When buying a franchise, comparing competing franchise opportunities is an important part of the due diligence process. Too often, prospective franchisees choose a brand they want to pursue, and then they pursue it without gaining an understanding of whether there are better opportunities available.
In a previous article, we discussed five sources of information for comparing franchise opportunities. Here, franchise attorney Jeffrey M. Goldstein shares 10 tips for using these information sources to make an informed buying decision:
1. Franchisor History and Executive Experience
While franchisors are companies, they are companies run by people—and the people at the top matter. When comparing franchise opportunities, it is worth spending some time reviewing Item 2 of each franchisor’s Franchise Disclosure Document (FDD) to learn about its executives’ experience both with the brand and within franchising in general.
It is also important to review Items 3 and 4 of the FDD. In these Items, franchisors are required to disclose their recent bankruptcy and litigation history. If a franchisor has recently been through bankruptcy (or is currently going through bankruptcy), or if it has a history of litigation, this could be a sign that there are too many risks that are beyond your control.
2. Estimated Initial Investment
Generally speaking, similar franchise concepts should have similar initial investment costs. When comparing competing franchise opportunities, you can look at Items 5 and 7 of the FDD to see how much you will have to invest in order to open for business. Is one franchisor’s Initial Franchise Fee significantly higher than another’s? Are the franchisors’ Item 7 estimates vastly different? If so, why?
3. Royalties, Marketing Fund Contributions and Other Fees Paid to the Franchisor
As a franchisee, your royalties and marketing fund contributions will eat into your profitability. While there are some general standards within franchising, even one percent of gross revenue can make a big difference. Similarly, if one franchisor’s renewal or transfer fees are prohibitively high, this is a factor that you should consider when choosing which opportunity to pursue.
4. Registered Trademark Ownership
When buying a franchise, you are paying for three main things: (i) access to the franchisor’s system, (ii) the franchisor’s support, and (iii) the right to use the franchisor’s trademark. If a franchisor’s trademark isn’t registered, it isn’t fully protected—and this means that the franchisor could potentially be forced to rebrand during the term of your franchise. All franchisors should prioritize trademark registration, and if a franchisor’s principal trademark isn’t yet registered, this is a factor that is worth considering.
5. Designated Suppliers and Mandatory Purchases
In addition to royalties, marketing fund contributions, and other fees paid to the franchisor, the costs of using designated suppliers and making mandatory purchases can also limit your profitability as a franchisee. These types of purchasing restrictions limit your autonomy as well, and, for some prospective franchisees, they are enough to take potential franchise opportunities off of their list.
6. Territory Rights and Restrictions
Territory rights and restrictions often vary widely between competing franchise systems. As a franchisee, it is important to have adequate territorial protections—including protection against encroachment by the franchisor. When comparing franchise opportunities, you will want to carefully compare the territory rights and restrictions outlined in Item 12 of the FDD and in the franchise agreement. Along with the size of your territory, you will also want to consider factors such as:
- Is your territory truly exclusive, or just “protected”?
- Are there any exceptions to your territorial protections (i.e., for company-owned locations)?
- Are you restricted from marketing or selling outside of your territory?
7. System Size, Growth and Location
Along with ensuring that your franchisor’s trademark is protected, you will also (most likely) want to make sure it is recognizable within your geographic area. At the same time, however, you will want to make sure that your area is not already so oversaturated that you will be competing with other franchisees within the system. With this in mind, when comparing franchise opportunities, you will want to consider the size and location of each franchisor’s system, and you will want to consider each system’s recent growth (and each franchisor’s growth forecast) as well.
8. Financial Performance Representations (FPRs)
Prospective franchisees should take all financial performance representations (FPRs) with a grain of salt. Most Item 19 FPRs use limited data and are subject to numerous caveats and exceptions.
With that said, if a franchisor provides an FPR, it is certainly worth reviewing. If you are considering multiple franchise opportunities that all come with FPRs, you should analyze each franchisor’s data to ensure that you are comparing apples to apples.
9. Customer and Franchisee Satisfaction
As a prospective franchisee, reading reviews and speaking with current and former franchisees can provide crucial insights that you won’t get from the franchisor. In addition to reviewing each franchisor’s materials and speaking with each franchisor’s representatives, you should also seek out independent reviews and opinions from as many customers and franchisees as possible. You can find customer reviews online, and each FDD you receive should include current and former franchisees’ contact information as an Exhibit.
10. Franchise Agreement Terms
Finally, to make an informed decision about your choice of franchise opportunities, you will want to carefully review the franchise agreement terms. You should hire a franchise attorney to inform you of all contractual risks—including any risks that are unique to a particular franchisor. Hiring an attorney to conduct a franchise agreement review is a key step in the due diligence process, and it is essential for ensuring that you know what you need to do in order to keep your franchise.
Discuss Your Search with Franchise Attorney Jeffrey M. Goldstein
If you are searching for a franchise opportunity and would like help making an informed buying decision, we invite you to get in touch. We offer four tiers of franchise business review programs for prospective franchisees. To discuss your options with franchise attorney Jeffrey M. Goldstein in confidence, call 202-293-3947 or contact us online today.
