Due Diligence When Buying a Franchise
Careful examination and research are pivotal to success when starting a franchise business. It's important to undergo a detailed inspection of the franchisor, develop a complete understanding of the franchise agreement, estimate the operating expenses, and assess a multitude of other factors that might sway your franchise investment.
This overview summarizes the necessary steps and considerations when carrying out this essential examination for a potential franchise opportunity.
Review the Franchise Disclosure Document (FDD)
At the heart of your due diligence process lies the Franchise Disclosure Document (FDD). This legal document, which franchisors must provide prospective franchisees, serves as an informative gold mine about the franchisor and the franchise system. It includes audited financial statements, initial franchise fees, the franchisor's business history, and more.
Reviewing the FDD is central to the due diligence process, as it allows you to understand the franchisor's operations and the potential risks and rewards of the franchise opportunity.
Review the Franchise Agreement
In addition to the FDD, it’s also important to understand the details of your franchise agreement. The franchise agreement is a legal contract between you and the franchisor that outlines the terms and conditions of your franchise business. It covers important topics like the length of the agreement, your rights and responsibilities as a franchisee, the franchisor's support and training programs, and the conditions under which the agreement can be terminated.
It's important to thoroughly review this document and seek legal advice from a franchise lawyer before signing the dotted line.
Assemble Your Cabinet: Advisors to Consult
When performing due diligence, it's not just about you navigating the complex franchise landscape. Often, seeking expert opinions can be immensely beneficial, particularly when navigating some of the complex documents mentioned above. Attorneys experienced in franchise law, accountants, and business brokers can provide crucial insights and guidance, helping you make an informed decision about your franchise investment.
These professionals can clarify complex elements of the FDD, advise you on the financial viability of the franchise, or even help you strategize for success. Don't underestimate the value of their expertise and perspective.
Understanding the Economics of the Franchise
The initial investment required to start a franchise is often clearly stated in the FDD, but there may be additional costs that are not immediately apparent. These can include ongoing franchise fees, marketing costs, equipment and supply costs, and more. As part of your due diligence you must fully understand these costs and ensure they fit within your business plan.
Understanding the local market for your potential franchise is key to your success. This involves assessing the demand for your product or service, the level of competition, and the performance of existing franchises in the area. It's also important to consider the location of the nearest competing franchise units and the impact they may have on your business.
The goal of every business owner is to turn a profit. As a prospective franchisee, you should have a clear idea of when you can expect your investment to start yielding returns. This requires a detailed understanding of your expected income and expenses and a realistic sales growth projection.
Get to Know the Franchise and Franchisor
Establishing a strong relationship with the franchisor is crucial for your success as a franchisee. This involves understanding the franchisor's business model, their support systems, and their expectations of franchisees. It's also important to evaluate their reputation in the franchise industry and their relationship with current franchisees.
Speaking with current and former franchisees can provide valuable insights into the day-to-day operations of the franchise, the support provided by the franchisor, and the potential challenges you may face. These conversations can be an invaluable source of information during your due diligence process.
Every FDD includes contact information for current franchisees under item 20 - use it.
Due Diligence Checklist
Create a checklist to ensure you cover all aspects of due diligence. This can include reviewing the FDD and franchise agreement, consulting with advisors, evaluating costs, assessing the local market, understanding the franchisor, and speaking with franchisees.
Review the Franchise Disclosure Document (FDD) thoroughly.
- Seek legal advice to understand the franchise agreement fully.
- Consult with experienced advisors in franchise law, accounting, and business.
- Assess the total costs of running the franchise, including both explicit and hidden costs.
- Evaluate the local market and the potential impact of neighboring franchise units.
- Create a realistic projection of when your investment will start to turn a profit.
- Understand the franchisor's business model, support systems, and expectations.
- Engage in meaningful conversations with current and former franchisees.
Get Ready to Buy
Conducting due diligence is an integral part of buying a franchise, and thoroughness is key. It can seem like an arduous process, but it's a crucial one that will significantly contribute to your venture's success.
With a detailed and thoughtful approach, you will be well-equipped to make an informed decision about your franchise investment, ensuring that you are not just buying into a business, but investing in a future that aligns with your personal and financial goals.
So take the time to explore, analyze, and consult before you plunge into the world of franchising. Your future business self will thank you.