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Franchise Health: How to Get a True Read

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Investing in a franchise is no small commitment. Depending on the longevity and brand recognition, the initial franchise fee could be anywhere from $10,000-$50,000 for a single unit. Add that to the initial start-up cost and your financial investment could be upwards of several hundred thousand dollars.

Bottom line: That’s a substantial financial commitment.

In order to make this transaction an investment rather than a gamble, it’s essential to gauge the health of the franchise. The last thing you want to do is borrow against your 401k and have the franchise go belly up three months down the road.

One of the ways to determine the health of a prospective franchise is item 20 in the Franchise Disclosure Document (“FDD”) “List of Franchise Outlets.” This detailed list is a roadmap of where the franchise has been, as well as where the franchise is going.

Related Article: Why an FDD Should Be Your Guiding Beacon

FDD #20 outlines three years’ worth of documentation on the status and number of franchises, transfers, terminations, and projected new franchises. From this information, I want you to view the franchise through three different lenses:

Decline

Businesses, especially franchises, strive to expand. If a franchise’s numbers are shrinking, there is likely a problem in the business model. The other reason may be that the franchise model didn’t transfer well to other areas of the country.

Spend time looking for overall and region specific trends in franchise closures. If there is a regional trend, compare that region’s demographics to your own.

Transfers & Terminations

Transfers typically happen for one of two reasons. First, the franchisee is struggling and wants to recover a percentage of the initial investment. Second, the franchisee grew the business over time and leveraged the transfer as a tactical exit strategy. Terminations by the franchisor typically indicate the franchisee was in default under the terms of the franchise agreement.

Transfers and terminations alone don’t disprove the business model. Not everyone is a strong fit for running a franchise. But, when the two combined exceed 10% of the total franchisees, it’s a red flag there is a problem in the business or market.

Rate of Expansion

Expanding too rapidly can also be a red flag. When you sign on as a franchisee, you will need intensive training and support to get the business up and running. If the franchisor is bringing on too many franchisees, there is the possibility they won’t be able to give you the support and training you need to launch successfully.

Conclusion

Purchasing a franchise typically is the largest single investment you ever make. Ensure it generates a positive ROI through extensive due diligence. That includes reading between the lines on disclosure FDD #20.

If you are in the final stages of purchasing a franchise, let me help you comb through the FDD. Together we can make sure you get your franchise started on the right footing.

Published: August 4, 2015
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Source: This article was originally published by Legal Matters LLP

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Robert Steinberger

Robert Steinberger, who often goes by Bob, is a founding partner of the Law Offices of Soden & Steinberger, LLP. He is adept at both creating the best legal structure for enterprises as well as setting the foundations for franchise owners and buyers. While Bob’s practice focuses on both business entity formation and litigation, his specialty is franchise law. As a part owner of a franchise, he brings a unique perspective to navigating the franchise landscape. His free Franchisor Workbook gives a head start on expanding a business empire.

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