Thinking of owning a business? Franchises make it easy, but it’s risky to go after any opportunity without some careful consideration. You’ll need to invest time into every part of the process, from understanding the skills you can apply and defining your ownership goals to exploring financing options and making concrete decisions about which brand to buy into, where to locate, and who to hire. One of the most important steps in buying a franchise is due diligence.
What is franchise due diligence?
When you’re considering a franchise, you’ll complete a due diligence process. You, your accountant, and your attorney will team up to review the ins and outs of the company you intend to buy into. You’ll start this process after you express interest in a franchise, request a franchise disclosure document (FDD) and application, and attend a discovery day event but before you formally agree to buy a franchise unit.
Through the due diligence process, you’ll learn about the costs of ownership, make financial forecasts, verify the franchisor’s claims, and ensure that you understand how the franchise is positioned in its market.
Most of the information you need will come from the FDD, the franchise agreement, audited copies of the franchisor’s financial statements, and sample franchise unit income statements. You can also connect with other franchisees, read articles about the franchise, review franchise complaint sites, and speak with your franchise representative to gather more information.
|Wondering how to find franchise unit owners’ contact information? Check item 20 of the FDD.
If you plan to connect with other owners, try to arrange in-person meetings at an owner’s franchise unit’s site. This will allow you to see how the business operates while you ask questions about the franchisor’s support and training, learn about sales patterns, and gather insights and advice that might help you make a decision.
What should I be looking for?
Through your research, you should try to answer these questions:
- Is the franchisor’s organization financially, legally, and operationally sound?
- How much support does the franchisor offer?
- Are franchise unit owners happy with the operating model and support offered?
- How many franchise units generate a profit?
- Of those that are profitable, how many units generate a profit that exceeds what you could earn in a diversified investment portfolio?
- How does the success ratio of the franchisor’s units compare with the success rates of other franchisors?
- How many franchise units have closed or changed ownership in the past several years?
- What’s the potential for making a profit with this model in my target market?
- What practices does the franchise use to reach and market to its customers?
- Are customer buying patterns steady, or is there seasonality?
- If there is seasonality to sales, can franchisees cover their costs during the downturns?
- Are there any outstanding legal claims against the franchisor, and if so, what is the nature of those claims?
- Has the franchisor filed for bankruptcy in the past?
A good accountant and business attorney are musts for franchise due diligence. Your accountant can help you work through the franchisor’s financials, spot discrepancies, and model how much cash your franchise unit might generate. This pro can also help you understand the costs required and create scenarios that show you the range of profits you can expect from the business.
Would you like to connect with an accountant with this skillset? Check out some of our favorite firms:
The attorney you choose will help you understand the FDD and the terms and conditions of the franchise agreement. This is important because both documents may use terms unfamiliar to a person who’s never owned a franchise unit or worked through the technicalities of this kind of investment.
Even with experience in franchise investment, you can benefit from an attorney’s support. This pro can ensure you understand the requirements and restrictions you’ll need to abide by when you become a franchise unit owner.
An attorney can also help you understand the local laws and restrictions that your business will need to follow. Plus, they can point out any litigation that’s pending against the franchisor or individual franchise units.
|Another benefit of working with an attorney is support in negotiations. Your attorney might help you reduce or delay certain costs, expand the size of your assigned market or territory, or extend the amount of time you need for crucial parts of the process (such as site selection).
What are some of the red flags I might find through the franchise due diligence process?
Problems can pop up in every part of a business. Some of these problems could be insignificant and easy to overcome. Others, including hefty franchisor debts or the need for frequent or expensive upgrades, may turn you off from the buying into the business altogether.
You might find problems in the market, too, and some could be big enough to change your mind about the purchase. Problems like diminishing sales, rising costs of inputs, and strengthening competitors could fall into this category.
What happens after my assessment?
The due diligence process will help you lots of details about the business you intend to buy. And, ideally, it’ll help you make an informed decision on whether you should proceed.
|Be sure not to rush the process. Take the time you need to review each aspect, verify every claim, and find answers to your questions.
After working through the terms, financials, and other concerns with your accountant and attorney, you might have the confidence you need to proceed with the purchase. If so, you’ll sign and return the franchise agreement, complete the interviews your franchisor may require, and line up the financing you’ll need to complete your purchase.
You can learn how to secure financing and the options that are available to you in this guide:
For more free guides, resources, and articles about starting and operating a franchise unit, log into your owner’s portal.