Editorial

Prospective Franchisees — Do Your Own Due Diligence Before Deciding Whether to Sign Up as a Franchisee

All too often, franchisees whose relationships have turned sour with their franchisors contact me and indicate that they exclusively relied on the franchisor’s representations before making their decision to sign up as a franchisee. Prospective franchisees should not do this. Instead, prospective franchisees should do their own research for purposes of corroborating the statements and representations made to them by the franchisor before signing up as a franchisee. This article discusses some steps that prospective franchisees can take to help ensure that they are not being oversold on prospective Franchise opportunities.

First, prospective franchisees should interview many current and former franchisees of the franchisor’s system. Do not just interview the ones that the franchisor suggests that you should contact. All too often, prospective franchisees are told by the franchisor which of the franchisor’s current franchisees that the prospective franchisee should contact for purposes of evaluating whether the Franchise Opportunity is good. It has been this Franchising attorney’s experience that these franchisors sometimes act unscrupulously and steer the prospective franchisee to only the best performing franchisees, and thereby cherry-pick the franchisees it wants the prospective franchisee to communicate with for purposes of putting the best possible face on the franchisor’s system. Be cautious prospective franchisees, and do not be led by the nose by the franchisor in this regard. Do your own due diligence.

Importantly, you should contact franchisees that have gone out of business. Find out what those franchisees’ experiences were, so that you can make an informed decision.

To help aid you in this regard, the Uniform franchise Offering Circular (“UFOC”), provided to you by your prospective franchisor, contains, at its Item 20, a list of franchisees in the franchisor’s system. For example, when speaking with these franchisees (including those that have gone out of business), find out if the franchisor helped the franchisee with finding its location. Additionally, ask if their financial performance is comparable to what has been represented to you as to what you could expect to achieve. Also, ask if the franchisor provided adequate training so that the franchisee could operate the franchise. These are examples and, as such, you should ask those questions that are most relevant to your particular situation. In sum, you should contact these franchisees for purposes of fully understanding the franchisor’s system, and the opportunity, in greater detail.

Second, it may be a good idea to hire an accountant when putting together your business plan, so that you fully understand where your money will be going. For example, royalties that will be paid to your franchisor will be “off the top.” In other words, you will pay royalties to your franchisor based off of your franchise’s gross sales—not its net income. Moreover, franchisors often require Franchises to pay various fees and use only approved vendors, which may dramatically increase the costs associated with your franchise’s operation if you do not properly account for those expenses. This is why it may be a good idea to hire an accountant, so that you fully understand the franchise opportunity.

Finally, it is a good idea to hire an attorney to review the UFOC and franchise agreement. An experienced franchise attorney knows what to look for in a UFOC and can help you avoid potential pitfalls contained in your franchise agreement. An attorney can help you negotiate more favorable terms and, potentially, save you tens of thousands of dollars.