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What Franchisors Want Franchise Buyers to Know Before Signing

Once a candidate has found a franchise opportunity that they are interested in, it’s time to do the homework.

For many, purchasing a franchise will be the most significant investment they’ll ever make, and no one should ever buy a franchise without performing the proper due diligence. While there may be a misconception that franchisors just want to sell as many units as possible, smart franchisors only want to partner with the right franchisees, and that is why most franchisors encourage prospects to dive deep into the opportunity before signing on the dotted line. Whether it be looking over the Franchise Disclosure Document or talking to advisors, it’s imperative to really dig in and do the research required to get a full understanding of the brand and the franchise requirements.

Here are 10 things franchisors want franchisees to do (and know) before joining a brand.

Read the Franchise Agreement and FDD

While this may sound basic, many people don’t fully read and understand the franchise agreement in its entirety. The same goes for the franchise disclosure document (FDD). This hefty document can be daunting for prospects, which is why they should be sure to go through it with a franchise lawyer or expert who can help them understand. 

“When researching any franchise concept, the FDD is an important step in the process because it really lays out all of the expenses and costs involved in building out your first center or location,” said IDEA Lab Kids CEO Devina Bhojwani

Seek Franchisee Validation

It’s important to speak to a variety of individuals when doing your homework. Franchisors might have a list of recommended franchisees to speak to, but don’t rely solely on them. Seek out your own targets. Moreover, consider speaking to those who have left the system to get their perspective and experience with the brand. 

A good rule of thumb is to call 10 to 15 franchisees. The contact information will be found in Item 20, which is a spreadsheet that contains all the franchises that have opened, closed or transferred in the past three years. 

“It is a good rule of thumb to look through that list and try to contact some of those franchisees for validation during your due diligence,” said Bhojwani. “It is all publicly available information, so the franchisees know that their info is on there. We recommend all prospects reach out to all 25 of our franchisees during their research process.” 

Seek the Advice of Experts  

When contemplating buying into a franchise system, don’t go to just any attorney. Make sure to seek out a franchise business advisor or a franchise attorney for help. Don’t risk wasting time or money with someone who doesn’t understand the franchise requirements. 

Allowing an industry professional to review your documentation and research will afford a much-needed perspective and will hopefully yield some insight. Encourage experts to play devil’s advocate and help you examine the franchise from every objective vantage point.

Understand the Unit-Level Economics 

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. 

If the P&L is not provided in Item 19, make sure to get it from one of the franchisees you speak to.

Find the Actual Costs of Initial Investments

Item 7 of the FDD lists the startup costs of a franchise, but it’s only limited to the first three months of working capital. If it takes longer to break even, startup costs could be much higher. Make sure to really dig into the costs that will be associated with joining the brand.

“Other than the initial franchise fee, you have to look at things like your rent, insurance cost, utilities, legal improvements, vehicles, furnishings, etc.,” said Bhojwani. “It is so important to get the whole picture in terms of the costs involved, especially because it will take a while to generate revenue.”

Take Stock of Your Liability 

Many franchisees do not realize that they are subject to what’s called “vicarious liability,” which is taken on by a franchisor due to the acts of a franchisee. Reviewing the circumstances and frequency against your franchisor will provide you with a crucial impression of what’s to come in this business relationship. Assessing your personal financial liability and resources is also an integral part of the due diligence process. Item 9 of the FDD covers the franchisee’s obligations.

“This portion of the FDD helps the franchisee understand what is required of him or her,” Bhojwani said. “While a franchisee does have a lot of autonomy, it is important to remember that the FDD and procedures are set in stone and can’t be changed.”

Analyze Growth Possibilities 

It’s important to see data relating to franchise growth, and Item 20 is where you will find it. Item 20 is a growth chart of the brand over the last three years. 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, and discuss your growth plan with established franchisees to gauge the scalability of the business.

“One of the first places I want franchisees to look at is the Item 20 of the FDD — how many units have opened, how many closed,” said Corey Elias, founder of franchise consultant firm Franchise Captain. “If a brand is closing more units than they are opening, that could be a problem. Sometimes it can be explained, but franchisees want to join a system that people are already successful in.”

Talk to the Leadership Team

If possible, get to understand the leadership team’s vision of the company and business philosophy. Whether it is during a discovery day or a separate phone call, try to find out where the brand and industry are going and how they plan on staying relevant. This will give you a sense of what direction the organization is heading in and whether you have confidence in the leadership of the organization.

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. Reading the footnotes of the audited financial statement is where you will get insight on how the numbers are derived from the audit.

“Look at the notes carefully,” said Kay Ainsley, Managing Director of MSA Worldwide, a franchise advisory group. “What kind of information is being provided? How does that information relate to where your location would be? Franchisors should try to provide the most realistic information they can, and footnotes can help explain things like where the units referenced are located. That can mean a lot in some industries, like restaurants, for example.”

Review the Lawsuits

Understand and ask questions if there is any litigation listed in Item 3 of the FDD. Lawsuits aren’t necessarily a red flag — the longer a franchise has been around and the larger it is, the more likely it is that legal issues have arisen. Make sure to ask questions and understand what stemmed from the litigation. Always keep an eye out for any concerning signs.

“If brands have litigation on the books, it can be a bad sign,” Elias said. “But it is also a matter of understanding why that litigation exists. If a brand is large, with hundreds of units, it will likely end up with at least some litigation. It takes time and research to really dig in and understand if those instances are red flags or not.”