opportunities terminated during the past 3 years. An unusually large number may signal danger. In addition, if very few purchasers remain, your ability to obtain information based on the experiences of others will be hampered.
- Litigation History of the Seller and its Partners, Officers, Directors, Sales Representatives and Affiliates
The disclosure document will tell you if the seller or any of its partners, officers, directors, sales representatives or affiliates have been 1) convicted of a felony involving fraud; 2) defendants in an action involving fraud or the business opportunity relationship; or 3) subject to an injunction relating to fraudulent dealings or to the business opportunity relationship. Even if a lawsuit is only pending, too many claims against the seller and its principals may mean the seller has not been living up to its agreements.
- Insolvency or Bankruptcy of the Seller and its Partners, Officers, Directors and Affiliates
The disclosure document will also tell you if the seller or any of its partners, officers, directors or affiliates have filed for bankruptcy, been adjudged bankrupt or have been reorganized due to insolvency.
- Description of the Business Opportunity
What specific products and services will the seller provide to you? Is the product of high quality? Look for details on patents, warranties, frequency of repairs, consumer ratings and any state or federal restrictions on use of the product. Is there a market for the product? Ask for market studies to answer this question. If training is not fully explained in the disclosure document, ask about it. Request information from existing purchasers about their training. Also request information on the seller's marketing plan, if any. Will national advertising be provided?
- What Will Be Your Total Outlay (Cost)?
How much will you have to pay in initial fees, deposits and down payments? Will you have to make any payments to someone other than the seller? What for? Will you have any recurring expenses to run the business, such as royalty payments, rent, advertising fees, training fees and any additional equipment or inventory expenses?
- Seller-Assisted Financing
If the seller or its affiliate will offer you financing, find out the material terms and conditions.
- Operational Restrictions
Are you limited in what goods or services you can offer for sale? Must you only sell to certain customers? Are there any geographical limitations on the area where you may offer or sell goods or services? Geographical restrictions may limit your expansion plans. Will the seller provide you with territorial protection to prevent market saturation? How many hours and days per week must you remain open? Does the seller have any rules about closing for illness, death or vacation? How many employees, if any, must you hire? Do you need any special regulatory permits or licenses to begin operations? All of these are important questions.
- Business Opportunity Contract
Under what conditions could you terminate or modify the contract? Is renewal automatic? Does the agreement have any covenants not to compete?
- Site Selection
Will sites be selected based on a market survey? What will the seller do to help you pick an appropriate site? Would you be able to change the site if it turns out to be unsatisfactory? If the seller offers little help with site selection, think twice about buying.
- Earnings Claims and Projections
The disclosure document will tell you how many purchasers over the past three years achieved earnings in the amount or range specified by the seller. In addition, the disclosure document will explain the bases and assumptions underlying sales and earnings projections.
- Multi-Level Marketing Considerations
Do not be afraid to ask questions of the MLM company and participating distributors, especially those with whom you will share a common upline. How many levels of downlines can earn you bonuses and commissions? How long does it usually take for the company to pay its participants? Are there any strings attached to your receiving overrides and bonuses? For example, must you attend a national sales convention at your own expense to qualify?