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How To Start Your Due Diligence on a Franchise

Finding all the information you need to make a decision regarding a franchise investment is a big job. Here are a few places to start.

So, you’ve found a franchise concept that looks appealing. Now you need to start due diligence — find out everything you need to know. The ins and outs of a franchise model can be complicated, but Scott Hislop, a Transworld Business Advisors franchisee, recommends starting small.

“Develop your own advisory board with individuals you trust will help you make good financial decisions,” he said.

Though there’s a long list of steps to take and things to consider, starting the process with a trusted team by your side allows for a strong foundation and will help you to more confidently evaluate all factors.

If you are looking to bring a specific concept to your area, and the franchise is not yet established in your community, you need to be especially intentional about your due diligence.

“It is normal for entrepreneurs to visit a very successful concept or franchise in another state or region and think they could be successful bringing it into a new area,” Hislop said. “This is a mistake many entrepreneurs make, and it is very risky. Therefore, due diligence is very important to make sure it is a sound financial investment and you are not making the decision based on emotion.”

Hislop volunteered a few reasons why risk is higher in this scenario:

  • Potential customers are not familiar with the brand. Therefore, you need to spend more dollars on marketing.
  • Products or services might not fit customers in your area. For example, hot coffee or soup might not fit in the south.
  • Business decisions are based on dreams and hopes, not research and data.
  • Franchise restrictions are too limiting for optimal efficiency and profitability. For example, raw materials need to be sourced from a certain vendor, and your location is too far away for competitive shipping.
  • Startup costs are ALWAYS higher than budgeted.
  • The learning curve for running the new business is much steeper than thought.

While it is not guaranteed that every single risk will apply to every single franchise concept, this list illustrates why due diligence is so important. If you start without a clear plan or intentions, you may miss some warning signs.

In an effort to cover all of your bases and feel confident that you have not overlooked any worrying traits of a franchise concept, Hislop says the following steps should be taken:

  • Take time to read and understand the FDD.
  • Research past sales of this franchise.
  • Talk with as many other franchise owners as possible. No one is going to say anything bad about their brand in the first conversation, so you must have in-depth conversations.
  • Shock your pro-forma forecast with 25% to 50% reduction in revenue in the first year. Do you have enough working capital to endure that?

He added that financial information and historical performance are most important. If you’re buying a concept that has been in operation for enough time to see trends, look at those trends!

With a strong, trustworthy team by your side, you will be able to address any high-risk factors regarding your prospective investment and take the necessary investigative steps Hislop puts forth. Starting small and taking each step with intention will prepare you well to gather the intel you need and make the best decision for you and your goals.