Before you invest in a franchise opportunity, it is important to take the following four steps to validate the franchise opportunity:
CALL FRANCHISEES THAT ARE IN THE SYSTEM
This is an important initial step in validating a franchise opportunity. The franchisees that are in the system already (and any that have left the system) are the most knowledgeable about the system and the franchisor. You can find the full list of all franchisees in the system and those who have left the system in an exhibit to the Franchise Disclosure Document (FDD). Tables of Contents to the FDD will list it as an Exhibit. You do not need the permission of the franchisor to call the franchisees or former franchisees listed in the FDD; this is your right. These franchisees and former franchisees will be able to answer questions about (a) the support and training that the franchisor offers, (b) the costs to open the franchise, (c) the time it takes to be in the black (making a profit), and (d) many other answers to the questions you will have. For a list of my top 10 questions to ask franchisees, see my blog on this topic – http://lanardandassociates.com/top-10-questions-to-ask-franchisees-before-you-buy-a-franchise/.
READ THE 23 ITEMS OF THE FDD
The Federal Trade Commission (FTC) requires that a franchisor provide you with the Franchise Disclosure Document (FDD). The federal government (and certain states) believes that it is important that certain information be provided to you before you invest your time and money in a franchise. The 23 Items of disclosure in the FDD are in the front section of the FDD. They are required by federal law to be written in “plain English”. It is important that you carefully read these Items of disclosure so you have a clear understanding of what your obligations are to the franchisor and what to expect from the franchisor. You should read all 23 Items, but focus particularly on the financial disclosures, which are Items 5, 6 and 7. In those three Items I recommend you read the body and footnotes of the Items. You may want to listen to the podcast I gave describing each of the Items of the FDD: http://www.blogtalkradio.com/franchisefocus/2014/05/15/what-to-look-for-in-a-franchise-disclosure-document–part-1 and http://www.blogtalkradio.com/franchisefocus/2014/06/26/what-to-look-for-in-a-franchise-disclosure-document–part-2.
EVALUATE THE AUDITED FINANCIAL STATEMENTS OF THE FRANCHISOR
The franchisor’s audited financial statements are listed in the Table of Contents of the FDD and are typically found in the mid to back section of the FDD. These financial statement should give a prospective franchisee and his or her accountant important information on the financial health of the franchisor. You or your accountant should determine if the franchisor is financially strong enough to support the system it has in place today and the growth that is anticipated. The growth of the franchise is shown by Table 5 of Item 20 of the FDD, which indicates how many franchises are to be sold in the current year and following year. This analysis is important because it is usually a very difficult situation for franchisees when their franchisor goes into bankruptcy. Often the franchisees lose their business when that happens.
HIRE EXPERIENCED FRANCHISE LEGAL COUNSEL
This should be the final piece in your validation of the franchise opportunity. Hiring experienced franchise legal counsel is an important step in making sure you should move forward with the opportunity. An experienced franchisee attorney (like the attorneys at Lanard and Associates) review FDDs and franchise agreements routinely and understand this highly regulated and unique niche area of law. As part of the review process, we will explain to you your obligations to the franchisor and franchisor’s obligations to you. We will also tell you what is typical and what might be a concern.
The four steps to validate the franchise opportunity discussed in this article are critical to take before you invest your time and money in a franchise opportunity.