New York Franchise Law Blog : Franchise Lawyer & Attorney Charles N. Internicola, Providing National Representation of Franchisees and Franchisors

Below are five steps / factors / issues that you should be considering and evaluating before investing in a franchise.  There are many more than five, but the following is a start.

(1) Due Diligence is Critical – If you are considering the purchase of a franchise it is critical that you conduct an in depth evaluation of both the franchisor and the potential franchise opportunity. Far too many franchisees just assume that if a franchise system has multiple franchisees, good looking stores and trade dress, that the franchise opportunity must be profitable. However “profitability” is not guaranteed and all franchises are not created equal. You must research and evaluate the franchisor, the franchise system and whether or not the franchise opportunity is a good fit for you.

(2) Thoroughly Examine the Franchisor’s FDD with a Qualified Professional – If you have already contacted a franchise company to inquire about your potential purchase of a franchise opportunity, chances are that you have been handed, mailed or emailed an extensive document referred to as an “FDD”. FDD stands for “franchise disclosure document” and is the legally mandated disclosure document that a franchisor must provide to you at least 14 days prior to your execution of any agreements or your payment of any money. The FDD is an important document that will serve as a significant resource to enable you to more thoroughly examine the franchise opportunity that you may be considering. The FDD will contain information about the franchisors management team, the franchisors “estimate” of the start-up costs that you should expect to incur and the royalties and on-going fees that you will be required to pay. FDD’s are important and before investing in a franchise you should hire an experienced franchise lawyer to review this document.

(3) Contact Existing Franchisees – One of the biggest resources that a prospective franchisee should consider is the opinion and experiences of existing franchisees. When evaluating a franchise opportunity, take some time to politely contact existing franchisees (choose a franchisee in another state or someone that you will not be in competition with), let the existing franchisee know that you are considering the purchase of a franchise and that you would appreciate it if they would speak with you about their experiences and satisfaction with the franchisor and the franchise system. Don’t just contact franchisees recommended by the franchisor – seek out the advice of as many independent franchisees as possible. Item “20” of the FDD titled “Outlets and Franchisee Information” should include a list of the existing franchisees and their contact information, so use the FDD as your starting point to identify franchisees that you should contact.

(4) Understand that Franchise Agreements are Negotiable – When a franchise opportunity is presented to a prospective franchisee, many times, the prospective franchisee is advised that the franchise agreement is “not negotiable”. Some franchisors and their sales staff may even take this approach a step further and advise that even if they wanted to change the franchise agreement that it would be illegal for them to do so. However, before you simply sign a franchise agreement and pay a franchise fee, you must understand that franchise agreements are indeed negotiable. It is not illegal for a franchisor to negotiate the terms of your franchise agreement. While you must be reasonable with your expectations about the franchise agreement terms that a franchisor may or may not be willing to negotiate, review the franchise agreement with your franchise lawyer and develop an approach to address and negotiate some strategic points that may enhance your rights as a franchisee. Some of the critically important franchise agreement terms that you should be evaluating with your franchise lawyer and potentially negotiating, include:

(a) Scope of your protected territory;
(b) Grace periods regarding the commencement of royalty obligations;
(c) Liquidated damages and liability for early termination;
(d) Renewal rights;
(e) Transfer rights;
(f) Cure periods for alleged defaults; and
(g) Potential "rights of first refusal".

(5) Sometimes the Best Decision may Be to “Walk Away” - It is critical that you remain “honest with yourself” during your due diligence investigation and the consulting with your franchise lawyer. That is, the franchise that you once believed to be a great opportunity (one that you were previously excited about and told your family you were purchasing) may turn out not to be what you expected. Sometimes in the excitement of this entrepreneurial venture you may be inclined to discount or overlook warning signs that should serve as a red flag. Understand that walking away from a franchise transaction, sometimes, may be the best business decision. 

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NYC Business Solutions (a division of NYC Small Business Services), the Manhattan Chamber of Commerce and the US Department of Commerce will be conducting and coordinating a seminar - "How to Buy Your First Franchise or Grow the One you Have" -  for both prospective and current franchisees.  

