How to Evaluate a Start-Up Franchise Company
by Ed Teixeira
In a previous article I presented the advantages and disadvantages of
purchasing a franchise from a new franchisor. This article provides key factors
that should be considered before making your decision. Learn how to evaluate the
start-up franchise company.
A lack of franchise history can make validating the performance of a start-up
franchise program very difficult. If you’re considering a start-up franchise
engage the services of a qualified accountant and franchise attorney to assist
in the evaluations.
An overview of new franchise start-ups:
- There are approximately 300 new franchise concepts that start-up
- New franchises are launched from an existing business that lends
itself to franchising.
- It can be enticing to become a part of a new and unique franchise
- Don’t expect to be buying the next KFC or McDonalds.
- There can be a number of benefits from getting in on the ground floor
of a brand new franchise, but there are also risks.
Evaluate the performance of the business used to design the franchise
Because a start-up franchise is new there is usually limited franchisee
history that can be used to evaluate the quality of the franchise. This means
that added focus must be placed upon the business that served as the model or
launching pad for the new franchise. It’s critical to obtain as much financial
information as possible regarding that business. Use your accountant and
franchise attorney to assist in your evaluation. Obtain a detailed evaluation of
the business. Know what the sales and earnings have been. Offer to execute an
NDA if the franchisor resists disclosing financial information. If the
franchisor refuses to disclose information than walk away
Detailed scrutiny of the franchise program
How will the addition of a royalty and other fees on the franchisee income
statement impact the projected bottom line? This is another reason to have
financial information pertaining to the business. If the pre-tax income was 15%
before any royalty fees then a franchisee could be looking at less than 10% in
Tie in basic terms of the franchise agreement such as territory, royalty and
fees to the operation of the original business. Will the franchisee operate in a
much smaller territory than the original business? Add the royalty and other
fees onto the income statement of the business as a way to determine how a
franchisee income statement could look
Market analysis and competitive review
Does the franchisor have a detailed market analysis? There should be data
that will demonstrate there is a market for the franchise products or services.
If you and your advisors need to rely upon lots of talk and little substance,
you could be headed for trouble. You’ll also need some information regarding
competition. Some competition can be a positive sign whereas no competitors
could mean there is limited demand in the market.
The franchisor is required to provide financial information in the Franchise
Disclosure Document. Your accountant needs to review this information to confirm
that the franchisor has sufficient capital to operate and grow the franchise.
Too little capital can lead to aggressive franchise selling in order to obtain
franchise fees. Some registration States require new franchisors to
provide a guarantee and/or escrow of initial franchise fees so that the
franchisees receive the agreed upon services. Limited capitalization could
prevent the franchisor from providing services and support to new franchisees
Franchisor experience and staff
When a business owner starts a franchise program they go from running one
business to two. In addition, the founder may have limited franchise experience.
Since the majority of start-up franchisors will have limited staff it’s
important to conduct a thorough appraisal of franchisor staff. Someone at the
franchisor level with franchise experience will be a plus. You and your advisors
will need to gauge the business competency and capability of the founder. At the
start-up phase of a new franchise quality of staff is more important than
Unless you’re the first franchisee there will be franchisees you can contact
for feedback. If the franchisees are new with a limited track record, zero in on
quality of franchisor training, support and responsiveness. Be sure to focus on
financial performance. Is the franchisee on target or are they behind their
Visit www.franchiseknowhow.com where there are a number of articles under
Buying a Franchise
According to noted New York attorney Michael Einbinder “Buying a franchise
from a startup franchisor presents unique opportunities as well as risks.
As one of the first franchisees you may have more leverage than in negotiating
with a mature franchise system. The risk lies in the lack of experience
and possibly undercapitalized state of a new franchisor. As with any
investment, the key is your due diligence."
Purchasing a start-up franchise can provide an opportunity to gain
substantial rewards by getting in at the start. However, there can be
substantial risks associated with the start-up franchise. Be sure you conduct a
detailed and in depth due diligence.
© 2010 FranchiseKnowHow, LLC
Ed Teixeira is the President of FranchiseKnowHow, LLC. He can be reached at