Operating A Franchise Business

6 Big Red Flags To Avoid When Buying A Franchise

Sometimes called “chain businesses,” franchises are licensed by parent companies to utilize their trademarks, operational methods and resources. In exchange for selling its products and services, the franchisee (i.e. the owner of the storefront) pays fees and royalties to the franchisor (i.e. the parent company). From fast-food restaurants like McDonald’s to hotels like Marriott, franchises offer entrepreneurs the opportunity to launch their own businesses without the high risk and lack of resources often associated with startups.

Of course, not all franchise businesses are created equal. To succeed, entrepreneurs must research potential franchisors thoroughly and keep an eye out for any operational problems or systemic weaknesses. The last thing you want to do is tie your fortunes to a sinking ship. Here are six red flags you should avoid when buying a franchise.

1. Lack of Disclosure

Also known as an FDD, a franchise disclosure document details the responsibilities of both the franchisor and franchisee after the sale. Along with fee and royalty details, the FDD may include important information about the franchisor’s financial history, including past bankruptcies. If you’re thinking of buying a franchise, a lack of disclosure in the FDD can be a red flag that the franchisor is trying to conceal certain facts. Additionally, an incomplete FDD can indicate that the franchisor is working without the assistance of a lawyer.

2. Lack of Existing Franchises

If a franchisor has been in business for several years, a lack of new or existing franchises can be a red flag for operational or other issues. Before you purchase a franchise, take the time to speak to current franchisees about their experiences, and be sure to review the unit information provided in the FDD, as high turnover rates can be a sign that franchisees are not happy with the franchisor’s performance. You can also review the statistics for some of the top-performing franchises in the U.S. for insight into what types of businesses to pursue and what types to avoid.

3. Too Many Legal Problems

When reviewing FDDs, lawsuits are a serious red flag. Whether the franchisor is suing the franchisee for overdue fees, or if the franchisee is the one bringing litigation, an abundance of legal issues may suggest future strife in your own relationship with the parent company. Do your research, and avoid opportunities in which franchisees seem less than pleased with their experiences. Make sure to also look for infighting within the parent organization, where one owner is suing another. If several franchisees are claiming fraud by the franchisor, you may be better off staying away.

4. Problems With Pricing

Want to ensure your new franchise has the best chance of success? Pricing issues, such as restrictions on suppliers, can have a serious impact on your ability to turn a profit. If the franchisor does require you to use its own products and services, take the time to ensure the prices are competitive with what’s currently on the market. Do not take the parent company’s word for it. It is your job to make sure that starting the business makes sound financial sense. Additionally, you should consult with existing franchisees to make sure supplies are delivered on time in order to avoid being left in the lurch.

5. Lack of Support

One of the perks of buying a franchise is that owners can benefit from the reputation and resources of the parent company. However, not every franchisor offers the same level of support to its franchisees. Before buying a new franchise, read the FDD thoroughly to learn the obligations of the franchisor. You should also find out how much aid other franchises are receiving. If other franchisees feel like they were abandoned after the initial training period, you can expect to receive the same treatment once you’ve signed.

6. Lack of a Strong Business Model

Before entering into a franchise agreement, it’s important to understand the business model of the parent company. Along with detailing basic operational protocol, a business model explains how a company will remain valuable to both customers and franchisees. If the salesperson seems overly pushy or confused about the organization’s operating procedures, or if a number of franchises have closed in recent years, it may be a sign that the franchise lacks a strong business model and is destined for failure. Also, look at the business models of the parent company’s competitors; the fact may be that the industry is changing and certain models are becoming irrelevant.

Start a Successful Franchise

Thanks to their established reputations and superior resources, franchises offer a number of benefits over more traditional startup businesses. However, potential franchisees should do their research and consider all the factors when choosing a franchisor. By taking note of the above red flags, you can select a franchise business with the best chance of success.

Chapter 8.
Red Flags To Watch For When Buying A Franchise 3 min read
Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.