There are certain requirements to be followed for offering a franchise or a business opportunity. We have all seen the following types of claims on websites: “Be Your Own Boss!” …..“Work Part-Time from Home” …..“Earn $5,000 a month with our System”… “100% return on your investment guaranteed!” or “Quick and Easy!” …..“Start Earning Today.” These are all just a few examples of a typical ad by an affiliate or MLM that promote some form of business opportunity. All of these types of “opportunities” carry special and significant legal liability from a consumer protection standpoint.
The FTC Business Opportunity Rule
The FTC has a rule that governs offering business opportunities called the “Business Opportunity Rule” that is separate from the Franchise Rule. The FTC’s Franchise Rule used to cover both franchises and certain business opportunities until the interim rule was made effective. But, most business opportunities MLM’s and affiliates promote over the Internet are not franchises. The FTC recognized this and called for the need for a separate rule not covering franchises. The FTC proposed a new Business Opportunity Rule back in 2006 and the final rule has now been made official effective March 1st, 2012. (FTC’s Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunities, Federal Register, March 30th, 2007).
The term business opportunity means a commercial relationship created by any arrangement where:
- the seller solicits a prospective purchaser to enter into a “new business” opportunity (a “new business” is a business in which the prospective purchaser is not currently engaged, or a new line or type of business);
- the purchaser is required to make some payment as a condition of obtaining or commencing the business opportunity;
- The seller, expressly or by implication, orally or in writing, represents that the seller or one or more designated persons will: (i) Provide locations for the use or operation of equipment, displays, vending machines, or similar devices, owned, leased, controlled, or paid for by the purchaser; or (ii) Provide outlets, accounts, or customers, including, but not limited to, Internet outlets, accounts, or customers, for the purchaser’s goods or services; or (iii) Buy back any or all of the goods or services that the purchaser makes, produces, fabricates, grows, breeds, modifies, or provides, including but not limited to providing payment for such services as, for example, stuffing envelopes from the purchaser’s home.
Under the Business Opportunity Rule, unless you are exempt, anyone who offers or sells business opportunities must make the required disclosures to the purchaser at least seven (7) calendar days before one of two events: either (1) the execution of any contract in connection with the business opportunity sale; or (2) the payment of any consideration to the seller. If you offer any business opportunities as defined above, you will have to make the required disclosures under the Rule to each prospective purchaser within the required time-frame.
MLM’s are essentially exempt from the new Business Opportunity Rule. Instead, the FTC will rely on Section 5 of the FTC Act to enforce any deceptive practices against MLM’s. In the analysis that accompanied the Rule, the FTC “decided that the proposed Rule was too blunt an instrument to alleviate fraud in the sale of MLMs. The Commission therefore determined to continue to challenge unfair or deceptive practices in the MLM industry through law enforcement actions alleging violations of Section 5 of the FTC Act and not through the Business Opportunity Rule.”
What must be disclosed?
Here are the following disclosures you must make if you area seller of business opportunities:
- First, sellers must state their name, business address, and telephone number, the name of the salesperson offering the opportunity, and the date when the disclosure document is furnished to the prospective purchaser;
- Second, sellers must disclose whether or not they make earnings claims and, if so, must state the claim or claims in a separate earnings claims statement attached to the basic disclosure document. (Note: making deceptive earnings claims is the most common problem in the offer and sale of business opportunities);
- Third, sellers must disclose prior civil or criminal litigation involving claims of misrepresentation, fraud, securities law violations, or unfair or deceptive business practices that involve the business opportunity or its key personnel;
- Fourth, sellers must disclose any cancellation or refund policy;
- Finally, sellers must provide contact information for at least 10 of their purchasers nearest to the prospective purchaser’s location.
Can I have my customers waive the rights to disclosure?
It is against the Rule to have any prospective buyers waive or disclaim receipt of the disclosures required to be made under the Rule.
What About Making Earnings Claims?
There are earnings claims disclosures required to be made if you make any earnings claims. According to the FTC, an “earnings claim” is any oral, written, or visual representation, to a prospective purchaser that conveys, expressly or by implication, a specific level or range of actual or potential sales, or gross or net income or profits. See my recent post for some examples of the types of earnings claims and using earnings disclaimers and disclosures.
When calculating the number and percentage of purchasers who attained at least the represented level of earnings, the business opportunity seller must include all purchasers who purchased the opportunity prior to the ending date of the time period on which the representation is based.
What happens if your business opportunity doesn’t have an earnings track record?
The Rule lets you use industry information, but only if your business is able to measure the performance of existing purchasers of the offered business opportunity and document that those existing purchasers’ typical performance equals or exceeds the average performance of purchasers of other business opportunities available in the industry. If you offer a business opportunity with no or very limited prior sales, using industry stats would lack a sufficient basis to demonstrate that these statistics reflect the typical or ordinary experience of your prior purchasers.
State Business Opportunity Laws
Business opportunities alone are not illegal, but most states (26) have adopted “business opportunity” laws. These laws typically cover every type of business opportunity that one can think of. Many specifically cover MLM plans as well. State laws restrict sales of business opportunities or MLM plan unless the seller gives potential purchasers disclosures before the purchase and/or registers the opportunity with some state agency.If the business is not subject to the disclosure requirements under the Franchise or Business Opportunity Rule, it could be under these 26 states.
Under state laws, a business opportunity is generally defined as a sale or lease of any products, equipment, supplies or services for which the seller represents that: (1) the purchaser may, or will derive income which exceeds the price paid for the opportunity; or (2) it will provide a sales or marketing program to enable the purchaser to derive income which exceeds the price paid for the opportunity. As stated, most states will require registration with the state where such opportunities are being provided. More importantly, significant personal disclosures about the promoters, their backgrounds, and their personal finances are required to be made in many cases.
These financial disclosures required are usually abbreviated versions of the disclosures required under the Business Opportunity Rule. Purchasers typically have the right to rescind their contracts under these laws also and have other important remedies. Some states even require that the promoters of business opportunities establish an escrow account into which all or a significant portion of the purchase price must be placed until the goods are received by the purchaser.
The Minimum Initial Investment Exception
State laws imposing these requirements were adopted to prevent significant losses from the consumer. Accordingly, there is a minimum initial investment threshold that must be met before these laws will apply. Under the FTC Franchise and Business Opportunity Rules, and under most state laws, the minimum threshold is $500.00. But, the minimum threshold in some states is as low as $200.00 (i.e. Maryland). Most Internet MLM providers of business opportunities are sure to charge less than the minimum amount to avoid state disclosure and registration requirements.
The problem is that the states and FTC differ on their interpretation of what constitutes an “initial investment.” Under various state laws, these costs often extend beyond those initially needed to “acquire the opportunity.” The FTC rule, followed by most states, is that any required purchases within the first six months of joining a program are part of the initial investment. But, other states specify that the “initial investment” extends for the duration of the term of the contract governing the parties’ relationship. The bottom line is that your business won’t be exempt if you offer a business opportunity with a total initial investment of more than $200 in the first 6 months.