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The Most Important Step When Buying a Franchise

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Performing a comprehensive evaluation of a franchise is a critical step before you pay the franchise fee and sign the agreement. Learn how to perform this important activity.

There are key steps in the franchising process but none more important than evaluating a particular franchise. Having spent a number of years in the franchise industry, I’ve observed, that many prospective franchisees fail to fully evaluate the franchise they are looking to purchase. Some individuals leave this activity until the very end and may even cut corners. Once you’ve found the franchise opportunity that matches your financial, business and personal attributes you need to start performing your due diligence. Webster defines due diligence as: “the research and analysis of a company or organization done in preparation for a business transaction (as a corporate merger or purchase of securities).” However, when it comes to performing due diligence on a franchise opportunity there is one important difference compared to traditional business transactions. The difference is that investing in a franchise represents the beginning of a relationship with the franchisee wedded to a franchise program and franchisor. An important part of the evaluation is to utilize professionals who can assist and guide you along the way. This includes a franchise attorney and accountant. Don’t make the mistake of being “penny wise and pound foolish.”

Although there is a great deal of advice and guidance available on the Internet and from other sources, there is no substitute for having professional advice. A common mistake is to start the due diligence process at a particular point in time when in fact this activity is ongoing and should begin the first time you request information from the franchisor. For example, the mere process of requesting and then receiving initial franchise information from the franchisor may seem like a rather mundane step in the franchise process. For example, the time it takes to receive the information and whether or not you’re promptly contacted by a franchisor representative, can provide an indication of how organized and responsive the franchisor is. A lack of franchisor follow through, this early in the franchising process should be duly noted if you decide to proceed with that particular franchisee.

Key areas that require competent due diligence:

  • The Franchise Disclosure Document (“FDD”) and franchise agreement. Your franchise attorney and accountant should review the FDD to identify problems areas. In addition to the basic terms of the franchise agreement, other items that require a close examination include franchise litigation and the franchisors financial statements. Another important item to consider is whether the franchisor makes an earnings claim in the FDD. With the exception of a start up or small franchise system, the lack of an earnings claim could be considered a red flag when evaluating a franchise.
  • The responsiveness of franchisor staff. A lack of a timely response can indicate that the franchisor may be understaffed and/or disorganized. Determine if your questions were answered on a timely basis.
  • The basic franchise operation. Understanding how the franchise business is operated and what skills are required will indicate if your skills match the requirements needed to be successful. Although a franchise is based upon a system and support from the franchisor it is the franchisee that runs the business on a daily basis.
  • Franchisor performance. It’s of critical importance to know how well the franchisor trains and supports its franchisees. Are there scheduled meetings, webinars and conferences used by the franchisor to communicate with and support the franchisee network? Is there a franchisee association or franchise advisory council in operation?
  • Franchisee profitability. You need to know if franchisees are meeting their financial goals including when they reached break even. Verify if the investment schedule in the FDD approximates what franchisees needed to invest.
  •  The market for the franchise product or services. It’s important to validate the quality of the franchise brand and market for its product. Does the franchise appear in Google searches? How effectively is the franchisor using social media?
  •  The franchise territory. There ought to be a large enough franchise territory to allow for ongoing growth. A franchise territory that is too small can stifle future growth and limit sales and profits.

Gathering information

The information you’ll need will come from:

  • Interviews with franchisor representatives
  • Discussions with existing franchisees
  • A review of the FDD
  • Franchise market analysis
  • Internet searches, newspaper and magazine articles about the franchise

Franchisee Feedback

The most important aspect of your franchise due diligence is to obtain feedback from current and former franchisees.

Speak with enough franchisees so that you have representative feedback. I would suggest a minimum of 8 to 10 franchisees. The more franchisees you speak with the more credible the feedback. You should speak with existing and former franchisees in order to gain a broader perspective.

Call franchisees in different parts of the country as well as in the geographic area you’re interested in. If you can arrange a personal visit to a franchisee it could be very helpful. Although many franchisees might be unwilling to spend the time, it’s worth a try.

An important note about franchisee feedback: There is a school of thought that considers information and feedback from exiting franchisees lacking in credibility. This opinion is based upon the belief that many franchisees fear retribution from the franchisor if they make negative comments about the franchise. In addition, some people are reluctant to acknowledge that they may have made a mistake when they purchased the franchise. Despite these comments, I continue to take the position that existing and former franchisees are the most reliable source of information for conducting due diligence.

Sample Questions

  1.  How long have you owned the franchise?
  2.  How did you come to obtain the franchise? Were you referred by another franchisee? Was it through an advertisement? Was it from a consultant or broker?
  3.  Has the franchisor fulfilled the requirements that they said they would when you first met them? In other words, has the franchisor basically done what they promised?
  4.  Depending on the number of years that the franchisee has owned this business, ask if they have seen the franchisor make appropriate changes or enhancements to the franchise program over time. Some franchisors do little to enhance the franchisee program, but instead, look to sell more franchises without reinvesting into the franchise system.
  5.  Has the franchisee had any disputes or issues with the franchisor, and if so, how were they resolved? Who resolved the dispute? This is important, since most franchisees have had some problems, whether minor or major. However, certain franchisees are reluctant to bring a problem to the appropriate level.
  6.  Find out what the persona or corporate culture is at the executive level of the franchisor. Obviously, this is going to depend on the size of the franchise. It is important to grasp a sense from the franchisees as to how they view the leadership of the franchise.
  7.  In terms of operating this franchise, were there requirements they didn’t anticipate?
  8.  Was it difficult finding qualified staff for their franchise?
  9.  Did the franchise meet the financial expectations of the franchisee? If not where did they fail?

Individuals considering a franchise need to perform a comprehensive evaluation of the specific franchise before paying their franchise fee and signing the franchise agreement. Investing in a franchise without performing adequate due diligence can be risky and can lead to future problems.

2012 FranchiseKnowHow, LLC

Ed Teixeira is the President of FranchiseKnowHow, LLC. He can be reached at franchiseknowhow@gmail.com

 

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