Thinking About Buying a Franchise? Do the Right Amount of Due Diligence

By Ellen Sullivan

Published in Advantage Business Magazine   –   August 15, 2013

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What exactly is due diligence? How much is too little or too much? Due diligence, by definition, is the research and analysis of a company or organization done in preparation for a business transaction. Much of the information needed to do due diligence on a potential franchise purchase is available. You need to know where to get it.  Obtaining the right information at the right time, and engaging the right team of experts is the core of an effective and efficient due diligence process.

Businesses that succeed and demonstrate sustainability are based upon a solid business plan and profitability model. The majority of franchises that are operating today have this, or they would not be in business. That said, a key step in the decision about whether or not to purchase a franchise involves due diligence. Before you fall in love with a concept, or rely on what a salesperson told you, or assume a business will be successful, or sign any documents, or pay any money, it’s imperative to take the time to do your homework.

Before You Dive In – Create an Advisory Board

Assemble a team of key professionals. Engaging these experts can guide you in due diligence and through the ups and downs of the lifecycle of your business.  They can save you time, money, and potentially from making a poor decision.

  • An accountant to provide financial advice, document review, financial modeling, and financial management oversight.
  • A franchise or business attorney to review documents and the corporate structure. For some specialties, such as healthcare, a specialized attorney should be consulted. These legal professionals will guide you through the legal landscape of the franchise and business law, regulatory requirements, and the franchise documents. Regulations vary from state to state. Understanding the legal picture is important when addressing compliance requirements, managing risk, and to avert future litigation.
  • Depending upon your background, other professionals to consider may be a business or a marketing consultant. Meanwhile, check out the local Small Business Development Centers (SBDC) for staff and tools available to help with financial and business planning and go-to market strategies.
  • A reputable franchise broker can suggest specific franchises that fit best with your goals, skill sets, and interests (personally and professionally).  A reputable broker will be candid with you as you progress through the due diligence process.

 Where to Start – The Federal Disclosure Document

The Franchisor will provide you with a Federal Disclosure Document or FDD. This is a legal document required by the Federal Trade Commission (FTC) that must be presented to prospective buyers of franchises in the pre-sale disclosure process.   This document discloses extensive information about the franchisor and the franchise organization, intended to give the potential franchisee enough information to make educated decisions about the investment. A copy of the franchise agreement should be included. There is a 14-day wait period required by the FTC between the receipt of the FDD and the signing of an agreement.

The FDD package provides a wealth of knowledge, with details about how the franchise system is working. It can be several hundreds of pages in length and it contains important data, financial information, and legal requirements. Examples of the information disclosed include:

  • Franchisor ownership and changes in ownership
  • Bios of principals and key personnel
  • Number of units that have sold, resold, or closed over time
  • List of franchisee owners by location
  • Significant lawsuits filed by franchisees
  • Financial performance
  • Fees, estimated investment costs, royalties, marketing funds requirements, and other costs
  • Franchise Agreement
  • Audited Financial Statements
  • Term of Agreement, options to renew and on what terms
  • Territory included in agreement and exclusivity rights

Provide a copy of the disclosure documents to your accountant and attorney(s).  Plan to have a review session with each expert to understand the documents in depth and know the facts. You will be piecing together important details that disclose the strengths and weaknesses of the franchise system. Know what legal and financial obligations are required. Decipher the rules. Understand other details such as restrictive covenants and rules around trade secrets.

Talk To Those Who Know – The Franchisees

While much of the information you need is found in the FDD, there is still more work to do. Obtain names and contact information for franchisees. Most franchisors will provide an introduction for you to the franchisees. Talk with as many as you can. Be prepared ahead of time with a list of questions. Most are willing to answer a few questions. Be respectful of their time.

Some sample questions include:

What kind of support is available for franchisees?

Were you satisfied with the training?

What was your experience to breakeven?

Do you have input into the vendors?

What do you get for your royalty payments?

What were your hurdles?

How close was your experience to the FDD?

How on point was the project plan provided by the franchisor?

How is the marketing fund used?

What worked?  What didn’t?

Would you do it again?

Kathee Murphee, President and CEO of Jacksonville Comfort Keepers franchise, recommends talking with franchise owners. “Talking and listening to other franchise owners is an important step in due diligence. You can learn information from others’ experiences that can help you be successful in your own decision making.”

What Else Should You Know?

Additional research on your part will help to answer questions such as:

  • What is the sales proposition of the product?
  • Is the product sustainable? Where is it in its lifecycle?
  • Who is the competition in your market? Are they successful and why?
  • What is the market saturation level?
  • Is the franchise credible in the public and press? Does it enjoy a good reputation?
  • Are the cash requirements reasonable?  What will you do if you need additional working capital?
  • Is lending available? And if so, who is lending and to whom?
  • What kind of staff is needed? What is the degree of difficulty in finding and hiring the right staff?

Meet the Franchisor

Many franchise systems hold Discovery Days. These typically involve a visit to the corporate office where you’ll meet the principals and key staff, hear presentations, observe an operating unit, and get a sense of what the franchise is all about. This is the time to ask any lingering questions. It’s your chance to size up the franchisor. In turn, the franchisor will be doing the same, deciding if you would make a good addition to their system.

One Last Question

How receptive is the franchisor to the franchisees’ input? A franchisor committed to its franchisees will have a method for franchisees to voice new ideas, help solve problems, and maintain a balance in decision-making. One way to offer input is through a Franchise Advisory Council, where the franchisor and franchisees come together to better the overall system. A group such as this can be key to the success of the franchise.

Balance the Pros/Cons and Move Forward

Now it’s time to put it all together. Take all that you have learned about the product and the franchisor, all the advice from your advisory group, along with your financial plan, and personal goals, and decide if this particular franchise is right for you. Are you passionate about the possibility? Marshall Reddy, President of FranNet of North Florida sums it up best: “Matching your talents with the right franchise is a recipe for success.”