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In June 2009 the Minister of Local Government made this hard hitting statement:
“…I am taking the liberty of sharing this experience with this assembly to argue that if the North West is indicative, in any way, of what is happening in our municipalities in the other eight provinces then we need to declare a national state of emergency on local government in this country…This is a sector that is perceived to be incompetent, disorganised and riddled with corruption and maladministration….During several research surveys conducted regarding public perception on spheres of government, local government has always scored the lowest…..Even the latest research results points to that sad perception. For that matter, the results show that the public rating of municipalities is at an all-time low…”
Minister Sicelo Shiceka – SALGA NMA – 10 June 2009, East London
Apart from heavy hitting speeches there has been action, I thought I’d note one set of investigations that has already taken place:
Investigators submit preliminary report on Mkhondo municipality
3 September 2009
The team of investigators appointed by the Mpumalanga provincial government, in terms of section 106(1)(b) of the Local Government Municipal Systems Act, 2000 (act No.32 of 2000), to investigate allegations of maladministration, fraud, corruption, nepotism, poor service delivery, poor implementation of the Integrated Development Plan (IDP) and lack of proper consultation in terms of resource distribution and infrastructure made against the Mkhondo local municipality has submitted its preliminary report to the provincial government.
The report has indicated the following findings:
On financial mismanagement, the investigation report has revealed that there has been mismanagement of moneys allocated for projects. There have also been municipal officials found to have been paid unduly. Such moneys must be recouped and implicated officials should face disciplinary hearing. Some officials and councillors have been found to have misused municipal credit cards. The use of credit cards has been discontinued by the Administrator. There was no policy to deal with credit cards.The administrator will immediately set up a policy on use of council credit cards. Disciplinary hearings will be held against the implicated officials. In most municipalities the use of credit cards has been long stopped.
Fleet management
The preliminary report has also indicated that there was a lack of proper monitoring and accountability on municipal vehicles, which led to the misuse of government fleet and wastage of fuel. The administrator has started putting systems in place to minimise the abuse of council resources.
With regards to employment of personnel, the findings have indicated that there have been cases where individuals were employed illegally in breach of the employment procedures. These dubious appointments will be probed further and individuals found to have been wrongfully employed will be dealt with severely.
The municipality has started designing new policies and systems that will ensure that all employees and employees of the municipality are appointed in a transparent manner based on their skills and competencies. Nepotism is a punishable offence. Disciplinary action will commence immediately against all implicated individuals.
The administrator will be given four months to conclude all outstanding matters on the investigations, and MEC Norman Mokoena will oversee the process. The provincial government would like to thank the community for cooperating with the administrator and his team during the period the municipality has been put under administration.
Enquiries:
Mabutho Sithole
Cell: 082 398 3348Simphiwe Kunene
Cell: 082 413 3931Vusi Mashabane
Cell: 076 762 6510Issued by: Office of the Premier, Mpumalanga Provincial Government
3 September 2009
Source: Mpumalanga Provincial Government (http://www.mpumalanga.gov.za/)
We need to start seeing municipal officials being fired or prosecuted, we need to see councillors held directly accountable. There is a lot of talk about this taking place, lets see it happen. Its the only way to get those in power at the municipal level to take their mandates more seriously.
This is a very frank speech given by Deputy Minister of Cooperative Governance and Traditional Affairs (COGTA), Yunus Carrim on the occasion of Institute of Municipal Finance Officers (IMFO) Conference, Johannesburg the 6th October 2009.
This speech shows the seriousness with which COGTA is tackling the failings at the municipal level. The national department has been over hauled rapidly and are geared to being more hands on in striving to improve delivery – on the departments biggest problems in its previous incarnation as DPLG is that it was disassociated from what was going on, on the ground in municipalities. and communities .
COGTA’s success is critical in ensuring that a) a coherent 360 degree vision of service delivery is developed – developmental planning is still a fractured practice – and b) that the right systems and people are motivated to support that vision.
Addressing financial challenges in municipalities in the context of the review of the local government model
Allow me, in the first place, to say how pleased and honoured I am to be here. I convey too the heartfelt good wishes of Minister Sicelo Shiceka who, as much as he was keen to attend, simply could not be here today. He spoke last Tuesday at the Association of Public Accounts Committees Conference in Cape Town, and I would commend his speech to you, as it is of immediate relevance to the work you do.
On behalf of both of us, I extend our sincerest congratulations to you on your 80th anniversary. I am struck by the value of your theme for this conference ‘Making the Elephant Dance’. And I agree with your President, Mr George van Schalkwyk, when he says in the foreword to the conference programme, “So making the elephant dance is not easy. We will have to do things differently as the current strategies, management practices; environmental governance and work ethic are just not sustainable. We will need to innovate and learn the new tune, the beat and the appropriate steps to better utilise the available resources”.
And I agree too when he says “what really matters is not what Institute of Municipal Finance Officers (IMFO) members put into the profession or what they get out of serving the profession, the real test is what they leave behind when they move on”. And it is around these themes of ‘Making the Elephant Dance’ and on innovation and leaving a legacy that this talk is pegged.
You are indeed, as municipal finance officers, crucial to the success of local government. A lot depends on you. How much, it sometimes seems, you are not aware of. But, believe you me, you are absolutely crucial. And so it is too that we welcome the memorandum of understanding you signed with South African Local Government Association (SALGA) last year and we hope it will be effectively implemented.
It is clear, certainly, that unless we improve financial management and fiscal governance in municipalities we will not be able to significantly improve service delivery and development. There is a very close relationship between improved financial management and fiscal governance, and effective service delivery and development. Indeed, it may well be too that if we improve service delivery and development, we will also in turn, improve financial management of municipalities.
It is clear that the “service delivery protests” that have been breaking out all over the country this year are not just about municipal service delivery. They are about a range of issues affecting all three spheres of government and are better termed “community protests”. But, interestingly, in many cases residents protested about issues relating to financial mismanagement, fraud and corruption at municipal level. In some cases they seemed to have separated these issues from service delivery, but in others they clearly identified these issues as being responsible for the poor service delivery in their areas. Whatever the case, it is clear that financial management and service delivery are closely related.
A review of the cooperative governance model
As you know, our department is facilitating a major review of the cooperative governance system. The respective powers and functions of national, provincial and local government are being reviewed. The review is dictated by practical, not ideological, imperatives. We are 15 years on now. What has been our experience? How has our system of cooperative governance been working? What aspects of the system work and what do not?
Remember that we shaped our current system in a particular context of a negotiated settlement. But are we in the same context as in 1994 to 1996? Are we under the same pressures? Do we need a more objective foundation for our governance system that is based more on our long-term needs and less on the need to strike immediate political compromises? Which features of our cooperative governance system should endure and which are contingent, having been shaped largely to meet the needs of a different context? We need a debate about this! A huge public debate, the debate has barely begun. As key stakeholders, you need to actively participate in this debate.
A major imperative for the review of the cooperative governance system is our need to build a developmental state and ensure far more effective service delivery and development. It is unlikely that the cooperative governance system that is at the heart of our Constitution will be dismantled. It is likely though that the form of our cooperative governance system will change. The particular powers and functions allocated to the three spheres of government may well change. At the very least, they will be fine tuned and clarified. A much more integrated and effective inter-governmental system is likely to be developed that is more consistent with the needs of an atavistic developmental state committed to accelerating service delivery and development.
Local government in distress
It is certainly clear that the current model of local government is not working. We just can’t afford to let local government continue the way it does. We need changes. Among the questions we need to ask are:
* should the boundaries of municipalities without a minimum fiscal base be re-drawn?
