Evaluating a franchise opportunity: 5 red flags

evaluating a franchise

When evaluating a franchise, it’s critical to research every opportunity very carefully. Do you know how to spot indicators of potential problems? Be particularly cautious when you encounter any of these issues:

Evasive or unprofessional franchisor

When evaluating a franchise, it’s your job to ask questions and scrutinize responses. If the franchisor is evasive, unprofessional, or aggressive, consider it a sign you should look elsewhere. If they’re not courteous and cooperative during the sales process, there’s little chance they’ll be any easier to deal with when you’re a franchisee.

Unhappy franchisees

What should you do when evaluating a franchise where many of the current franchisees seem dissatisfied? The safest move is to move on to other opportunities. It’s preferable, of course, to find that the franchisees you speak with are satisfied with their business, its financial results, and the value they receive from the franchisor.

Franchisee turnover

The due diligence process for evaluating a franchise includes review of the Franchise Disclosure Document (FDD). The franchisor must disclose the history of franchisees who have left the system and the reasons they did so. A high rate of turnover can be a red flag. You’ll need to determine whether it means that the business is not consistently successful at the unit level.

During your research, differentiate between units that close because the owner could not succeed and units that the owner sells as an exit strategy. How long has the franchise been in operation? In a younger franchise system (i.e., active for only 5-10 years), any significant turnover should be carefully explored. If the turnover is a result of the termination of franchisees, this indicates a problem. Turnover due to resale of successful units is another story.

Litigation history

Check the FDD to see whether the franchisor has a history of litigation. As a general rule, more than one or two cases per 100 franchisees could indicate a problem area. Look at the contested issues to distinguish, for example, actions brought by the franchisor against franchisees who aren’t paying their bills versus those brought by franchisees alleging misdeeds by the franchisor.

Too good to be true

There’s a good reason for this old adage: if an opportunity seems too good to be true, it probably is. If a franchisor is unwilling or unable to recognize and disclose the flaws in their business (every business has them), be forewarned. Transparency is a good thing, and that means telling prospective franchisees about the challenges as well as the benefits.