Seminar Date:  February 17, 2010

Seminar Time:  8:00 AM - 10:00 AM

Seminar Location:  110 William Street, 4th Floor, New York, NY 10038

Seminar Registration Information

 If you are considering the purchase of a franchise your best resource and asset will be "information". Information about the franchisor, information about your legal rights, information about your estimated start-up expenses and information about your rights and obligations as a franchisee.  My point being attending a seminar such as the one offered by NYC Business Solutions can only be helpful in this important decision making process.

Hopefully, you will also find our articles about  buying a franchise to be helpful. Good luck.

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When  purchasing an "existing business" (whether a franchised or independent operation) prospective purchasers are faced with the critically important task of conducting a "due diligence" evaluation/investigation of the business under consideration.  While there are many steps to the "due diligence" process and while many of these steps are the same whether the business is a "franchised operation" or an "independent location", one critically important distinction and factor that should not be overlooked and must be evaluated by the prospective purchaser of an existing franchise is:

"whether or not there is value in the franchise system?".

That is, as a purchaser, you must evaluate and determine what added value (i.e., profits and cash flow), if any, that you will be afforded by purchasing and operating a "franchised business" (and becoming a franchisee) as compared to a competing but "non-franchised" independent operation. When making this "assessment" you must recognize that there is tremendous variation and value between franchises - that is, some franchise systems add real value and advantages while some poorly run "franchise systems" simply drain the profitability of its franchisees.  When making this assessment, some of the factors that you should consider, include:

• Higher Sales Do Not Necessarily Equate to Higher Profits.  As a franchisee one substantial obligation that you will be undertaking will include the payment of "royalties" to the franchisor.  Since royalties are typically based on a percentage of your "gross sales" the franchised business that you are evaluating will most likely have higher operating costs than the non-franchised business.

• Not all Franchise Systems are Equal.  Some "franchise systems" are simply poorly run and ill conceived business operations that afford little, if any, value to its franchisees.   So, don't just "assume" that the franchise business that you are considering will be properly supported by the franchisor - ask questions, speak to other franchisees and evaluate the benefits of the franchise system that you are buying into.

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For the first time franchise or business purchaser "due diligence" is critical.  Although the term "due diligence" may sound odd or out of place, it simply refers to the "pre-purchase / pre-investment investigation" that you undertake before signing a franchise agreement  or business purchase agreement.  In his article "What is Due Diligence in Business Acquisitions" Ney Grant provides an excellent overview of this process.  In my book I describe a purchasers "due diligence" obligations, as follows:

A prospective purchaser must approach "due diligence" as a constant and continuing information gathering and evaluation process respecting each and every aspect of the prospective business and the business purchase transaction.

As the prospective purchaser of a franchise "due diligence" investigation should not be viewed as a mere formality but rather an important "life line" standing between you and the possibility of making a bad decision.  Keep in mind that that a good decision and a good due diligence evaluation may lead you to the conclusion that the franchise that you believed to be "perfect" and a "great opportunity" may not be right for you. Unfortunately the decision is not an easy one to make and, as a franchise lawyer, I advise my clients that you must check your emotion at the door and be prepared, if necessary, to "walk away from a deal".  From my clients perspective sometimes the best deals are the ones that never happen.

As a future entrepreneur there will be many opportunities available to you - take your time and make sure that you select the one that fits you and offers you an opportunity for success. If you are considering the purchase of a franchise and considering the steps that should be undertaken in the "due diligence" process, I strongly recommend that you review our due diligence articles.

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When purchasing a business or franchise, your lease agreement will serve as one of the most influential factors in determining the profitability of your new business.  In states such as New York and New Jersey where rents are higher, paying particular attention to your rent factor is critical.

