You’ve set your franchise selection criteria. You’ve narrowed down your choices. You’ve started talking to the franchises that look like a fit.
At this stage, you're looking to confirm that your top choice franchise is truly the right match for you. Or, you’re gathering more information so you can decide on one franchise out of a few finalists you have in mind.
This article describes the 6 essential steps to conduct your due diligence on prospective franchises.
1. Go to “discovery day”
For many candidates, a franchise’s “discovery day” is the gateway to learn all the nitty gritty details of the franchise, to meet the franchise’s representatives, and to get connected with experienced franchisees.
During a typical discovery day, you’ll meet with representatives from the franchise, including the franchise's development team, operations team, and current franchisees. You’ll attend presentations and workshops, where you’ll get an overview of the franchise and its business model, as well as information on how to start and operate a franchise location.
You’ll have a chance to ask questions and get answers from the franchise's representatives and other franchisees. In many cases, you’ll also get to tour a franchise location and see firsthand what it's like to operate a franchise.
Just as you’re scoping out the franchise, a franchise will be sizing you up as well. To put your best foot forward, I suggest you prepare answers to these typical questions:
- Why do you want to be a franchisee with this company?
- What makes you excited about the company’s future prospects?
- What is the company’s mission statement?
- What do the company’s core values mean to you?
- Where do you see yourself in five years?
Additionally, at least prepare a few questions to ask the franchise. As you'll remember from your earliest interviews, this is the best way to show that you’re engaged and serious.
You can save yourself a lot of time doing further research if you can manage to disqualify a franchise early on. So, feel free to ask some probing questions to gauge the business opportunity.
Be aware, franchises can be skeptical of candidates who are interested in making a lot of changes to their business model. At the same time, it’s important for you to feel confident that the business model will work for you, or that you can adapt the business model to work at the location(s) you have in mind. Be aware of this dynamic as you ask questions pertaining to any potential adaptations to the business model.
2. Talk to experienced franchisees
Talk to at least four franchisees. If you can, I recommend speaking with even more. It’s especially useful to seek out people who have started franchises in locations that have similar characteristics as the location you’re considering.
This will allow you to get a diverse range of perspectives and experiences from different franchisees who have operated the franchise in different locations and under different circumstances.
Here are some questions you can ask current franchisees to get a handle on what it’s like to be in their shoes.
- How long have you been a franchisee?
- Are you happy with your decision to invest in this franchise?
- How long did it take you to break even?
- What support and training has the franchise provided?
- How much money have you made as a franchisee?
- Have you experienced any challenges or obstacles as a franchisee?
- What is your relationship like with the franchisor?
- Would you recommend this franchise to others?
If they’re not profitable yet, ask why. In most cases, this is a serious red flag.
Many franchisees are happy to talk about their experiences and they can provide a wealth of insights.
3. Meet with franchise representatives
Before agreeing to start a new franchise location, it's important to meet with several representatives from the franchise. These may include:
- The franchise sales representative. This person will be responsible for discussing the franchise opportunity with you and answering any questions you may have.
- The franchise's operations team. You might meet with people who manage marketing, sales, HR, and real estate. This team is responsible for providing support and training to franchisees. They can give valuable insights into what you can expect as a franchisee.
- The franchise's legal team. This team can usually answer any legal questions or concerns you may have.
After your meetings, it’s worth pausing to ask yourself: Do you feel you can work well with the people you’ve just met? Are they people you want to spend time working with?
While you won’t spend much time at franchise headquarters, you will want to have good working relationships with the people you’ve just interacted with.
4. Project your cash flow
Draw up a cash flow projection to see how many locations it will take to meet your financial objectives.
To prepare a cash flow projection for a franchise you're considering starting, follow these steps:
- Review the franchise's financial performance data, including any revenue and profit margins that are provided in the franchise disclosure document (FDD). This will give you a sense of the potential financial performance of the franchise.
- Identify the initial costs of starting the franchise, including the franchise fee, equipment and supplies, and any necessary renovations or construction.
- Estimate the ongoing costs of running the franchise, including rent or mortgage payments, utilities, salaries for employees, and other operational expenses.