* is the two-tier system of district and local municipalities working? Do we need to improve the system or abolish it?
* how do we ensure greater national and provincial government support for local government?
* do we need to more clearly separate the legislative and executive functions of local government as we do in the case of provincial and national government?
* how can we ensure that internally displaced persons (IDPs) are productively linked with provincial and national development plans?
* what would be an effective funding model for local government?
* what would a good financial management and fiscal governance model for municipalities?
* how can we improve public participation in local government, including through ward committees?
* how can we ensure effective capacity building of municipal councillors and officials?Of course, there are many other crucial questions too. And you must help to shape them. You will be particularly helpful in helping us to deal with the financial challenges. Perhaps you could also help us with a fundamental question: To what extent are the many current financial and financial management challenges in municipalities linked directly to the complex local government model we have? How by changing the model would we be better able to cope with the financial and financial management challenges being faced by municipalities?
In other words, which of the financial and financial management challenges we currently experience at local government level can be addressed by changing the model and which challenges are more general and will persist whatever the model? And in respect of the latter, how do you think we could address these challenges effectively? We need new methods, surely, new ways of dealing with the challenges? As we have failed so far to effectively deal with these challenges.
It’s not, of course, as if we can take major decisions on the local government or cooperative governance system overnight. There will be full and considered discussions with all the key stakeholders, and the public generally will be given full space to have their say. Some of the changes agreed to may be introduced before the 2011 local government election. But most of the changes will probably follow the 2011 elections.
Local government is, however, currently in severe distress. And we have to act more immediately to address the distress. So, the department, together with other key stakeholders, including SALGA, is working on a local turnaround strategy. We have received “state of local government” reports from the provincial departments of local government and are putting together a national report as the basis for a turnaround strategy to be developed at a National Indaba on Local Government from 20 to 22 October which will be addressed by the President.
The turnaround strategy will be implemented in two phases. The first phase will be from January 2010 until the 2011 local government elections. The second phase will be implemented from the 2011 elections onwards. The strategy will evolve and be fine tuned as the features of the new model of local government are shaped through the policy review process.
Some financial challenges
But whatever the model of local government decided on, there are some financial challenges that will have to be addressed and addressed far more effectively than now. It is on these aspects that I will focus on today and not on all of them which you, in any case know more about than me, but on some of them. Aspects of how to address the challenges must, certainly, be inserted into the turnaround strategy.
Most of us know what the financial challenges are. What we don’t know are the answers to them. The “state of local government” reports submitted by the provinces are still being processed. But, so far, what is emerging from them about the financial challenges is largely familiar. Based partly on these reports and what we all know generally the following, very briefly, are some of the financial challenges of municipalities that can be identified:
* There are municipalities that are simply not financially viable. They just do not have a fiscal base. Without grants from the national and provincial government they will wither away. In fact, according to our department, 57 municipalities receive more than 75 percent of their revenue from national transfers. According to our department, a number of local municipalities have indicated that they are 100 percent grant dependent, these include for example; Aganang and Molemole (in Limpopo), Ndwedwe and Maphumulo (in KwaZulu-Natal), and Mamusa and Molopo (in North West).
* To increase the efficiency of service delivery, the intergovernmental system is dependent on the proper co-ordination of policy, budgeting, planning, implementation and reporting between the spheres. Substantial increases have been made to the transfers (both operational and infrastructure) to local government over the last few years in acknowledgement of its increased service delivery responsibilities.
Yet, many municipalities are not in a position to meet their developmental mandate due to an inadequate economic base or high levels of poverty and unemployment. An increasing reliance of municipalities on transfers (equitable share and others) from national government to fund their activities is evident, with government grants at 22.4 percent of total operating revenue in 2007/08 as the second largest source of revenue for municipalities.
“The local government budgets and expenditure review: 2003/04 to 2009/10” indicates that at 42 percent in 2006/07, service charges are the largest source of operating revenue for municipalities. The share of service charges in total operating revenue has however declined from 49 percent in 2003/04 to 42.9 percent in 2009/10 mainly due to the sharp increase in national transfers.
* There is an acute lack of financial management skills, even of the most basic kind. There is a scarcity of professionals with financial skills. But also, in far too many cases the people appointed to financial positions in municipalities do not have the necessary skills. Often they are political appointments; people appointed because of their political leverage, not their technical skills. Even where financially skilled people are appointed, they are not retained; there is too high a turn-over of financial staff.
* There is a lack of internal controls and poor governance. Most of the audit committees in municipalities do not function effectively
* There are ineffective business processes and systems
* There are onerous, complex and costly financial reporting requirements, placing a major administrative burden on municipalities. According to the Financial and Fiscal Commission (FFC) submission for the division of revenue for 2009/10, 225 questionnaires from national organs of state were distributed to municipalities within one year.
Many of them seek similar data. This is not to mention requests from provincial government departments. The analysis of this data is seldom shared with municipalities, says SALGA. Municipalities are also required to conform to generally recognised accounting principles (GRAP) accounting standards by 30 June 2010, irrespective of their fiscal and financial capacity. At 30 June 2008, according to SALGA, at least one third of the municipalities had still to convert to the new standards
* The financial capacity building programmes need to be coordinated and be significantly more effective
* According to the Auditor General’s 2007/08 report, the audit outcomes of the municipalities were as follows:
adverse opinion three percent
disclaimer of opinion 30 percent
qualified 20 percent
unqualified, emphasis of matter items 32 percent
unqualified, no findings one percent
audits outstanding 13 percents.* Municipalities have poor debt collection records. Municipalities are owed over R53 billion. According to our department, in June last year 85 municipalities had debtor levels higher than 50 percent of their own revenue. Of course, a significant part of this debt to municipalities is owed by government departments and the private sector.
Service charges are the main source of revenue for municipalities, and so challenges experienced with enforcing debt collection and an increase in the age of debts (for example, outstanding debts of more than 90 days) impact hugely on their financial viability. This is compounded by the high number of indigents and the culture of non payment. 43 municipalities reported negative opening cash positions for the third quarter ending 31 March 2009. Of course, many municipalities report losses (both water and electricity) due to illegal connections.
* Many municipalities show a poor ability to accurately plan and spend their budgets. The NT reports, with the preliminary results of the financial year 2008/09, those 35 municipalities over spent their budgets by R2.6 billion while 182 municipalities under spent by R19.1 billion.
* The grants allocated from national government are not coordinated. Last year, according to SALGA, there were about 17 different grants administered and managed by different national sector departments
* In several cases, municipal infrastructure grants and other conditional grants are spent on operational activities
* There are uncertainties about the financial implications of the restructuring of the electricity distribution industry
* Assets are managed badly
* There are high levels of fraud and corruption
* Implementing the Property Rates Act has proved to be far more challenging than expected
* There is undue political interference by both political parties and councillors in the financial management of municipalities, with the lines of division between politicians and administrators being blurred.
Some responses to the financial challenges
These are just some of the challenges. Of course, there are many more. But the point really is what to do about them? And we just cannot anymore afford the luxury of inadequate responses any more. We simply have to get the right answers. Of course, some of the things we have to do will be the same as before, only we will have to do them far more effectively and maybe in new ways. But we also have to think of doing new things.
We have to find new methods, new responses, that are far more effective. You are the experts. We want your help. We want you to be innovative and imaginative, and we want you to come up with effective responses to the many financial challenges municipalities confront. As a department we are, in cooperation with other stakeholders, obviously working on responses. I will deal with some of them here. And also raise other responses that we might want to consider too.