When the business that you are purchasing is a franchise, some additional lease agreement "due diligence" factors that you should consider, include:

• Is the Lease a Sublease. Whether or not the lease for the business premises is transferred to you directly (as the purchaser of the business and the new franchisee) or if the lease is held by the franchisor (as the direct tenant) and then to you, indirectly, as a subtenant. This is important because in instances where the franchisor has direct control of the lease, it is possible – if you breach or terminate the franchise agreement – for the franchisor to attempt to “step in” and take over the operations of the business that you are purchasing. Again, this concern only comes about in instances where you breach the terms of the franchise agreement;

• Is there a Lease Management Fee. Whether or not the franchisor charges a monthly lease management fee. This applies mostly in instances involving the franchisor’s sublease of the business location and constitutes, typically, an administrative monthly fee charged to you by the franchisor for being identified as the direct tenant on the lease;

• Restricted Lease Use Clause. Whether or not the leased business location may be converted to a non-franchised business location in the event of a termination of the franchise agreement; and

• Protected Territory. Whether or not the franchise agreement includes a protected territory (i.e., a specified geographic radius or map located within a certain proximity to the business location) within which the franchisor will not sell any additional franchises.

Your lease will serve as one of the most critical business assets that you will be acquiring, so you must get the terms right.  If the business that you are purchasing is a car wash or gas station in New York, Long Island or New Jersey your lease agreement due diligence must also include an assessment of the property for potential environmental conditions.

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In an earlier post I discussed the critical importance of obtaining an environmental assessment prior to purchasing a car wash or gas station.  In a recent transaction (where I represented a client purchasing a gas station business on "leased property") an issue was raised as to whether or not an environmental assessment is necessary when (a) the property is leased - and thereby not owned by the business purchaser, (b) the landlord agrees to be responsible for any pre-existing land contamination, and (c) the landlord maintains an environmental contamination insurance policy.

Basically, the question that has been raised is: "if I am buying the gas station business only (not the land) and the landlord is responsible for past contamination, do I still need to obtain Phase One Environmental Site Assessment?  

Answer: Yes, because even if the landlord is responsible for past contamination (i.e. the landlord will pay for the cost of remediation) as a business purchaser you nevertheless want to avoid contaminated property since any future remediation will require that you shut down your newly purchased business during the "clean up" process.  So even if the landlord or the landlord's insurance company is paying for the remediation costs, you will nevertheless lose thousands of dollars since you will be required to close your business during this process.  Another reason why you will require an environmental assessment is to determine a baseline as to the condition of the property prior taking over the station's operations - this will be critical to avoid future conflicts with your new landlord who may claim that you caused contamination that may have existed long before you.

For a brief but helpful review of insurance options that you should consider for a gas station business, Solomon Williams has written a helpful article on this topic.  As to why insurance is "vital" to your gas station business, Mr. Williams, offers the following summary:

Opening a gas station requires certain insurance policies. These policies need to cover everything from employee protection to public liability insurance as well as environmental and storage tank insurance. If you sell groceries or other items as well as gas then you should also include the necessary insurance for this type of business. The easiest option is to find an insurance company that will tailor a single insurance package to meet your needs.

However, while insurances will serve as a critical component to the overall success of your business, when purchasing a gas station you will nevertheless need an environmental assessment.

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Without question, successful businesses are dynamic, adapt quickly and succeed in "any" economic climate.  As a business lawyer, I have the benefit of working with and learning from hard working clients (with businesses large and small) who, time and again, rise to the challenge, accept the economy for what it is, make the necessary investments and take the necessary steps to adapt and succeed. Instead of hearing complaints about the economy or bad luck, they focus on expansion, the refinement of business systems and adding customer value.

Law is a business that is governed by the same set of "business principals". That is, to be successful, a law firm must be driven toward continuously developing and improving the critical systems and legal skills/assets necessary to consistently deliver "client value".  

So How do you Achieve Client Value?

"Client Value", as a matter of fundamental business principals, can only be achieved by evaluating the interaction and balance between (a) the legal fees charged , (b) the timeliness of the legal services rendered, (c) the quality of the legal services rendered, and (d) the priority of the legal project as measured by the significance of the client's business systems and/or goals that are supported or protected by the underlying legal services.

