Red Flags to Look Out for When Doing Franchise Research

Although franchising can provide entrepreneurs with a rewarding path to business ownership, the prospect of investing in a franchise doesn’t come without its share of challenges and potential pitfalls. While an emerging franchise brand may look like a lucrative opportunity, it’s important to keep an eye out for any warning signs that could signal trouble ahead.

With this in mind, we’ve compiled a list of some of the most immediate red flags you should be looking for when conducting franchise research.

Litigation

A good indicator of a potentially problematic franchise is a history of litigation involving the franchisor. Litigation could hint at strained relationships between the franchisor and its franchisees, financial strain, operational distractions, damage to the brand’s reputation, and an overall increased risk for franchisees.

“A long list of lawsuits, either by or against the franchisor, could mean that the corporate office has a hard time getting along with franchisees and/or vendors,” wrote David Greenberg of The Empowered Franchisee. “Frequent litigation can also drain a company financially, regardless of how the lawsuits resolve.”

You can find any and all information regarding previous or current litigation involving a franchise by reading through a brand’s Franchise Disclosure Document (FDD).

Lack of Experience

The experience of a franchise’s leadership team is another critical factor that has the ability to impact the success and sustainability of a franchise opportunity. Although every franchise must start somewhere, having a leadership team with a track record of success as entrepreneurs in other businesses and industries can be indicative of a franchise’s potential for success.

On the other hand, if a franchise’s leadership team lacks experience and is brand new to the franchising space, this may raise concerns about the brand’s ability to manage, provide support and ultimately, expand. After all, one of the main benefits of buying into a franchise is the expectation that you’re joining a proven system with an established blueprint for success. But that opportunity becomes riskier with a less-qualified leadership team.

High Fees

High fees within a franchise should also be approached with caution. If a brand has abnormally high royalty fees, it’s crucial to understand exactly what you’re paying for. These fees typically cover the cost for a range of services and benefits, including ongoing support, guidance and access to the franchisor’s expertise. In short, franchise fees should align with the value and resources you receive as a franchisee. But you don’t want to be paying more than the industry average if you’re not going to be receiving said benefits. As such, it’s recommended that you compare the franchise’s fees to others within the same industry. If yours is charging notably higher fees, that should raise a red flag as it could impact your overall profitability and return on investment.

Franchisee Dissatisfaction

Franchisee dissatisfaction and high turnover rates are other important factors to keep an eye out for while conducting your due diligence. If a brand is experiencing a high turnover rate, especially one involving franchisee terminations, that may indicate underlying problems within the system. Reasons for high franchisee turnover rate could be anything from insufficient franchisor support, contractual disputes or financial difficulties. It’s important to speak with both current and former franchisees to learn more about the behind-the-scenes workings of the franchise in order to be able to make a well-informed decision about whether or not to invest.

No Item 19

For the uninitiated, the Item 19 shows prospective franchisees what their earnings may look like as an owner of the brand. Without this, it can leave prospective franchisees in a state of uncertainty and make it challenging to assess the financial viability of the franchise. In fact, Franchise Times declared you should not pursue a brand that leaves its Item 19 blank or lacking detail.

However, this isn’t always the case. Some newly established franchise brands may not include an Item 19 in their FDD simply because they are in the early stages of development and don’t have sufficient financial data to provide to franchisees. In these cases, you’ll have to use your own judgment.

Be Mindful

Remember, when doing your research, if an opportunity seems too good to be true, it may very well be. Investing in a franchise is a major life decision, so take your time and review your options carefully. We can’t overstate the importance of thoroughly examining the FDD to prevent any unexpected challenges or surprises from arising after you’ve signed the franchise agreement.