Clearly, there has to be better overall governance in municipalities to ensure better financial management. Changes to the current model of local government will have to provide for more effective governance of municipalities. Aspects of this would, for example, include greater clarity on the respective roles of politicians and administrators in the financial management of municipalities; a clearer separation of the legislative and executive functions of municipalities; and more effective oversight by councillors of executive structures.
A key consideration in the shaping of changes to the current model of local government and the entire cooperative governance system has to be the funding model of local government and the financial management challenges. We need to ensure that changes made provide that local government is able to get the funds necessary to implement its constitutional mandate and manage its finances more effectively.
The financial management model needs to be simplified yet effective. Certain core requirements should apply to all municipalities, but other requirements should differ according to the fiscal and financial capacity of municipalities. There is a need for a reasonable differentiated approach. In this regard, it will be very useful to hear from you what changes you think should be made to the Municipal Finance Management Act and other legislation affecting the financial management of municipalities.
Some of us believe that the Municipal Demarcation Board needs to give serious attention to the re-drawing of the boundaries of municipalities that are not financially viable. We need a new, massive financial training programme for councillors and officials to be developed through the concerted co-operation of all the stakeholders, including IMFO, SALGA, National Treasury, Cooperative Governance and Traditional Affairs, Development Bank of South Africa (DBSA), the private sector, tertiary education institutions
As you probably know, our department, in co-operation with National Treasury, the Auditor General’s office, SALGA and DBSA has launched the Operation Clean Audit programme, 2014. Our aim is to significantly improve financial management and fiscal governance in local and provincial government so that service delivery and development can be improved. I will focus mainly on the municipalities here.
We want to see municipalities produce quality financial statements so that the AG can express accurate opinions on the financial state of municipalities. The campaign also seeks to encourage managers to have a holistic and integrated approach to fiscal management that is linked to constantly improving service delivery, rather than a narrow focus on financial statistics. Sometimes there is too narrow a focus in municipalities on aspects of financial management.
There needs, in our view, to be more focus on asset management, procurement, value for money, cost benefit analysis with regard to projects and on economy, efficiency and effectiveness. It doesn’t help for managers to look at financial statements without looking at the overall constitutional mandate of municipalities to ensure service delivery and development.
Municipalities also have to have functioning and effective audit committees. Audit committees must scrutinise financial statements and risk management reports so that the ability of a municipality to deliver services to people is clearer.
Operation Clean Audit is also directed at ensuring that the key political leaders of municipalities are keenly aware of financial issues and take decisions with financial implications that are sustainable, and they should not be “short-term implicators” and populist. For Operation Clean Audit to work there has to be an effective relationship between the political leaders and administrators in municipalities.
As part of Operation Clean Audit we will be encouraging the provincial government departments to work closer with municipalities. We feel that it is important too that provincial departments and municipalities share information and learn from each other and emulate best practices.
Our aim is that by 2011 municipalities will not have adverse reports or disclaimers from the Auditor General, and by 2014 municipalities will have unqualified audits with no matters of emphasis. We are under no illusions about how challenging these targets are. But we think if we all cooperate properly these targets are attainable. Certainly, we should try to achieve them.
We believe that by doing some very simple things we can improve financial management in municipalities. For example, the filing systems in many municipalities can be improved fairly easily. There are some basic lessons that can be drawn on to improve financial reporting. Together with National Treasury, DBSA and SALGA we are finalising a major capacity building programme to improve financial management at municipal level. We are very keen to hear from you on what you think of this capacity building programme and how you can help. Our department will soon contact you in this regard.
We are also to work closely with National Treasury and DBSA to assist municipalities to find chief financial officers and other financially skilled people. Here again IMFO could help. Please do!
We launched Operation Clean Audit at a major meeting in Johannesburg in July. We have since launched Operation Clean Audit in four provinces and hope to have covered all the provinces by year end. Minister Shiceka led a debate in the National Assembly on Operation Clean Audit, and is to address several parliamentary committees on the programme tomorrow. We want parliament to monitor progress on Operation Clean Audit and hold us to account for it. So it’s clear that we are serious about Operation Clean Audit and we appeal to you for help!
As you know, the Municipal Finance Management Act (MFMA) provides for financial oversight committees in municipalities. And there is also National Treasury circular 32 on oversight. We feel that this oversight must also be undertaken by Municipal Public Accounts Committees (MPACs). However, it is only in Gauteng that municipalities have MPACs in all municipalities. But, in general, they do not seem to be particularly effective. National Treasury is meant to assist with the establishment of MPACs, but municipalities show little interest in them.
Our Minister has now sent letters to all the MECs of Local Government to seek to ensure that MPACs are set up in all municipalities by 15 December. Obviously, this deadline will be difficult to meet, but we believe that reasonably soon MPACs must be set up. We are going to work with National Treasury, Association of Public Accounts Committees (APAC), SALGA and other stakeholders to do this. We are also working on a model for MPACs. Here too you could help.
These MPACs should learn from the experiences of Public Accounts Committees in the provincial legislatures and national parliament. They should examine:
* financial statements of all the executive organs of a municipality.
* audit reports on those statements
* audit reports on municipal entities
* the council’s annual reports
* any other reports with a financial bearing.The MPACs should also initiate any investigation in areas that fall within their competence.
Clearly, some of the failures in financial management at municipal level result from weaknesses in our cooperative system of government where unhelpful and wasteful “silo mentalities” still persist. For improvements in municipal financial management, both national and provincial government have to support local government more effectively. Both provincial and national government are going to more actively monitor how municipalities manage their finances. We are considering requiring municipalities to present monthly financial reports to the provincial and national departments. We are also thinking of requiring provinces to play a direct role in the management of the municipal infrastructure grant
Our department is acutely aware that there are far too many local government capacity building programmes by too many different organisations with differing orientations. This is costly, wasteful, confusing, and unproductive. And it must come to an end. We need coordination among the capacity building organisations and stakeholders and a clear, consensual and focused approach. Our department is very keen on this and we are engaging with others to get agreement on this, but even more important, united action on this.
Of course, part of the support national and provincial government can offer to local government is simply pay the debt they owe municipalities. The Minister is committed to actively intervening through the cabinet and other structures to ensure that government departments pay the debt they owe to municipalities. Of course, the arrears will not all be paid immediately, but we are determined to see improvements over time.
We are also looking into how we can help municipalities recover the debt owed to them by the private sector. Of course, the recession is biting hard and scores of people are losing their jobs. So the numbers of indigent are increasing and the numbers who can pay their debts to municipalities increasing. But there is still significant scope for municipalities to recover part of their debt from those who can afford to pay and they simply have to do this! We would like to see municipal debt reduced by half by 2014. We also need to consider extracting the arrears owed to municipalities from the salaries of civil servants and public representatives.
At its September National Executive Committee Lekgotla, SALGA considered a report that stressed that municipalities must “improve their overall handling of revenue matters, especially current collections and the management of debtors. If policies on free basic services, indigent and credit control are all correct and in place, and if billing is correct, there is no reason for anyone not to pay what is billed. This is first of all a social and political matter before it is a technical matter, and SALGA calls on all its members to ensure that all revenue collections are greatly improved.” We agree.
Very briefly, among other issues that need to be considered to improve the financial position of municipalities are the following:
* The Division of Revenue Act has to be reviewed to ensure a more equitable and differentiated support to municipalities. The formula for the equitable share also has to be reviewed, partly to ensure that it is more redistributive and provides more support to financially weaker municipalities
* There needs to be a review of all grants to local government to ensure co-ordination of the grants and their more effective use
* There is a need for a massive anti-corruption campaign. The supply chain management process also has to be reviewed and the procurement process must be tightened to reduce the prospects of fraud and corruption
* With the phasing out of the regional services (RSC) levies, the need for an appropriate temperate, sensible business tax for municipalities
* A more productive and effective relationship between party political structures, councillors and administrators.
I understand that this Conference will also be considering the King III Report as it applies to corporate governance in municipalities. This is very important. We are very keen to know what the outcomes of your deliberations are.
So let’s “make the elephant dance’” then!
So there we are then! Some, by no means all, of the financial challenges confronting municipalities! And some, by no means all, of the possible responses. So what do you say then? And more importantly, what are you going to do? We, as politicians, must do our bit and we will. But we need your help! Please give it!
Of course, the road ahead isn’t going to be easy. Nor will it be traversed quickly. But it’s you who said that we must “make the elephant dance”. And you acknowledged that it won’t be easy. But you believe that you can “make the elephant dance”. So let’s, together, do it!
Issued by: Department of Cooperative Governance and Traditional Affairs
6 October 2009
A nation and a health system under extra pressure from a quadruple health burden, requires extraordinary effort. South Africa has many of the essential ingredients in place to save hundreds of thousands of lives – will we act in time?
That is the opening statement on the cover of the Executive Summary of the “Health in South Africa” series released by one of the worlds leading medical journals; The Lancet. Contributors to this series include some of the most progressive South African health experts. The series does not make for happy reading.
Some of the major outcomes (our shortcomings) of the series are diagrammed in the image below (click to view in full):
The series notes:
The authors of the series are supportive of:
Below is the National Department of Healths Strategic Plan, worth viewing.
A recent Mail & Guardian investigation claims that almost half of all Director Generals in government have private business interests.
There is no law that prohibits them or any other government officials from having active private business interests. However let us reflect on the following:
On a promising note the new government does appear to moving on removing senior officials who are not operating as they should. In recent months Director Generals Njabulo Nduli (Forestry and Fisheries), Director General Pam Yako (Water Affairs) who apparently heavily escalated an IT project budget to Arivia,Kom and arts and culture’s acting deputy director-general Tale Motsepe.
Below is a press release from the Public Service Commission on this very issue dated 16th July 2009, the release is damning.
A. BACKGROUND
The predominant mode of service delivery in the public service is through private sector service providers and while at law nothing prohibits public officials from having private interests, the PSC, in order to minimize the risk of corruption developed a Financial Disclosure Framework which was made mandatory for all Senior Managers to abide by. This Framework requires all members of the Senior Management Service (SMS) in the Public Service to disclose all their registerable interests annually to their Executive Authorities, i.e., Ministers and MECs. The political heads of departments are in turn required to ensure the submission of the financial disclosure forms to the PSC exactly a month after the beginning of each financial year, i.e., by 31 May of each year.
However, since 1999/2000 when the Financial Disclosure Framework was introduced, compliance with it by many members of the SMS in the public service has been far from satisfactory. This in essence means that every financial year many senior managers fail to disclose their financial interests. Because of the mode of service delivery predominantly used by the public service, involving the outsourcing of the functions of the state with vast amounts of taxpayers’ money spent on this, the risk posed by this lack of commitment to a key instrument for inculcating financial probity and combating corruption cannot be overstated.
For example, for the first financial year (1999/2000) the PSC received 61% of disclosures. For the last three financial years i.e. 2004/2005, 2005/2006 and 2006/2007 there was a steady increase in the submission of the financial disclosure forms with a submission rate of 77%, 80% and 87% respectively. However, this improvement in the compliance rates has only been achieved after the due date. The inability to reach the 100% mark remains a serious indictment on the SMS members in the Public Service, and their Executive Authorities, because failure by even one public official can result in significant losses of taxpayers’ money channeled corruptly to private enrichment
As well as being responsible for the custody of the Financial Disclosure forms, the PSC now scrutinizes and verifies the information contained in these forms and periodically overviews the entire Framework to see if it is working as it was intended to. Key findings of the Scrutiny and Verification of a sample of forms for the Financial Year 2007/2008 and an Overview of the Framework as contained in the Report by the PSC show disturbing trends.
B. KEY FINDINGS OF THE OVERVIEW OF THE IMPLEMENTATION OF THE FINANCIAL DISCLOSURE FRAMEWORK: FINANCIAL YEAR 2007/2008
- Continued lack of commitment to instrument as indicated by persistent non compliance: The mandatory cut-off date for submission of the disclosure forms to the PSC is 31 May of each year. However for 2007/2008, the PSC only received 48% of the disclosure forms by the prescribed date. For the financial year 2006/2007 only 10% of disclosure forms were received by the due date. This breaks down as follows between the national and provincials departments:
- Only 38% of the forms of national departments and 59% of the forms of provincial departments were received by the PSC by the due date of 31 May, meaning that 2791 SMS members at national level and 1663 of the SMS members in the provinces did not submit their disclosure forms by the due date
- Of the thirty-seven (37) national departments, twenty (20) submitted their disclosure forms by the due date. Although this is a significant increase from the previous financial year (2006/2007) when the forms of only eight (8) national departments were received by the due date, of key concern to the PSC is that the departments which exhibit laggardly compliance by the nature of their service delivery mandates are those involved in big programmes and therefore having to issue massive tenders. The North West Province with 90% is comparatively the best performing province in terms of submitting the disclosure forms of their SMS members by the due date. The Free State with 29% is the worst performing province. The low level of compliance by the due date especially by the Free State and Gauteng (47%) raised serious concerns about their commitment, transparency and accountability.
- As at December 2008, 3188 disclosure forms (74%) of designated officials of national departments were lodged with the PSC.
- Only three national departments namely, the Departments of Arts and Culture, Correctional Service and Land Affairs had not by the end of December 2008 submitted any disclosure forms.
- Thus for 2008 only Six (6) national departments managed to submit all the disclosure forms of their SMS members by 31 May 2008 with an additional ten (10) national departments managing to submit all disclosure forms by 31 December 2008. A key concern for the PSC with the late conclusion and submissions of disclosure forms is that with the officials concerned there is no way of determining the risk of potential or actual conflict of interests and managing this in the intervening period between the prescribed deadline and when they eventually sign and submit their forms to the PSC.
- For the provincial departments, the overall submission rate as at 31 December 2008 was 89% which is significantly better than that of national departments which stood at 74%. Because the provincial level of government is responsible for the actual delivery of basic services, the interaction between the public and private sectors does tend to be more intense and with it potential conflicts of interests are more likely to occur. Given the risks associated with the interaction between the public and private sectors in terms of bribery and collusion, it is important that potential conflicts of interest be identified and addressed before actual conflicts of interest occur. The compliance rate at provincial level is therefore a cause for concern.
- The North West (100%) and the Northern Cape (100%) are the two best performing provinces.
- KwaZulu-Natal performed the worst (76%).
- Unsatisfactory Disclosure by Directors-General and Deputy Directors-General:
- As at 31 December 2008 there were 105 officials designated as Directors-General at provincial and national departments of which 78 (74%) had submitted their disclosure forms.
- For the same period there were 419 officials designated as Deputy Directors-General at national and provincial departments of which 295 (70%) had submitted their financial disclosure forms.
- In terms of national departments there were 38 officials designated as Heads of Departments (HoDs) as at 31 December 2008. Only 29 submitted their financial disclosure forms to the PSC. This represents a submission rate of 79% by the HoDs.