Basically, no one factor tells the story and only by combining a clear understanding of the clients business, business goals and business systems can a law firm deliver "valuable" legal services that balance all four factors.  Some examples to consider:

• Value cannot be achieved by a low legal fee if the legal services rendered fails to address or recognize future litigation contingencies that although not certain could be addressed and mitigated today;

• Value cannot be achieved by excellent legal services, if they result in high fees on a project or legal matter that will have little significance to the clients business or liability exposure;

•  Value cannot be achieved by moderate legal fees if the legal services do not meet the time line necessary to actually support the client's business.

The Value of a Small Focused Law Firm and Why Many Large Law Firms Can't Compete?

Today, with the specialization of legal skills, the expansion of technology resources and the refinement of business systems, the "experienced" small law firm or lawyer that possesses specialized and tested legal skills possesses a unique ability to deliver and offer a "client value" proposition that cannot be matched by the large firms. This is due to (a) the ability of the specialized lawyer to deliver a work product equal to or better than the large law firm, and (b) the imbalance caused by the large firms extensive overhead and the financial resources and salaries committed by large law firms to "inexperienced associates" - associates who will be working on your legal matters. 

What I am proposing is not universal (i.e. there are many large firms that I have witnessed deliver excellent value for particular matters) and that you should not decide on the retention of a law firm based solely (or primarily) on the size of the firm or the number of lawyers . Rather, focus should be placed on the skills of the individual lawyer that you will be working with and what factors the lawyer evaluates in delivering legal services and measuring "client value". My Bet, the specialized and experienced "small firm" lawyer will win this balancing act every time.

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When purchasing a business or franchise, in most instances, one of the primary assets that you will be acquiring is the "lease" to the existing business location / store that you are "buying".   A few of the many obvious reasons as to why your lease agreement will be crucial, include:

• Profitability - The monthly rent and "additional rent" will directly impact your profits;

• Permitted Use of the Business Premises - The lease "use clause" will restrict the the products / services that you will be permitted to sell / offer - including your ability to expand your products / services in the future.  For example, if you are leasing a gas stations, does your lease permit you to add a car wash or convenience store in the future? If you operate a soup franchise does your lease permit the addition of ice cream or similar products that a franchisor may require for product diversification?

• Assignability - The lease agreement will specify and determine your future right to sell your business and assign your lease to a third party purchaser.

Recognizing the obvious importance of the "lease assignment", as a purchaser, at the outset of your proposed purchase transaction, it is critical that you communicate with the landlord and obtain the landlord's written consent to your purchase transaction and the expected operations of your business.  The landlord’s consent must be identified as an express contingency specified in your purchase agreement and, among other things:

(a) be in writing;

(b) be signed by the landlord;

(c) acknowledge the landlord’s approval of the assignment;

(d) expressly acknowledge that the lease is in “full force and effect” with no outstanding defaults by the seller; and

(e) acknowledge the amount of the tenant’s security deposit.

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In the face of a recession has come a renewed interest and focus on franchising and franchise opportunities. Faced with the uncertainty of "corporate life" and layoffs rendering hard working and educated individuals without employment, a spotlight has been placed on franchise ownership and the resources available to prospective franchisees.

So what do We Learn From Viewing Franchising through the Prism of a Recession?

• No Business is Recession Proof - Including a Franchise: In her timely and informative article "When Career Turns Down, Franchising is Option" career columnist Eve Tahmincioglu correctly recognizes that purchasing a franchise is definitely an option that "out-of-work individuals with money" should consider.  However, Ms. Tahmincioglu cites to Small Business Administration statistics and cautions would be franchisees that a franchise business (like any business) is not recession proof.  So what does this mean?  Nothing is guaranteed and do lots of research - explained in the next point below.

