No one would buy a franchise without performing due diligence and looking into the franchise brand. While looking over the Franchise Disclosure Document and talking to advisors is important, it’s impetrative to really dig in and do the research required to get a full understanding of the brand and the franchise requirements.
Sean Fitzgerald, Chief Development Strategist at No Limit Agency, shares the top 10 things potential franchisees should look at while deciding to invest in a franchise brand.
1. Read and understand the terms of the franchise agreement.
“While this may sound basic, many people don’t fully read and understand the franchise agreement in its entirety,” said Fitzgerald. “Often times, people pass it over to an advisor to look over, but if you want to buy into the franchise you need to understand the full obligations.”
Fitzgerald also stresses that potential franchisees shouldn’t be afraid to ask questions about the agreement. Make sure you understand what you’re getting into as a franchisee.
2. Seek franchisee validation.
That means actually speaking with the brand’s franchisees. According to Fitzgerald, this is one of the most important things someone should do. Fitzgerald also suggests asking probing questions. Don’t ask how much you can make, try to ask about specific financial performance numbers they are experiencing, and what it takes to be successful in the system.
3. Seek business or legal advice.
When contemplating buying into a franchise system, don’t go to any old attorney. Make sure to seek out a franchise business advisor or a franchise attorney for help. Franchise professionals are experts in the industry and know the ins and outs of franchise agreements. Don’t risk wasting time or money with someone who doesn’t understand the franchise requirements.
4. Understand the unit economics of the business.
This would be in Item 19 of the Franchise Disclosure Document.
“It’s important to review and understand the unit economics of the franchise. Make sure to review the full Profits and Losses Statement,” said Fitzgerald. “If the P&L is not provided in Item 19, make sure to get it from a franchisee you speak to.”
5. Know the actual costs of initial investments, from opening to break even.
Item 7 of the FDD is the start up costs of a franchise, but it’s only limited to the first three months of working capital. If it takes longer to break even, start up costs could be much higher.
6. Pay attention to Item 6.
Item 6 in the FDD is where you can find fees associated with the franchise system. However, this may include more than just the royalties.
Fitzgerald urges potential franchisees to understand what the ongoing costs are above and beyond royalties. This may include the marketing fund, technology fees, and other additional costs.
7. Thoroughly review item 20.
It’s important to see growth, and Item 20 is where you will find it. Item 20 is a growth chart of the brand over the last three years.
“A healthy brand should see sustained growth,” said Fitzgerald. “If a brand is decreasing in numbers, you will want to understand why. However, that doesn’t mean it’s not a strong brand, but you will need to understand why.”
If a brand is not growing, it should be a concern. Make sure to get to the bottom of it, so you can make an informed decision before signing on the dotted line.
8. Talk to the executives or the franchisor.
If possible, get to understand what their vision of the company is and understand their business philosophy. Try to find out where the brand and industry is going and how they plan on staying relevant. This will give you the direction of the path of the organization is heading in and if you have confidence in the leadership of the organization.
9. Dig into the company’s audited financial statements.
You want to look for a brand that has the capital to continue supporting the franchise system. Fitzgerald also suggests reading the footnotes of the audited financial statement. That’s where you will get insight on how the numbers are derived from the audit.
10. Look at the lawsuits in Item 3.
Understand and ask questions if there is any litigation listed in Item 3 of the FDD. Fitzgerald notes that it’s not necessarily a red flag if this occurs. The longer a franchise has been around and the larger it is, there may be legal issues that have been brought up. Make sure to ask questions and understand what stemmed from the litigation. Always keep an eye out for any telling signs.