- Project your expected revenue based on the franchise's historical performance data and your own market research.
- Use a Google Sheet or financial planning software to create a cash flow projection that shows your expected income and expenses over a set period of time, such as one year.
- Review and adjust your projections as needed based on your assumptions and any additional information you receive from the franchisor or other franchisees.
Cash flow projections are just estimates. They may not accurately reflect your actual financial performance. Don’t view them as a guarantee of future results. Instead, look at them as a tool to help you plan and make decisions.
More and more franchisors are including financial and statistical data in their disclosure documents. This has been a boon to prospective franchisees, as it’s now easier to make more accurate projections for local markets. However, not all franchisors provide this information, so you’ll sometimes need to gather data on your own.
Working with professional advisors with knowledge of franchising can definitely make this process easier and help you come up with a more accurate picture of a franchise opportunity.
Once you’ve built a cash flow model, take a moment to reflect: How does the model compare to the cash flow of your ideal business? Does it look like this business will meet your financial goals?
If yes, then proceed on to the next step.
5. Read the Franchise Disclosure Document
If you’ve completed all the steps so far, then it’s time to crack open the franchise disclosure document (FDD) and start reading the fine print. This document explains the franchisor’s responsibilities to you and vice versa.
Franchises that operate in the US are required to furnish candidates with a FDD at least 14 days before they ask a candidate to sign the document or pay any money. This time gives you the opportunity to peruse the document and have a franchise attorney look over it as well.
As you read through the FDD, I recommend that you highlight or underline details related to the following key information.
- The franchise's business model – how it makes money
- The initial franchise fee and any ongoing fees you will be required to pay
- The terms of the franchise agreement, including the length of the agreement and any renewal provisions
- The franchise's financial performance, including its revenue, profit margins, and any available historical data
- The franchise's support and training programs, including what they offer and how they are delivered
- Your obligations and requirements as a franchisee, including any restrictions on how you can operate your franchise
- The franchise's legal history, including any past or ongoing lawsuits or disputes
6. Review the FDD with your attorney
I know you want to wrap up, make your move, and get going.
But a franchise agreement is a significant commitment.
Even if you don’t think it’s necessary, I strongly recommend you hire an experienced franchise attorney for a few consultations.
When hiring a franchise attorney, you should look for someone who has experience and expertise in franchise law. This includes experience with franchise disclosure documents, franchise agreements, and franchise regulations. It's also a good idea to look for an attorney who has experience worrying with franchisees in the specific type of franchise you're interested in.
I suggest asking your attorney these questions about the FDD:
- Are there any provisions in the franchise agreement that may be unfair or unreasonable?
- What is the franchisor's legal history, and have there been any past or ongoing lawsuits or disputes with franchisees?
- Are there any red flags in the FDD, or potential concerns, that I should be aware of?
- What are the key terms and provisions of the franchise agreement, and how do they affect my rights and obligations as a franchisee?
- Are there any state or federal laws that I need to be aware of when entering into a franchise agreement?
The purpose of these discussions is to ensure that you understand the terms of the franchise agreement and that you’re aware of any potential risks.
Meeting with your own franchise attorney is critical to protecting your rights as a franchisee and avoiding costly mistakes. There’s a reason that franchises are required to allow at least 14 days for you to review the franchise agreement. So please, don’t ever allow your excitement or confidence in a franchise to cause you to neglect this process.
Conclusion
The steps we’ve discussed constitute your due diligence on a franchise.
Now that you’ve met with your attorney, how do you feel about the franchise you have in mind?
Are you feeling 90% good about it, or 100%?
If you’re not feeling quite confident, I recommend you continue looking at other options. As your franchise consultant, I’m always happy to meet with you and give personalized, free, no-obligation advice.
If you feel quite good about the franchise, and you want to move forward, then do a final check with yourself.
- Does this franchise feel right for you?
- Is the franchise going to satisfy your financial and personal goals?
- Are you satisfied that you made an informed choice, even if something goes wrong?
If the answers are yes, yes, and yes, then seize the opportunity!
You’ve found a fit. You’ve done your due diligence.
Nothing should hold you back now. It’s time to square away financing and make your investment.
This franchise is the one for you.