Evaluating a Franchise’s Fine Print

Posted on October 30, 2017 in Business Transactions

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Be sure the business you’re buying is a strong, profitable brand with an untroubled history.

Picture this: It’s Day One of your business.

You have a business plan. Your operations manual is in place. You know your suppliers. Your branding has already been done and the business model has been tested, so you know it’s profitable. All you have to do is insert the “key” (by which I mean a sum of money), and you could be off and running on Day Two.

It’s the kind of scenario franchisee wannabes are often drawn to. But if it sounds too good to be true, maybe it is.

When franchises exploded onto the scene in the 1950s and ’60s, a host of fraudsters, criminals and organized crime elements wormed their way into many of these business opportunities. To stem the fraud tide, Congress and various state governments enacted laws requiring registration and detailed disclosures about the franchise, the money that franchisees have to invest, the intellectual property the franchisees get to use and any business operation demands the franchisor makes. Today, most franchises provide you with an FDD–a Franchise  Disclosure Document (formerly known as a Uniform Franchise Offering Circular). The FDD ensures that franchisees won’t face any nasty surprises.

So as you slash through the FDD thicket with your mental machete, here’s what should receive careful attention:

  • Litigation history: Check for a string of lawsuits against the franchisor, an affiliated company or anyone with an ownership or management relationship with the franchisor. Also find out whether franchisees have sued the franchisor, and why. It’s tough enough starting a new business. You don’t want to buy a troubled one.
  • Location, location, location: Find out what geographic territory you will be entitled to serve exclusively and how close other franchisee are to you. In New York City, having two McDonald’s franchisees within a half-mile of each other may be no big deal. On a lonely highway in the middle of Nebraska, it could be a death knell for your business.
  • Trademarks and other intellectual property: When you buy a franchise, you’re purchasing a brand–both the business systems as well as the intellectual property. Find trademarks, patents, copyrights or other proprietary information the franchisor has registered. If the brand is not strong and the IP has not been protected properly, you may find yourself with a weak sales proposition that does not attract regular customers.
  • Financial performance: Review all the numbers and financial statements carefully. You may need to invest substantial sums of your own money to find the right storefront and build it out to the specifications of the franchise. Determine when you will break even and decide whether this fits your timeframe for seeing a return on investment.
  • Other franchisees: Look carefully at how other franchisees have fared, especially those in your geographic area. Has there been a lot of ownership turnover? Did significant events affect their performance, such as floods, earthquakes, local recessions, major industries closing, regulation changes or shifts in supplier relationships? These questions will help you gauge whether the problems were specific to the way a particular franchise was run or are endemic to the industry.

Yes, it’s a lot of paperwork. But the time spent reviewing the disclosure document (with a real franchise attorney, not your Uncle Stanley the divorce attorney) is time you might otherwise spend building a company from scratch. So don’t skimp–do your due diligence. And look at all of the fine print.

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