• Selecting the Right Franchise Requires Research: In an earlier post I urge (strongly) that before you purchase a franchise contact existing franchisees and ask them about their experiences.  This point is critical, however, in terms of the "information gathering process", the internet has helped franchise purchasers level the playing field.  In his article "Blogs Provide Insight to Would Be Franchisees" Wall Street Journal columnist Richard Gibson provides prospective franchisees with critical advice and, most significantly, an analysis of Blogs that offer business purchasers with great information and advice . So if you are considering the purchase of a business or franchise read Richard Gibson's article and check out the blogs, which include:

Blue Maumau, Franchise Pundit, Franchise Chat, Rush on Business, Unhappy Franchisee.  Other great franchise blogs include: The Franchise King, Franchise Pick, Franchise Essentials.

•  If You are Buying a Franchise "Only" because You Lost Your Job - Don't Do It: With the many rewards that come with entrepreneurship and owning your own business or franchise come many difficult questions, obligations and choices.  While your current employment status (or lack thereof) may be "one of many" valid reasons to buy a franchise it should not be the only reason - otherwise, you may make a bad situation worse. In my article "Can (or even Should)  you Buy a Business or Franchise to Replace a Lost Job?" I have attempted to address this issue and identify some of the additional factors that should be considered.

Although the "current" economic climate is difficult, there are, nevertheless, many opportunities for those looking to make a leap into the world of entrepreneurship.  However, before doing this, take advantage of the valuable information offered on the web by the franchise and business community.

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With the reality of layoffs unfortunately accelerating, "interest" in entrepreneurship is growing. Many hard working and educated individuals are asking the question: “should I replace my lost job with my own business or franchise". This is a critical question and yesterday I received an email (from an individual ordering a copy of my book "An Entrepreneurs Guide to Purchasing a Business") that emphasized the consequences of this question and the need to get the answer right. The following is the text of the email:

Thank you. I was laid off from [____] Financial Services 14 months ago. I am [__] and a senior I.T. project manager and cannot even get an interview - much less a job. I do not see any alternative to going completely broke other than to buy some sort of business. I look forward to receiving the book from you.

Regards,  R___

(Name, former employer and age removed to preserve privacy.  At present, for clients and readers of this site, you can receive a free copy of the book)

So, should purchasing a business be viewed as a solution to a layoff?

Unfortunately, the answer to this question is both "yes" and "no". “Yes” because small business and entrepreneurship, unequivocally, has been and will continue to serve as the financial life blood for millions of hard working individuals and families. “No” because entrepreneurship and small business is not right for everyone and unemployment, by itself, should not be the deciding factor. Not every small business is profitable and before you commit to buying a business or franchise, consider some the following questions:

• Do you possess sufficient savings, capital and/or loans necessary to:

(a) purchase the business;

(b) fund the initial day-to-day operations of the business - keep in mind that it may take a number of months before your business generates "profits";

(c) cover your "personal" expenses and obligations until the business starts generating "profits"

• Do you have the support of your Spouse and Family - as the owner of a small business you will be assuming a level of risk and commitment extremely different from that of an "employee". Your investment in a business will affect the financial stability of your family for many years to come.  

• Are you ready to "wear many different hats" - as the owner of a small business, different from being a specialized employee of a large corporation, you will be responsible for everything.

While entrepreneurship may be the right course of action and response to a layoff, your decision to take this step must be based on factors that go beyond your employment status and include an evaluation of your  financial resources, family support and individual skills.  For additional insight and information to assist you with this analysis, check out "So you Want to be an Entrepreneur" by Kelly Spors, "Downsized? Franchise vs. Corporate Employment" by Joel Libava, and my earlier post "From the Corporate Frying Pan into the Franchise Fire".

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Due diligence is essential to all business purchase transactions. However, when the business transaction involves the lease or purchase of property that may be contaminated (such as a gas station, "quick lube" and car wash), your due diligence must expand to include the additional task of obtaining an environmental study.

So where do you start?

• Add an Environmental Contingency Clause to your Contracts - Make sure that your purchase agreements (such as your asset purchase agreement, lease agreement and/or real property purchase agreement) include an "environmental contingency" clause  permitting you to order and obtain an environmental assessment and study of the property.  If contamination is found, the contingency clause should be drafted in a way that permits you to back-out of the transaction and, importantly, get your deposit refunded.

