Franchises, MLM and buying a business: how to avoid costly mistakes

Pyramid schemes and MLM

The Commerce Commission's fact sheet says pyramid selling is prohibited under the Fair Trading Act, while multi-level marketing is not prohibited in itself. The key question is where the money comes from: if participants are paid mainly for recruiting others rather than for selling products, it is a pyramid scheme. Check the Commission's current guidance. MLM schemes are not themselves prohibited, but some are pyramid schemes in disguise.

• You have to pay an upfront fee, deposit or 'subscription' to start earning.
• You're told to recruit others, or to join through a referral link.
• Income examples are vague or show only the top few people.
• You must buy stock you can't easily return.
• You're pressured to decide quickly, or to use your savings or redundancy pay.

Buying a franchise

Franchising is a legitimate model, where you run your own business using someone else's brand and system. But the franchisor makes money from your fees, so check the numbers carefully.

1. Ask for the disclosure document and the franchise agreement. Have a lawyer who knows franchising read them before you sign anything.
2. Speak to at least five current and two former franchisees, not just the ones the franchisor suggests.
3. Ask for actual (not projected) profits for outlets like yours, in a similar location.
4. List all costs: upfront fee, ongoing royalties, marketing levy, fit-out, stock, lease and renewal. Work out the break-even.
5. Check restraint, exit and renewal terms: what happens if it doesn't work?
6. Ask an accountant to model best, likely and worst cases.

Buying an existing business

• Financials: at least three years of profit and loss and balance sheets, verified against tax returns.
• Why is it being sold? Check customer concentration, key staff and how much depends on the current owner.
• What are you buying: shares or assets, stock, goodwill, intellectual property? What debts or security interests come with it?
• Contracts and leases: are they transferable? Are there change-of-control clauses?
• Staff: employment records, entitlements owed, contractor arrangements.
• Any legal disputes or compliance issues.
• Make the purchase conditional on due diligence and finance. Get legal advice before you sign.

Protecting your money

• Don't spend redundancy pay on a business in the first few weeks. A decision made under stress is rarely your best one.
• Don't guarantee loans with your family home unless you've taken independent legal advice.
• If you've been scammed, contact your bank immediately and report it to CERT NZ and the Commerce Commission.

Free help: Citizens Advice Bureau (0800 367 222) and Community Law (communitylaw.org.nz) can point you to a lawyer or advice service.