As an attorney who represents individuals looking to invest in a franchise opportunity on a daily basis, I am often asked what are some ways I can lessen the business risk. I would suggest the following:
1. Speak to as many franchisees in the system as you can. They are your best resource as people who have been in your position and experienced what it is like to be a franchisee of this system. The list of all the franchisees in the system is in the FDD you were given. Call franchisees around the country randomly from that list. Depending on the number of franchisees, I would recommend calling 10-20% of the list. Do not use a list given to you by the franchisor; use the list in the FDD. Have a prepared list of questions to ask the franchisees, including, what they like and dislike about the support and training they received; do they think they are still getting value for the royalty payments that they made; would they invest in this opportunity again if they could do it over, and why; how long did it take them to get into the black; etc. You should also consider calling former franchisees and asking the same questions.
2. Read the 23 Items in the front section of the FDD. This is the information that the federal law requires be disclosed to prospective franchisees. There is a lot of very important information in those 23 Items and you should read all of them very carefully. In particular, you should focus specifically on the financial disclosures of Items 5, 6 and 7. Item 5 is the disclosure of the fees you will be paying the franchisor, or its affiliates, up front. Item 6 is the disclosure of the fees you will be paying the franchisor, or its affiliates, on an on-going basis. Item 7 is a chart, shown as a range of a high and low, that specifies the fees that you will be paying for various expenses needed to open up the business and the first few months following opening. I always recommend budgeting on the high end of the range so that you are not underfunded. For Items 5, 6 and 7, I would strongly recommend reading the footnotes to the Items, as well as the body of those Items. There are a lot of important facts in the footnotes of which you should be aware. I would also recommend that if you are planning on in any way relying on the Item 19 disclosure (Financial Performance Representation) that you also read through the footnotes to that Item.
3. Evaluate the franchisor’s audited financials. I strongly recommend having an experienced business accountant evaluate the franchisor’s audited financial statements contained in the FDD. A financially weak franchisor may lead to the bankruptcy of the franchisor, which leaves a franchisee in a very difficult, if not impossible, situation. Often, franchisees of bankrupt systems are not able to continue operation after their franchisor is in bankruptcy. The accountant should evaluate the financials in light of Item 20 of the FDD, which shows the number of franchises and the growth that is expected.
4. Retain experienced franchise counsel to advise you. It is imperative that you retain an experienced franchise attorney to evaluate your situation and the franchise documents on your behalf. Whether the franchise agreement is negotiable or not, having an experienced franchise attorney evaluate the opportunity is critical. The attorneys at Lanard and Associates can discuss with you whether there are concerns in the franchise agreement, whether certain terms are typical or not and provide you with a deeper understanding of the obligations you will have to the franchisor and the expectations you should have of the franchisor. Our attorneys can also set up your legal entity, and for brick and mortar franchises, review and negotiate the lease for your business.
For questions about a franchise document review, please contact Nancy Lanard, Esquire, 215-392-0030 x101 or via email at [email protected].