- For the same period there were 236 officials at the level of Deputy Director-General attached to national departments. Of these officials, only 153 (65%) had submitted their disclosure forms to the PSC.
- As at 31 December 2008 there were 67 officials designated as Directors-General at provincial, level of which 49 (73%) had submitted their disclosure forms. For the same period there were 183 officials designated as Deputy Directors-General at provincial level of which 142 (78%) submitted financial disclosure forms.The low level of compliance by Directors-General and Deputy Directors-General at both national and provincial departments is of concern to the PSC. At this level better compliance is expected because these officials take the lead in decision-making within their departments. Moreover, the major government contracts are also signed at this level and therefore transparency and accountability with regard to the Financial Disclosure Framework is of utmost importance.
- Repeat Offenders:
- The PSC found 249 senior managers to be repeat offenders who failed to submit their disclosure forms for two successive financial years.
- Only two provinces i.e. the North West and Northern Cape have no identified repeat offenders.
- At national level there were 179 senior managers who failed to submit their financial disclosureforms for two financial years in succession.
- Potential or Actual Conflicts of Interest based on the assessment of the Financial Disclosures forms :A sample of thirty percent (30%) of the disclosure forms, totaling 2038 forms, received for the 2007/2008 financial year which included Limpopo, Western and Eastern Cape provincial departments was assessed for the purpose of identifying potential conflicts of interest. The PSC found as follows:
- 434 senior managers may have potential conflicts of interest between their private interests and their official duties. Although this represents 21% of senior managers that formed part of the sample, it is a very significant and real number.
- The highest number of potential conflicts of interest at provincial level was identified in the Limpopo Province at 121 officials
- The highest number at national level i.e., 20 was identified at the Department of Social Development.
- d. Of the Seven-hundred-and-sixty-nine (769) disclosure forms of ten (10) national departments scrutinized by the PSC, 151 or 19% of the sample may have a potential conflict of interest between their private interest and official responsibilities.
That 434 out of 2038 senior managers (21%) who formed part of the sample may experience potential conflicts of interest if extrapolated to the entire SMS could mean that over 1700 managers in the Public Service (20%) could be experiencing potential conflicts of interest. This again underscores the importance of the Financial Disclosures Framework and the need for Executive Authorities to use the information provided through the financial disclosures to manage potential conflicts of interest and the risks associated therewith.
- Potential Conflicts of Interest According to Category:
- Of the sample scrutinized, 341 Senior Managers have interests in private companies whose core businesses are closely related to the core mandates of their departments.
- Another 51 senior managers have directorships or shares in multiple companies raising concerns about the extent to which these officials can devote their full time and attention to the Public Service.
- The PSC could not conclusively identify whether a potential conflict of interest exists in respect of 32 of the senior managers that formed part of the sample due to the fact that insufficient information was available on the financial disclosure forms of certain senior managers, and that not enough information concerning the company was available from the CIPRO database.
- Non-disclosure of Directorships/Partnerships in Private Companies and Close Corporations:
- The PSC found that 210 SMS members in the sample did not disclose their interests in some companies or closed corporations.
- A total of 112 senior managers from national departments and 98 senior managers from provincial departments did not disclose their interests.
- At national level 11 of these senior managers are employed by the Department of Science and Technology and 10 at the Department of Agriculture.
- At provincial level the highest number of such senior managers are employed by the Limpopo Province (43) followed by the Eastern Cape (34). The PSC’s scrutiny of the disclosure forms found that in many cases the companies that were not disclosed by the SMS members, actually poses a potential conflict of interest.
- Scrutiny of properties:
- a. 182 SMS members did not disclose their properties. The registration dates of the properties were checked a nd it was found that registration occurred well before the date on which the disclosures were due.
- b. A total of 54 senior managers in the Limpopo Province did not disclose all of their properties.
C. RECOMMENDATIONS:
The PSC recommends the following to improve the compliance with the Financial Disclosure Framework:
- Executive Authorities must prioritize this issue – The PSC has on numerous occasions advised and reminded Executive Authorities of the requirement that all senior managers in their departments must comply with the Framework by submitting the financial disclosures. It appears that such reminders are not followed up by Executive Authorities in all instances and members of the SMS may easily become complacent with regard to the submission of the disclosure forms.
- Non-Compliant SMS Members Must be charged with misconduct - Chapter 3, Section H of the public Service Regulations clearly stipulates that any designated official who fails to disclose his/her financial interests, or willfully provides incorrect or misleading details, is guilty of misconduct. The PSC recommends that Executive Authorities charge transgressing Heads of Departments with misconduct and ensure that other members of the SMS are charged with misconduct for failing to disclose an interest by instructing their Heads of Departments to do so in terms of the Disciplinary Code and Procedures, as contained in the SMS Handbook.
- Repeat offenders should be charged with misconduct and the Executive Authorities should obtain the outstanding forms of these repeat offenders and submit them to the PSC as soon as possible.
- Dedicated Staff to Manage the Process of the Conclusion of Financial Disclosure Forms by Senior Managers must be appointed within departments: This will ensure that the forms are submitted timely to the PSC.
- Disclosures of private companies and close corporations – Executive Authorities should ensure that members of the SMS are made aware that they need to disclose all companies, including dormant and non-profit making companies.
- Updating information pertaining to companies on the CIPRO website - SMS members should take personal responsibility for their resignations from companies by following up and making sure that their details are removed and the CIPRO data base is accordingly updated.
- Departments must put in place mechanisms for management of conflicts of interest as required to by the PFMA, National Treasury Regulations and Risk Management prescripts: At provincial level, departments should consider strategies to deal with persons who have been identified, through the disclosure of their financial interests, as having a potential interest by reassigning the duties of the official if this can be effected in the interest of the state. If this is not possible, a transfer to another component should be considered. If the reassignment of duties or a transfer is not possible, consideration should be given to request the official to resign from the private interest that is causing the conflict of interest.
- Interaction by Portfolio Committees - Given their Legislative and Parliamentary oversight role, Portfolio Committees should call departments and Executive Authorities to account where there has been non-compliance as well as low levels of compliance.
CONCLUSION
The management of potential conflicts of interest forms an integral part in the Public Service’s desire to become integrity driven. The PSC is concerned that financial disclosure forms are not submitted timeously to the PSC. The timely submission of disclosures places the PSC in a position to identify potential conflicts of interest and inform the Executive Authorities timeously. In doing so, the PSC is enabled to assist Executive Authorities and senior managers in preventing a potential conflict of interest becoming an actual conflict of interest. The PSC has, through the scrutiny of the sample of financial disclosure identified 434 managers who may have potential conflicts of interest. Of concern is that some of these senior managers have already been reported to the NACH and allegations of corruption have been leveled against the relevant individuals.
If these potential conflicts of interest had been identified proactively, Executive Authorities would have been in a position to introduce measures to ensure that there are no actual conflicts of interest. It is therefore incumbent on the Executive Authorities to introduce measures for the effective management of conflicts of interest in their respective departments. The PSC trusts that the findings and recommendations contained in this report will assist departments and Executive Authorities to improve the management of the Financial Disclosure Framework and that a greater level of compliance to the Framework will be achieved.
ISSUED BY THE PUBLIC SERVICE COMMISSION
For enquiries, please contact:
Mr Humphrey Ramafoko,
Director: Communication and Information Services
Tel: 012- 352 1196
Cell: 082 782 1730
Fax: 012- 325 8344Or
Ms Dikeledi Phiri,
Deputy Director: External Communication
Tel: 012- 352 1070
Cell: 082 386 5743
Fax: 012- 325 8344
Website: www.psc.gov.za
This is the fourth article in our series on franchising (especially restaurant franchising). Best to familiarise yourself with our other articles which sets our tone.
