When Researching A Franchise How Much Should I Spend On Due Diligence
The Simple Answer is: As Much As You Need To.
Investing in a franchise is one of the biggest investments most people make in their lifetime. For most first time Franchisees, it rivals the purchase of a house. Based on our research of over 12,000 Franchisee surveys and 1,200 Franchise Disclosure Documents, a few stark facts are present. 19 percent of franchisees were not profitable last year, and 31 percent of franchisees were unsatisfied with their franchise investment. That research indicates that a franchise
can be a rewarding experience, but there are investment risks. To minimize that risk, a prospective franchisee
must perform their due diligence to find a successful franchise investment opportunity.
What does due diligence mean when searching for a franchise?
Due diligence involves the research to gather information about the characteristics of a franchise system in preparation for an investment. It is the attention a reasonable person takes to review the investment to avoid harm. Due diligence and the steps taken are optional for every investor. If you were buying a house, you can decide to use a
real estate agent, to hire a home inspector, or use a lawyer. There are a number of similar due diligence options when researching a franchise investment.
What due diligence options are out there?
Take time to properly investigate a franchise. Expect the process of narrowing down an investment to take at least three months. Expect another 6-12 months before you open your location. A franchise is a 10+ year investment. Take the time upfront to find the best investment for you and it will pay off down the road.
As a franchisee, you will need to work hard to build your business. You should tackle your due diligence with the same work ethic. Perform you own independent research, search for the franchise on Google, Twitter, Facebook, etc. Follow the brand to see what messages are communicated through social media, and what the responses from consumers are to those messages. Search for consumer reviews on the brand from Yelp or another website.
Ask franchisors for their Disclosure Document and Agreement. Read it! As hard as the read may be, take the time to
read it and do your best to understand it before you visit a lawyer. If a franchisor does not provide their FDD or Agreement, you can find it online.
Speak to existing and former franchisees. Ask a lot of questions to both groups such as: Would you invest in the franchise again? Are you profitable? What problems have you encountered? Why did you pick this franchise system? What is your opinion of the franchisor? Does the franchisor respond to your concerns? You will find contact information in the FDD. Call as many franchisees as you can. Make a list of all franchisees, and systematically call each one. Leave messages, call back, and continue to reach out until you are satisfied with the answers you receive and can understand the general consensus of the franchise network.
Seek the help of a franchise consultant or a company that reviews franchises. Someone with industry knowledge that can provide insights into various aspects of a franchise that you may not be aware of. Consultants can range from $150 per hour to $3,000 for a preset franchise system analysis. Using franchise brokers may not cost you anything, but be aware that they may get paid by franchisors. To ensure a professional is working for you, you must
Review any Item 19 financial performance representations. Review franchisor financials to ensure the franchisor has positive cash flow and ensure the franchise system is financially healthy. This can cost around $2,000 to do a thorough analysis of Item 19 and a franchisors financial statement.
You should have already read the FDD andAgreement. Have a lawyer review, and ask them any questions you have based on your review. This may cost between $2,000 and $4,000. If there are specific concerns within the Franchise Agreement, your lawyer may be able to negotiate on your behalf. If you are attempting to negotiate the Franchise Agreement, your legal expenses will increase.
One of the hardest things for a prospective franchisee to do is walk away from a franchise system after performing their due diligence. But that is exactly why you go through the steps above. If, during the process, something does not feel right, or certain concerns arise, either address them with the franchisor and/or your lawyer, or do not invest into that franchise system. Investing in the right franchise system can be personally and financially rewarding. Investing in the wrong franchise system “Seek the help of a franchise consultant or a company that reviews franchises, someone with industry knowledge that can provide insights into various aspects of a franchise that
you may not be aware of.” can cost you personal and financial hardship.
A due diligence investment of your time, your hard work and potentially $5,000- $10,000 is the cost to minimize your investment risk and find the right franchise system for you.
As the CEO of FranchiseGrade.com, Jeff understands that there is no Silver Bullet or sure-fire, simple way to pick
a guaranteed franchise system winner. However, by using a little science and a lot of hard work, Jeff and the team at FranchiseGrade.com have developed a sophisticated research, analysis and comparison model to help potential investors and existing Franchisees assess a realistic value for any franchise system relative to others. It’s called a Franchise Grade.
With over fifteen years of small business experience and ten working in franchising as a multi-unit Franchisee, consultant and Franchisee Association President, Jeff has a good understanding of the level of hard work, dedication and commitment that drives a successful franchise system. As part of his ongoing involvement with the industry, Jeff also served as a Member of the Strategic Committee of the International Association of Franchisees
For more information visit: www.franchisegrade.com