• Obtain a Phase I Site Assessment - Obtaining an "environmental assessment" is not a complex process.  This assessment, performed by a licensed professional is typically known as a “Phase I Environmental Site Assessment”. This initial assessment will review the history of the property and provide you with preliminary findings as to possible contamination. Depending on the results of the “Phase I” study additional studies may be required.

Keep in mind that when purchasing a business such as a gas station, "quick lube" and even car wash, typically, you will be leasing land or purchasing property that may have a long history of "industrial type" activity that may be contaminated.   Once you purchase the business - even if you did not cause the contamination - you could be stuck with a big problem created long-ago. Environmental assessments are readily available, affordable (relative to the investment of your life savings) and should never be ignored.

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(Great, a lawyer answering a question about whether you need to hire a lawyer)

Answer? Yes - but not right away.  

The competent advice and guidance of a franchise lawyer will serve as a valuable tool (one of the many "tools" that are required) to be utilized on your road to entrepreneurship and the purchase of a franchise.  The advice provided by your franchise lawyer should be based on practical experience and involve a detailed review of the proposed franchise agreement and franchise disclosure document (FDD) and be followed by negotiatios with the franchisor.  However, while hiring a franchise lawyer is critical, it should not be your first step.

So what do I mean by "not right away"?  The process of buying a business is not a "sprint" (at least it should not be) but rather an "endurance event" that will require you to seriously evaluate your individual needs, business skills and expectations.  Once you have made this assessment, you will be faced with the challenging task of finding a business that is both profitable and right for who you are and your skill sets.  This is no easy task and will require that you do significant research (tons of resources available on the web), communicate with other business owners, communicate with existing franchisees (to do this, see "Contact Existing Franchisees before Signing a Franchise Agreement") and, possibly, seek out the advice of franchise professionals.  Don't just pick or get stuck on one particular franchise model or limit your research to the information provided to you by the franchisor's salesperson.  Remember, first and foremost, what matters most to a successful franchise investment are "profits" that will be  measured by your ability to take home money to your family each and every month.  So question everything.  If the franchise sells soup, then question how you will earn "profits" in the summer.  If the franchise sells ice cream, understand how "profits" are generated in the winter.  If the franchise appears to draw long lines or generate large revenues, then question what percentage of  those long lines and revenues are converted into "profits". 

Once you have completed your own internal analysis and "business review" , thats when the legal advice and analysis becomes critical.  The franchise agreement that you will sign will serve as the blueprint and road map for your business for many years to come.  As such, there are many, many critical issues that you must address with your franchise lawyer.  Some of the many issues that you must discuss and evaluate, include:

• The franchise fee that will be charged;
• The continuing royalty that you will be paying on a monthly or weekly basis;
• Advertising fund fees that you may or may not be required to contribute to;
• Approved vendors and suppliers of the supplies and products critical to your business;
• The protected territory that you may or may not be granted;
• Buildout and lease obligations that you will be required to undertake;
• Many, many other issues.

In many instances, (contrary to statements by a franchise sales person that their franchise agreement is "non-negotiable") your franchise lawyer will be able to negotiate and implement modifications to your franchise agreement that will have a substantive impact on your franchise investment and increase the odds for your success.  In today's economic climate, my experience has been that franchisor's are more willing than ever to negotiate with new franchisees.  Even things like deferring "royalties" for a number of months.  

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This is a question that I get often from my clients.  However, since lawyers are not the most qualified professionals to answer this question  (compared to a business appraiser or specialized consultant) I am not the most qualified to answer this question.  That said, business valuation is key and must be discussed with your lawyer prior to committing to a purchase agreement. While I am emphasizing the obvious, this issue comes up daily and in many transactions purchasers become "attached" to the idea of becoming a business owner and entrepreneur and let their guard down as to valuation.  So while your lawyer can not value your business, you must be taking every step to do so - preferably with the assistance of a qualified business account and certified business appraiser.  All of this should be coordinated with your business and franchise lawyer whose job is to ensure that you (and your contract deposit) are legally protected during this review period / due diligence.  