Continuing on our series of articles on the franchise industry in South Africa, we want to look at the Consumer Protection act and what it’s impact is on the franchise industry?
The Consumer Protection Act is the second major development in favour of consumer protection in recent years. The first being the National credit Act which is designed to improve transparency; prohibit unfair contract terms and practices; and prohibit anti-competitive practices. The Consumer Protection Act is designed to protect consumers from exploitation and unfair practices by unscrupulous businesses, and to empower consumers to make wise purchasing decisions. Together these Acts entrench the protection of consumers as prescribed under the Constitution of the Republic of South Africa.
Under the act, franchisees are regarded as “consumers” and franchisors as “suppliers.” Franchisees are given a number of consumer rights, including the right to equality, privacy, choice, information, disclosure, fair and responsible marketing, honest dealing, fair agreements, fair value, good quality, safety, and supplier accountability. Franchisees are also protected against undue influence or pressure; unfair tactics; and false, misleading, or deceptive representations concerning material facts. This would also apply to the contracting arrangements between franchisor and franchisee.
Under the Act a franchise agreement is defined as an agreement where a franchisor grants to a franchisee for consideration a right to carry on business under a system or marketing plan substantially determined or controlled by the franchisor. In addition, the franchisee’s business is substantially or materially associated with advertising schemes or programs or with the trademarks of the franchisor, or any combination of these that are licensed to the franchises. The agreement must be in writing and signed by at least the franchisee. The Act allows for a cooling of period of 10 business days, wherein a franchisee may cancel a franchise agreement they have signed without incurring any cost
The right to full disclosure is entrenched in the Act. This is in recognition of the number of cases where franchisees had been devastated financially after investing their life savings into franchises that were sold to them on the premise that the franchises would be far more profitable than they ever actually would be. Under the act, franchisors will be required to disclose certain information to prospective franchisees, as provided in regulations to be promulgated by the Department of Trade and Industry.
Currently, franchisees in South Africa have limited protection against unfair practices by franchisors under that country’s Competition Act, particularly in relation to the tying or bundling of unrelated products by a dominant franchisor or when it comes to exclusive dealing. Complaints stemming from these activities are, however, difficult to prove, and the franchisor in question has to be dominant or have market share.
The Act has taken the foregoing prohibitions in South Africa’s Competition Act and applied them regardless of whether the franchisor is dominant. The new law prohibits bundling or tying of products by a franchisor, unless the franchisor can show either (i) that the bundling results in economic benefits for consumers or (ii) that the convenience of bundling outweighs any restriction on consumer choice. Alternatively, the bundled goods or services must be offered separately and at individual prices.
The Act guards the right to consumer choice by generally providing that franchisors must not require, as a supply condition or as a condition of entering into an agreement, that the franchisee purchase goods or services from the franchisor or from any other designated supplier. It is a valid defense to show that products or services that the franchisee was required to purchase are reasonably related to the branded products or services that are the subject of the franchise agreement. It remains to be seen how closely linked to the brand “reasonably related” will need to be to excuse such a requirement by a franchisor. As a result, many franchisors will no longer be able to be the sole supplier of goods and services to a franchisee, unless it can be shown that the products and services are “reasonably related” to the brand.
Franchisors should take care to ensure that products and services essential to the protection of their brand are explicitly listed in their franchise agreements, to reduce any later issues regarding interpretation. In other words, the Act suggests that franchise agreements provide for core and non-core products. Core products or services would be the primary, unique products related to the brand.
With regard to transitional provisions, it appears that the Act will not apply to pre-existing franchise agreements (or transactions) entered into before the general effective date, expected to be October 2010. However it will apply to renewals of contracts. The Act highlights a number of factors relating to fair and honest dealings and unfair unreasonable and unjust contract terms. The Act allows for the cancellation of contracts, whole or part should it be deemed to have contravened these principles as detailed in the Act.
The Act will have huge implications for the franchise industry. For while it has boomed has also become a place for corrupt, fly by night operations. The Franchise Association of South Africa has expressed concern with regard to the implication of the Act and the burden it will place on its members. This is a concerning position as the Act can only create credibility for the franchise industry by ensuring that it closes the gap for illegitimate franchisors to operate.
Surely this would be a benefit to FASA, to cleanse the industry of undesirable operators. Franchisors who lack the capacity for adequate, transparent contracting and operations shouldn’t be selling off franchises. Organisations like FASA shouldn’t be accepting these franchisors as members or providing a potential front for their operations.
This is the third article in our series on franchising (especially restaurant franchising). Best to familiarise yourself with our other articles which sets our tone.
Commercial banks are part of legitimate business. We trust them with our savings, we store our incomes in them, and we borrow money from them, all the time assuming that the transactions are legitimate and reasonable and regulated to some extent. We rely on them for every aspect of functioning of civilised life-homes, cars, business, school fees and personal events. We also expect that they will exercise reason in their interactions with us because their survival depends on the patronage of their clients. So their responses to us are based on good credit lending praFFrctices and when banks make errors in planning, governments are hard pressed not to finance their recovery with taxpayer’s money, as in the case of the US recently. Banks are essential to the stability of our economy; citizens and the banks share a common investment in our economic future.
But have banks gotten too big for us. Do they represent something untouchable? So when they repossess homes and cars in a panic about the money that is being lost like a waterfall without following the specified due processes outlined in those contracts is this acceptable under the circumstances or is this just a case of bullying. And what really is their responsibility as the credit provider?
In responding to this question I will share with you our own insightful experience with the banking environment recently, which has been the cause of much debate within our own inner circle.
We took out a loan to finance a franchised restaurant. After the bank evaluated our application they informed us that we were not disadvantaged enough to qualify for any form of BEE preferences (the words used were “not black enough”). This opinion of the banks was nether policy nor constitutionally justifiable. However, we were in love with the business idea, so we didn’t make a scene. We put up 40% of the financing required for the franchised restaurant we wished to buy. The bank confirmed that it had done a due diligence on the restaurant and the franchisor and was extremely happy with the results and would finance the deal.
In fact the franchisor was so highly credible to the bank, that the bank offered them great deals on banking and transacting facilities for their franchisees and they offered the group an approved financing facility for all new franchise restaurant setups. Since we knew what the obligations placed on the bank were by law to thoroughly assess any new deal we felt extremely confident in all the new “benefits” the bank was offering the franchisor.
So when the figures provided to us and the bank by the franchisor turned out to be deliberately exaggerated and show that a fraud was committed by the franchisor so as to ensnare us in the business deal the issue of what exactly is the responsibility of banks in this circumstances was raised by us. The answer apparently is that the banks have no obligation. The bank completed a FICA assessment of the franchisor; their results didn’t cry out any kind of foul – it should have. There was evidence of their foul practice’s aplenty, which at the time was outside of our sphere of access.
Now that the bank is aware that there was a fraud committed by the franchisor does it discontinue giving out loans to new franchisees wishing to purchase restaurants in the same group or does it blacklist the group? No of course it does not.
Granted our matter hasn’t been to trial yet, but we can supply details (irrefutable forensic evidence) to the banks legal department and they can make a judgment about the caliber of clients they want to maintain or their obligation to new investors. If the bank continues to give out loans to unsuspecting buyers wishing to take up opportunities within the same group, would the new franchisees be able to sue the bank for facilitating a fraud since the bank has knowledge that the franchisor is suspected of fraudulent behaviour?
