Keys to Evaluating a Franchise Opportunity
There are many important elements to evaluating a franchise opportunity and which things are most important will vary among prospective buyers.
While each company has its own unique discovery process, there are some common elements that you can expect with any franchisor. As a potential investor you want to be sure to carefully consider the merits of the opportunity, but it is important to know that the franchisor is evaluating you as a candidate every bit as much as you are evaluating them as an organization. You are potentially going to become business partners and both of you must consent to that arrangement. You are bringing valuable skills, capital and labor and they are bringing the all important business model, which is the system for producing profit. You should treat this like a job interview, not like you are buying a car. Remember, they decide ultimately if you will be allowed to invest in their franchise, so your job is to make them want you. If you achieve this, then you get to be the one who says yes or no to the deal.
Another crucial element to be aware of when assessing a business opportunity is up until you start having conversations with real people, you are not evaluating anything other than marketing information. Reading a website or brochure is not due diligence. It is a ten miles wide and half inch deep endeavor that yields very little useful information. Investing in a business model is unlike buying a new television or refrigerator. To learn anything of value about an opportunity, you have to speak with the people at the franchisor as well as the people who own or have owned their franchise units. The control document for every franchise investigation is the Franchise Disclosure Document or FDD and you generally will not be provided it until you have a successful introductory conversation.
The first interaction between you and the franchisor begins by exchanging general information. They will give you an overview and send you initial information about the company. You will likely be asked to complete a questionnaire that gives them some baseline information to assess whether you are likely to be a good fit for their system. Keep in mind that the franchise sales person would like to sell a franchise, but the decision to do so is typically made by the executive leadership of the company. This group has to be convinced that you are the right person to operate their model effectively in a given market.
Once each party has decided that it makes sense to continue the discovery process you will be provided the FDD. The Federal Trade Commission mandates that this disclosure document is provided to any potential investor and it gives you detailed information about the franchisor. The format is standard and all franchisors must include information on 22 points of information that clearly illustrate the business costs and define the relationship you will have with the franchisor. The primary subject areas include:
- The history of the franchise and its officers and directors
- A description of the business model
- All costs and fees that you will be subject to under the agreement
- The obligations of both parties during the term of the agreement and thereafter
- All relevant litigation history of the company or its officers
- Business failures, ownership transfers, terminations or other potentially adverse information relating to the success rate of the existing units in the system
- Financial statements for the franchise company
- A list of the existing franchisees and their phone numbers
Some franchisors include earnings claims in Item 19 of the FDD document. This is optional and most choose not to expose themselves to liability by providing any claims, but in any case, speaking with franchisees in markets that are demographically similar to your own is the best way to get a read on your potential in this regard.
Even if you are familiar with reading contracts, it is advisable to have a competent franchise attorney review the FDD and your franchise agreement. Their job is not to renegotiate the terms, simply to help you make sure you know what you are agreeing to under the contract.
The franchisors are naturally excited about their own company and are obviously very positive about everything they do. This is to be expected, they should think that they are the greatest or they shouldn’t be franchising their model. This is why talking to the franchisees is so important. They will give you a very candid assessment of the franchisor and their level of happiness with the training and support that they receive.
In any franchise system, you will have a small statistical percentage of failures, usually due to franchisees that were either mismatched to the opportunity or who refuse to follow the system. Unfortunately people generally do not own up to the fact that they didn’t follow procedures and will blame their failure on the franchisor. So if during validation you get a bad review of the organization from one of the franchisees, press on because that person may be unrepresentative of the group. Typically you will find that most people are reasonably happy and some are ecstatic. If you find most people to be upset, then obviously that should be a red flag. During your conversations you will want to key on areas like; training, support, marketing, timelines, franchisor relationship and earnings.
It is always a good idea to physically meet with the organization that you will be investing in. Most companies now have a formal discovery day, where you will go to the corporate headquarters and meet with the senior executives and all of the department heads. You will be able to confirm what you already know, ask any residual questions and get a strong feeling of whether or not you fit into the company’s culture.
You can generally complete your entire due diligence in 30 to 45 days if you are committed. Either during or shortly after discovery day, the franchisor decides if they wish to award you a franchise and then it is time to make a decision. The franchisor doesn’t want to rush anyone, but they want to move the process along.
Both parties need to be excited about the relationship and should be ready to get started.
At the end of the day, evaluating the opportunity is the easy part. The hard part is finding the right opportunity for your unique goals and objectives so don’t leave any stones unturned in your search.
Dan Brunell is President of Dearborn West, LLC, an international business opportunity brokerage headquartered in Southern California.
Have a question about business opportunities? Contact Dan at: