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How to Do Due Diligence on a Franchisor
To many of my clients, the easy part about becoming a franchisee is deciding what kind of franchise to buy. The hard part is finding the right franchisor to buy it from.
But it’s not impossible if you keep a few ideas in mind, the most important being that due diligence is a two-way street. Put another way, if you’re thinking about buying a franchise, you should expect the franchisor to take a good look at your background, your qualifications and your finances before taking you on.
If this doesn’t happen, beware. The franchisor may be a novice, and the opportunity could become a calamity. In addition, remember what Ronald Reagan said of the Soviets – “Trust but verify” – and do your own due diligence.
Trust but verify
Here are five pointers for carrying out effective due diligence:
- “Validate” your franchisor. You’ll find contact information for
current and former franchisees in the Franchise Disclosure Document
(FDD). Contact as many as you can – in person if possible, by phone
otherwise – and ask them what expectations they had when signing on with
the franchisor, what they know now that they didn’t know then, and what
advice they have for prospective franchisees like you. Not everyone will
be forthcoming, but probe for financial data and other details
illustrating their experience. Compare the information on the franchisor
in the FDD with that of industry leaders. Is your franchisor a player,
or a marginal copycat whose future may be doubtful?
- Look at history. Make sure that your franchisor’s executive team
knows franchising, not to mention the specific industry in which the
franchisor operates – for example, fast food. You can be a newbie, but
the people in the home office need to know what they’re doing. Do they
have experience with successful, growth-oriented franchisors or with
franchisors whose lifecycle has not met the test of time?
- Study the record. Litigation is a fact of life in the business
world, so don’t be alarmed to find that your franchisor has spent time
in court. If, on the other hand, the record shows a multitude of
allegations of fraud or failure to service the franchise system, hire
counsel to investigate whether the allegations are legitimate or merely
a franchisee’s knee-jerk reaction to an action to collect royalties or
fees. In any event, make sure that any pending litigation won’t impede
your franchisor’s ability to keep going, not to mention your own ability
to get going.
- Crunch the numbers. You put money at risk in becoming a franchisee,
and so does your franchisor. The FDD will contain detailed information
on your franchisor’s financial position. Study it carefully, if
necessary with professional legal or accounting help. The franchisor
expects you to be around for 5-10 years. You should expect the same.
- Be choosy. Franchisors depend on their franchisees for success, and the good ones follow a disciplined process in selecting new franchisees. Ask about your franchisor’s process and the background of its current franchisees, and if you don’t like what you see, choose another franchisor.