At the very least the bank should consider suspending any new deals pending our case going to trial and being decided on, because should we win our case the franchisor may not be able to operate anymore and new franchisees would be placed at risk of defaulting on their loans, which is a risk to the banks bottom line.
At the very minimum this franchisor has committed FICA fraud? Should the bank not have called in SARS immediately? The bank leverages their risk on personal sureties signed by borrowers – the franchisees, so whatever happens with the business, the bank will get its money one way or the other. But should they? The National Credit Act outlaws irresponsible lending and by this it means that the banks assessment of whether a borrower is suitable for credit has to do with an assessment of the borrower’s ability to pay. If the borrowers ability to pay has everything to do with the business’s capacity to generate a certain profit, and the business was in fact never able to do that as the figures provided were a fake. Is the bank not responsible for irresponsible credit provision?
I’m not suggesting that the banks share responsibility for your business decisions or mine. You go to the bank for financing not buying into your idea. But they do have a role to play in not perpetuating a fraud when they know about it and they do have a job to ensure that there facilitation is not being used for money laundering or other such activities. The new Consumer protection Act certainly talks to the issue of facilitating fraud and specifies the right to have contracts cancelled in this case. What does that mean for a bank that knowingly provides financing to fraudulent franchisors. Can those loans be cancelled and they held responsible for the transaction?
On the cross side asking the banks to take more responsibility will be ensuring that loan facilities become even harder to access and you will pay for this risk in the repayments.
If you are hoping to see your banker as a partner in your business, best check out the development bankers, such as the Industrial Development Corporation or National Empowerment Fund. Since they accept a high percentage of risk they are better at evaluating the risk with you. If the business collapses they lose their cash too. So if you have to go after a franchisor that has defrauded you have a big partner on your side and you are out a considerably less amount of cash.
We are pleased to announce that we will be assisting one of the largest self-financing, state-owned national development finance institution that provides financing to entrepreneurs and businesses engaged in competitive industries to assess its investments in the private education sector.
The Sectoral Business Unit that we will be assisting has under management a portfolio totaling ± R 2 billion.
Our mandate is to provide strategic guidance on a) whether the institution should invest in this area any further and b) what the potential value areas would be.
Read our piece on education in South Africa.
This is the second article in our series on franchising (especially restaurant franchising). Best to familiarise yourself with our first article which sets our tone.
In this article we look at the rare instance of being the first franchisee. In our move into the franchise game we were approached to be the first franchisee of a new concept of stores for an established restaurant chain – the chain we are currently suing. We turned down that deal these are some of our thoughts on being the “ground breaker”
Starting a business is a tall order for most people and even a scary prospect especially for non-entrepreneurs hence the preference of starting with a proven model where the concept, business plan, and operating system are already put together in a franchise package.
However every franchise system has a first franchisee. The groundbreakers or icebreakers if we may call them, are the people who risk it all in pursuit of success and financial excellence.
And as important as success is to the first franchisee, it’s even more important to the franchise company. Their future growth will depend to a great extent on the validation and results of the first franchisee.
These are just some points to consider regarding getting involved with a startup franchise outfit, or an outfit that are expanding into new untested markets.
The following are the pros and cons of being the first franchisee:
Pros
Disadvantages
Perhaps the best approach for expanding the franchise model is to open up these initial franchises as partnerships between franchisor and franchisee. This protects both interests. From a franchisor perspective they get to protect their investment and further expansion of a new model and for a franchisee, you get the support and investment needed to set up and test a new business concept.
The sharing of risk is the safest and fairest approach to expanding a franchise concept model.
We have dedicated this blog to put up a number of thought pieces on the franchised restaurant industry in South Africa. We do this because the franchised restaurant industry has great personal interest for us as a result of our recent experience of having bought, run, cancelled the sales agreement and sued the franchisor.
As management consultants we have worked with researching, conceiving, redesigning, managing, marketing and evaluating all ranges of businesses- big and small. So when confronted with the challenge of buying a suitable franchised restaurant- it seemed like a “no brainer”! After all we had evaluated and ran much bigger business investments, and restaurants have been an area we have researched extensively. In addition most franchisors we encountered were not the most sophisticated business people. In fact many were poorly educated but flamboyant characters. Plus we had resources to support our decisions- we had assistance from deal makers who put together billion rand investments and one of the oldest and largest law firms in the country (been around since the days of the gold rush). So we were ready to take on this industry and make it a success.
But still we got scammed.
Being scammed hurts your pride as hard as it does your pocket. But the experience of it has been priceless. We have interrogated all aspects of the business in detail. We have learn an incredible amount about the contracting, financing and operating a franchised business in South Africa We have also discovered a great interest in the prevention and investigation of fraud in businesses- which has become a new area of consulting for us. We have developed amazing contacts in forensics and with the specialised units of the police and security industry and banks.
There are unique aspects to South African businesses, from its closeness to organised crime to its labour issues. We (Garsen and myself) shall share with you some of the pointers and tricks to surviving a franchise investment in subsequent articles in the hope that you will benefit from our experience, research and learnings.
So we made a few mistakes. The first being that we found love. We found it in the business we wanted to buy- it was doing a great trade in a “recession proof” end of Johannesburg. We liked the franchisor they were young, daring and dynamic with a fast growing empire. We also liked the partnership approach they adopted to working with their franchisees and saw much potential for working together with them to build something better. This fit well with our needs. We did not originally come from a background in retail; in fact we have spent the last many years of our working career scoping, designing, marketing and rebuilding businesses of others. Broadly referred to as management consulting. Consulting is fabulous, intellectual, challenging and we had gotten really good at creating something from nothing. But we needed more ownership, more emotional investment. Food has always been my idea of sensuality-passionate love (sad I know!). So finding this fit of restaurant and franchisor felt like the coming together of a puzzle. That should have been the first warning sign. Anything too good to be true- usually is! But this was pure seduction and we were in love with the idea of the business. So this brings us to our first lesson we share with you, of loving the deal and not the business.
Whatever your motivating to get into franchising- whether you are looking for something low risk to start- working off a proven business concept, or have extra cash to put into an investment or been enticed by the advertised success rates or the business itself and the prospects thereof. Whatever the reasons, negotiating for the business has to be the prime focus and not the business itself.
How you negotiate for the purchase inevitably determines what happens thereafter in your business not sparing your leverage should you engage in legal battles with the franchisor. Unpleasant as this thought may be. A business doesn’t come with guarantees and no one is going to take care of your interests except you. So diligently cover all the areas of the contract and be more persistent than the franchisor is resistant, make sure you get what you want from a deal or you take your business elsewhere.
The most important vetting exercise is really to find out how you can be in this business that you think you like without signing a franchise contract. If you can do that effectively, your return on investment over what would have been the franchise period will be at least double. And, no matter what they tell you, franchisees never have a better chance of success than independent, unaffiliated new business start-ups. The likelihood for success is exactly the same either way. Unless you are buying into a big brand concept, like a McDonalds or KFC which has a unique product that customers identify with. Being someone’s franchisee makes absolutely no difference whatsoever. There are usually many ways to obtain equivalent start-up and continuing support assistance without having to sign a franchise agreement. You just have to take the trouble to find out where they are. In most cases what you pay to set up a business or for the acquisition of an existing business is far in excess of the value of the business you are buying. Furthermore you continue to pay royalties for a name which in most cases has limited capital but comes with high restrictions that impact on your ability to survive in a changing economy. Also ensure that you know what comes along with your franchise contract. Franchise rules, license products, standard menus etc are all part of the package. These must enhance your business’s chance of survival and not just create another avenue of income for your franchisor- who is now able to force you to purchase new products which they have licensed that may be a lower quality, higher priced good that impacts on your business’s profitability. The Franchise contract must specify these products and the applicable quality standards. I have fond memories of returning deliveries of burnt coffee beans and putrid meats to the franchisor only to receive in return letters claiming breach of franchise agreement.
