Before taking the financial and emotional plunge into franchise ownership, it is vital that you do your due diligence to ensure your future happiness – and avoid financial catastrophe. You will want to make sure that not only is the franchise you’re investing in financially sound,but that it’s also a good fit for your personality and interests, and that the franchise culture is one that you believe in. To get answers to your questions, you will need to do your research – which will include reaching out to other franchisees, and asking hard questions of the franchisor.
Once you’ve done your research and had all of your questions satisfied, you can make an informed decision about what’s right for you. Take your time and be thorough – this is a big decision!
Quantitative Due Diligence
The first thing that most prospective franchisees want to know about is the money side of things. How much is the initial investment? Also note the franchisor’s ongoing advertising fees and royalties. Those are the easy figures to determine, as they are found in the Franchise Disclosure Document (FDD) – which you’ll receive early on in your conversations with the franchisor (if you don’t it’s a red flag!). Your franchise consultant will help you tease out what’s important from the FDD – and provide you with resources to help you interpret what you are reading. Later in the process you will want to hire a franchise attorney to dig deeper, and protect you from any hidden minefields that may be buried in the fine print.
The harder questions are: How much can I expect to see in profits as my business grows? At what point will you break even? What are the bottom line net margins (EBITDA)? Those questions are NOT disclosed fully in the FDD, because the federal trade commission does not REQUIRE this information in what is called item 19 of the document. There will hopefully be some partial disclosures, but not full disclosure. This is partly because in every system there are differences in the way individual owners run their books. And partly because these franchises have attorneys – who recommend to their franchise clients that they don’t do anything that could open themselves up for lawsuits. And given that full EBITDA disclosures of ALL franchisees in the system is not industry standard (and frankly not practical to gather data for) the obvious legal recommendation is not to do so.
So how do you adequately discover this information? By a process called validation, which is simply calling numerous franchisee’s in the system and asking them! They are allowed to tell you anything, and most of them are happy to do so. The contact information for all current franchisee’s is required to be disclosed in the FDD – as well as those that have left the system in the last three years! So it’s easy but time consuming, and the most important step that should never be skipped.
Here are a few starter questions:
- What is your annual gross revenue?
- How did your initial investment compare to the franchisor’s estimates?
- What’s your favorite part of the business?
- What are some struggles you’ve faced or that you currently face in the business?
- Do you see returns for your contributions to the franchisor’s advertising plan?
- Do you feel like you made a good investment? Would you advise me or other friends and family to invest as well?
There are hundreds of similar questions you can (and should!) ask. Interview as many franchisees – and former franchisees – as you need to feel comfortable. Remember, if it doesn’t feel right, this may not be the franchise for you!
Qualitative Due Diligence
Equally as important as profitability and functionality is the culture of the franchise. Digging into the culture of a potential franchise will help give you an idea if you could be happy running it. When all is said and done, you want to make a sound investment and run your own business on your own time – but you need to be happy doing it!
For help finding the franchise that’s right for your personality and lifestyle, take our franchise match-up quiz! It can help you get started on your own franchise journey.