Red Flags to Watch for When Buying a Franchise

RochelleBailis by Rochelle Bailis on June 25, 2014
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A franchise has a better chance of succeeding than a business started from scratch, according to the U.S. Small Business Administration. Many franchises become successful, long-lived businesses, but there are a few things to watch out for to avoid getting a bad deal on your new business

Franchises That Discourage Discovery

By federal law, the franchising company must provide a potential buyer with a disclosure document. Part of the official Franchise Disclosure Document is a list of current owners of the company’s franchises. You will be able to see the number of franchises that are currently in business and the number that have closed. Some franchise companies provide buyers with a customized list of franchise owners that they encourage you to call as part of your discovery process. While this isn’t a bad practice, there are some that discourage buyers from calling anyone else. This gives them the opportunity to push the successful owners as references and to cover up the ones who aren’t.

If calling other franchise owners or looking further into other aspects of the company is discouraged, there may be things that the company is trying to hide from you before the papers are signed. Read through the disclosure document carefully, and don’t be afraid to ask about any aspect of the business and find out anything you need to know.

Too Many Cancelled Franchises

The list of terminated franchisees can give you a good idea about how well the franchises do in the real marketplace. Franchises that have been cancelled, terminated or never renewed are common, but if there are a large number of them, this may be a serious red flag. Franchise owners who didn’t choose to renew their franchise likely had a good monetary reason for doing so. If there are a large number of terminations, there may be rules in place that will make running the business difficult.

To avoid a large number of non-renewed franchises, some companies will actually repurchase specific franchises that are doing poorly to avoid raising their number of non-renewals. If there are a large number of corporate-owned outlets, ask about how many owners those sites have had and whether they were repurchased by the company from other owners.

A History of Lawsuits

The disclosure document will have a comprehensive list of lawsuits filed against the company. It will also list lawsuits and convictions involving its executive officers in regards to the company. Take a look at the number of lawsuits and whom they involve. Are many franchisees suing the company? Are there any fraud or felony convictions against the executive officers? If there are many lawsuits against the company, it may not be sticking with its own agreements. If there are convictions against the executive officers, there may be serious trouble in the company’s past that can affect you as a franchise owner.

Disclosure Document Stalling

According to the U.S. SBA, a franchising company must provide a buyer with the disclosure document at least 10 days before contracts are signed or money exchanges hands. If the company gives you excuses about getting the document to you or will only give it to you in person, this is a red flag. If there are some of the red flags listed above on the document, the company may want you to read it while they are with you so that the worst aspects of it can be explained away. If you are stalled, you may not have enough time to read through the hundreds of pages of the document and to have your lawyer look into the disclosure before it’s time to sign.

RochelleBailis

Rochelle is an experienced business writer, marketer and researcher. She is currently the Senior Editor and Content Producer at Intuit.

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