Some important factors that a prospective business / franchise purchaser should consider:

• Due Diligence is critical - always insure that you thoroughly review the finances (tax returns, royalty reports, purchase order receipts and register receipts) of the business that you are purchasing to verify the earning claims of the seller.

• Conduct on Site Due Diligence - Don't stop at a "paper review", spend time "on-site" interacting with customers and sampling/measuring daily sales.  This is not asking too much and the attorneys can structure confidentiality agreements to protect the seller and encourage him or her to provide you with access.

• Include a Due Diligence Contingency Clause - If your financial review/due diligence cannot be completed prior to signing the business purchase or franchise agreement , then ensure that your agreement includes a "due diligence contingency clause" enabling you to complete your review and back out of the agreement if necessary.

• Coordinate Communications - Ensure that your attorney, accountant/valuation professional speak and coordinate their activities. 

• Remember that Profits (not gross sales) are Key - This is an obvious point but one that should be emphasized again and again.  The most important factor to you will be how much money you get to take home to your family on a weekly or monthly basis and not the gross sales of your business and how much you paid the franchisor in royalties.  So don't get enamored with gross sales, pay attention to the recurring expenses of the business.

Essentially, leave no stone unturned.  By the way there are a multitude of valuable resources out their, always be circumspect, but check them out, i.e., www.franchisepick.com, www.thefranchiseking.com, www.unhappyfranchisee.com.

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You have identified a franchise concept that you are extremely interested in.  You have met with the franchisor’s sales staff, completed an application and are impressed, so far, by what you see. However, before taking that next step, before paying a franchise fee or signing a franchise agreement, contact existing franchisees to get the “inside track”. 

Where do you get existing franchisee information?  In the franchisor’s disclosure  document (also known as the “FDD” and formally known as a Uniform Franchise  Offering Circular) that must be provided to you by the franchisor at least 14  calendar days prior to you signing a franchise agreement or paying any fee to  the franchisor.  The FDD is an extensive document and, quite frankly, one of the few “life-lines”  that will be available to help you make a true assessment of the franchise opportunity that you are considering. The legally mandated information contained in the FDD, and thereby disclosed to you as a prospective franchisee, is extensive, extremely relevant and should be reviewed with both a franchise lawyer and business accountant.  However, sticking to the point of this article, that is obtaining information from existing franchisees, please know the following:

• Item “20” titled “Outlets and Franchisee Information” should contain extensive information about (a) existing franchisees - including their names, addresses and contact information, (b) the number of franchise outlets in operation (at least as of the date of the FDD), (c) the number of franchise outlets that are expected to open within the next fiscal year, and (d) the number of franchise outlets that were closed, sold or terminated in the last fiscal year;

• Contact existing franchisees (not just the “star” – multi-unit franchisees who the franchisor suggests you speak with) and politely ask them about their experiences as a franchisee, the support given to them, the quality of the product (or service) and, if possible, the cash flow and profitability of the business;

• Pay particular attention to the number of franchise outlets closed, terminated or sold during the past year.  If there are a significant number (relative to total overall outlets) of closed, terminated and/or sold outlets, proceed with caution and ask lots of questions. Please keep in mind that while it may be inevitable to have a few closed outlets due to a “franchisee’s mismanagement or lack of effort”, look out for a pattern of closings, terminations and outlet sales and do not just accept an explanation blaming a closed outlet on a franchisee’s lack of effort.  In many cases, a closed outlet may be a function of neglect by both the franchisor (in terms of support and product development) and the franchisee; and 

• If the franchisor is projecting a significant increase in the number of projected outlet openings (a projection that should be included in Section 20 of the FDD) question whether or not the franchisor possesses the managerial staff and infrastructure to properly support all of these new outlets.  

When purchasing a franchise, there is a lot to consider and, inevitability – like every entrepreneur, you are bound to make mistakes. However, by contacting existing (and terminated) franchisees you can learn from some of their mistakes and cut down on your own.

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