Franchise Fortune Telling

Ah, the sweet smell of success! That’s what we all want when we buy a business. If only there was a way to tell which businesses would bring us riches and which would bring us to tears. While there’s no Magic 8-Ball® in franchising, there are ways to tell if a franchise company has major problems. If your franchise research uncovers any of these five red flags, take it as a sign to move on to another opportunity.

• During your franchise research, a company you investigate is required by law to provide you with their Franchise Disclosure Document. One item that must be disclosed in this document is any LITIGATION HISTORY the franchisor has had with its franchisees. It is not uncommon for a large franchisor (one with a hundred or more franchisees, for example) to have had an unhappy franchisee. So, if you do find some litigation history, you will want to consider two things:

1. What is the number of litigations compared to the overall system? One or two per 100 franchisees is not necessarily a red flag but if you see more than that – lookout. The franchisor may be promising more than they can deliver.
2. What was the nature of the litigation? Litigation can run both ways and a franchisor can sue a franchisee for non-payment of money owed. If the litigation is from franchisees who allege fraud by the franchisor, consider this a red flag.

The franchisor should be prepared to discuss these items and you will want to find out how these matters have been resolved. If you don’t get straight answers or you feel something is just not right, pass on this opportunity—or as the 8-Ball might say, “Outlook not so good!”

• The FDD is an enormous help to potential franchisees when vetting a particular company. Franchisors are required to put in writing information about any UNITS THAT HAVE FAILED. It is your job to consider this information and put it into the larger picture. You do not want to see a number of failures in a young company, one that has been franchising for only 5 or 10 years. However, if a company has been in business for longer than 10 years, you would expect to see some turnover as franchisees retire or sell their businesses to other franchisees and move on. The FDD will list the reason the franchisee has left a system so if you see a number of failures from owners who could not make the business profitable, you need to ask yourself if this is a sign of a system-wide problem.
• Let’s assume you’ve made it this far in your research and the company you are interested in has cleared your first two hurdles. Your next step will be to talk to a number of existing franchisees in the franchisor’s system. You’ll have a number of questions to ask, such as how they feel about the corporate staff, the training they received, and they money they are making. The more people you can connect with the better because you need to get an overall view of the franchisees’ attitudes towards the franchisor. If you find a number of UNHAPPY FRANCHISEES you will want to back away from this franchise. If the majority of franchisees tell you they are successful and happy in their business, your chances of also being successful are, “Most likely.”
• While you are reading the company’s disclosure document, check to see if there is an Item 19 listed. This is where a business will provide, if they so choose, an earnings claim. If this information is given and the numbers seem satisfactory, so far so good. Be sure to verify these numbers with a number of their franchisees. Any numbers provided are supposed to be accurate but you’ll want to get confirmation from those people out in the field. If the numbers are provided and the franchisees agree with them, this business has passed another hurdle.

However, if you find the franchisor is SECRETIVE ABOUT THE NUMBERS, that’s a definite red flag. There are, of course, valid reasons why a franchisor may not provide an Item 19. Perhaps they’ve changed the model and the figures don’t accurately represent what a franchisee of the new model could earn. In some cases the company is too new to have enough data to provide earnings claims. You’ll have to use your best judgment here and if you are even the least bit uncomfortable with your findings – or lack thereof, consider this opportunity to be, “Very doubtful.”

• Once you’ve made it this far in your research of a particular company, you’ll have had a number of conversations with the sales people. How were you treated? Did they answer your questions professionally and in a timely manner? Consider also the personalities of the franchisees you talked to – were you able to connect on a personal level with many of them?

You may wonder why this even matters. After all, you’re buying a business, not getting married, right? Well, not exactly.

If you join a franchise company, you become a part of that company and your relationship will be full of give and take for a lengthy period of time. How do the company’s CULTURE AND VALUES fit you? Do you trust these people with your financial future? You want to feel comfortable in the belief that they will be as committed to your success as you will be.  If you don’t get that feeling, well there’s many other fish in the franchisor pool.

Finding the perfect franchise opportunity, just like fortune telling, is a subjective enterprise. What matters is what the information means to you. There are nuances to every business and nuances to every personality and finding those that mesh well can take time and effort. To simplify the process, be sure to eliminate any companies that have red flags like those mentioned above. Your chances for success will be multiplied and even that Magic 8-Ball will likely give you a, “Signs point to yes,” answer.