Choosing the Right Franchise: Do Your Due Diligence
Congratulations. You've finally found a short list of franchisors that have made the cut. Unfortunately, your grand opening is still a long way off. "It takes a good two to three months of pretty focused energy for a franchisee to do adequate due diligence and come to some point of clarity," Omholt says.
Each franchisor will have a Franchise Disclosure Document (FDD), which will quickly become your best friend. Under the Franchise Rule, the FTC requires that you receive the document 14 days prior to signing any contract with the franchisor. You will need to study it closely, and be prepared to devote a significant amount of time to doing so—the FDD will typically be about 100 or 150 pages long (including attachments).
Here are some things to look for in the FDD, according to the FTC:
• What is the initial franchise fee? What are the ongoing royalty fees? Are there any other fees? (Some franchisees have to pay an additional marketing or advertising fee.)
• What are the rules and restrictions? Franchises have a number of controls to ensure uniformity, such as restrictions on goods and services you sell, suppliers, how you operate (hours, employee uniforms, signs, bookkeeping and accounting procedures), sales area (limited to a specific territory) and rights to termination and resale, and renewal.
• What is the franchisor's business background? How long has the franchisor been in business, what is the experience of the management team? Is there any history of bankruptcy?
• What is the franchisor's litigation history? "If you see a lot of litigation," Elgin says, "even if you don't know exactly what's causing it, it's not a good sign."
• Is there a financial performance representation? Some franchisors will include this earnings claim as item 19 in the FDD, which shows the average franchisee's revenue and profitability, according to Siebert.
• Find out what you're actually paying for. What type of initial training will I receive? What type of marketing and advertising support will I receive? What type of other support will I receive? (For example, will I receive an ordering system or point of sale system?) Will the support and training be ongoing, with monthly visits?
If you have any questions, be sure to ask your franchisor. It's always a good idea to meet with the franchisor in person to get a sense of their management style and to make sure you're comfortable with it. Ask them what the day to day life of a franchisee at their business is like, or what types of traits or skill sets they have found to most likely lead to success.
In addition to the actual FDD, be sure to evaluate the franchisor's business plan to really understand the concept and what drives customers in the door. The business plan should include a clear marketing strategy and detailed financial projections.
Don't be afraid to do some research on your own. You should look into what kind of competition there is for the business, as well as the failure rates, and any other special requirements. Falvey discovered that other air conditioning and heating duct cleaners tended to do poor work, so the market was ripe for a company that would do high-quality, professional work. He also discovered, however, that he needed to get special licenses in the state of New York to do the work.
Perhaps the single most important part of your due diligence will be talking to other franchisees. You can actually find their names and contact information in the FDD.
"If the other franchisees are not so happy, they will be the first to tell you where the franchisor fell down on the job," Siebert says. "You're going to want to get an objective source willing to say the good and the bad about these guys." You can also avoid scams.
Ask at least 10 to 15 of them about the training, the ongoing support, what types of returns they have made on their investments, and how much they were able to resell for.
"It's about avoiding the expensive mistakes," Elgin says. "That's why you're paying the fees. In theory, a franchise has blazed the trail already and created a track record of success that you can check ahead of time."
Dig Deeper: How to choose the right franchise location
Choosing the Right Franchise: Resources
Federal Trade Commission (FTC) Consumer Guide for Buying a Franchise
Franchise Business Opportunities and Franchises for Sale Directories:
Franchise Gator
Franchise Solutions