The representations about the wonderful support that you can expect to receive as a franchisee are always overstatements. ‘You are in business for yourself, but not by yourself’ is the mantra. Don’t believe everything you hear- read the contract to see what you are really being promised. The contract always says — in some form of legalistic sounding language — that you get whatever support the franchisor feels like providing from time to time. That’s it. There is never a contract covenant to provide competent and competitively effective support. But nobody ever figures this out before the franchise investment is made. It is always discovered after the fact, when it is too late and you have bought nothing but the right to sue, if you can afford to sue. Buying the right to sue is always a bad investment!
Consult a lawyer who specializes in franchising. Consider the time and money you put into hiring an expert as an investment in your future. A lawyer can tell you what your rights are in a specific situation and help you craft the right business plan to protect your business. As a business owner, you owe yourself nothing less. Consider the old saying” free advice is worth every cent that you have paid for it”.
One of the primary reasons that franchise scams still exist today is due to the individuals who do not do their homework and invest in these “opportunities”. They allow the bad opportunities to remain in business. Go on line and research news stories about the company and the industry. Visit their web site and get information about their consumer offering as well as their franchise offering. Learn what you can about their management and thoroughly research their background. When you first contact the company ask them about the process they use in selecting franchisees. If you get the sense that they don’t select franchisees but are in the business of selling franchises, that’s the first indication you should have that the franchise is risky. If the company is willing to “sell” you a franchise before you can perform a thorough evaluation of them and they can perform a thorough evaluation of you, that’s another indication of a poor franchise system. If on top of that the salesman you are talking with is not an employee but an outside sales broker that’s even a stronger indication. Remember, unless you buy, the franchise the brokers don’t earn any money. Never pay any monies or deposits upfront. Any franchisor who asks for money before you are happy to commit to an investment cannot be trusted- they are interested in making a sale and not the success of your business.
Start off with the disclosure document. Once you get the disclosure document be prepared to analyse it thoroughly. If this is an opportunity that still interests you after you read the company’s information, you should engage a qualified franchise attorney, consultant or accountant to help you in conducting your due diligence. The franchise salesperson or broker works for the franchisor and should not be a source of advice that you rely upon. Neither is your bank. Your bank’s only interest is whether you can pay back your loan- and it’s all the same to them if it’s from the proceeds of a successful business of the repossession of everything you own. So don’t rely on your banker’s advice with regard to the credibility of the franchisor. They will not take responsibility for this advice when the deal turns sour. Rely only on the qualified resources you hired to help you with the due diligence.
What is the financial condition of the company? Your investment is likely to be significant. In some franchises between debt and equity your investment may be more than seven figures. What about the franchisor, will you have more skin in the game then they do? Do they have a history of profitability? Are they earning their revenue from royalties and other continuing sources of revenue or are they relying on the sale of the next franchise to make payroll. Even new franchisors need to have financial resources to meet their commitments.
Franchisors must disclose relevant litigation. Sometimes litigation is good. Any franchisor that enforces system standards will occasionally need to sue its franchisees. If they are able to still maintain a good relationship with their other franchisees than that type of litigation is an indication of a strong and responsible franchisor. However, if there are pages upon pages of lawsuits from franchisees in the disclosure documents, that is not a good sign. You need to understand the basis for the lawsuits and make a decision based upon the facts. Your attorney can help you analyse the franchise litigation. These are just a few of the questions you will need to assess in determining whether the franchise is a scam. Your outside advisors will be able to help you put aside your entrepreneurial burn to get into the game and assist you in conducting a proper due diligence on the opportunity. Don’t get into a franchise unless you have the assistance of a qualified expert. The franchise salesman that has befriended has the advantage of having been through the selling process hundreds of times. This is likely to be your first experience.
Treat a franchisor that has few or no current franchises with extreme caution. In the past, it has not been unheard of for companies that have never actually opened a single operating unit to aggressively sell franchises to unsuspecting franchisees. Naturally, the few franchisees that were eventually able to open for business failed because the company’s franchise business plan was ill-conceived and had never been tested. Minimally, the franchisor should be able to document the success of several existing franchises. They should also be willing to put you in touch with current franchisees so that you are able to confirm their success firsthand.
Something else that should make you cringe is an inferior selection process. Quality franchisors run potential applicants through a fairly comprehensive selection process. This process screens applicants not only for their financial capacity to purchase a franchise, but also for their industry experience and their ability to manage a small business. If a franchisor doesn’t seem to be interested in any qualifications beyond your ability to buy into the franchise, bells and whistles should be going off. It’s quite likely that the success of the franchise isn’t a real concern for these franchisors. All they’re really looking for is a way to make a quick buck – at your expense.
Legitimate franchisors should also be able to produce verifiable financial data for the company as well as data for individual franchises. This information is vital in helping you assess the feasibility of owning a franchise should you decide to do so. You not only need to know the earnings of a typical franchise, but also whether or not the company’s financial position is sound enough to ensure its long-term survival. If a franchisor is hesitant or unable to produce financial data it’s usually because the numbers don’t paint a very rosy picture. Make sure that you get raw sales data as well as financial accounts. Financial accounts which are provided are only useful if they are audited statements and not internal management accounts. You must be able to get your auditors to do a verification of these figures from the raw data sources and an audit of equipment that is part of the sale. Remember the registration numbers of equipment on the audit must match that which you receive as part of the sale. Also compare the financials with what the franchisor says it is paying in tax- this gives you a good indication of income and/or the honesty of your franchisor. Avoid investing in a franchisor that is changing banks at the time of your deal. You may not know the reason for this decision, but it does break the “audit trail” and that prevents you from getting essential information.
Franchisors are required to provide franchisees with disclosure documents specifying the details of franchise ownership within their company. If the disclosure documents are overly vague and the franchisor is unwilling to fill in the blanks with details, run away from the opportunity as fast as you can. Otherwise, you risk becoming tied into a dead-end business with little (if any) legal protection for your interests. This disclosure must also include breech letters from landlords, financiers, health and other violations and summons and all licenses contained by the business.
Finally, make sure that the contract is everything it is supposed to be. If they promise that you will make a certain amount of money or that your expenditure is pitched at a certain level, you need to get it in writing in the contract, otherwise, you have no guarantee that they will follow through on that promise. Also, it is strongly recommended that you get a lawyer to read through the contract before you sign anything, no matter how confident you are in your ability to understand it and the reputability of the company. Experience does count so bring in a specialist- much better to avoid the bitter personal experiences.
While some franchises do offer a good business concept, there are many scams out there and many businesses serve as fronts for organized crime and money laundering. Also many franchises are nothing more than a pyramid scheme the only beneficiaries being those first pioneers of the franchise. So beware in your dealings and look out for inconsistencies and hesitations- you could be dealing with a scam. Pay upfront for good advice its way cheaper than the forensic and legal costs that follow later if the business deal was not transparent and turns into a failure or a fraud. At the end of the day- all business is a risk. There are no guarantees against outright and clever fraud, as we had discovered in our own experience. But the above pointers protect you against the likelihood of you being a victim of a scam. Most importantly don’t begin any negotiations until you have worked out what you are looking for in deal. If the deal on the table is not the deal you want- simply walk away. There are many other options available to you. Do not compromise. Look for the deal you will love.