For potential franchisees, performing careful due diligence before signing a franchise agreement is one of the most important steps toward long-term success.  Franchising can offer a proven business model and brand recognition, but it also involves complex legal and financial commitments.  Below are several practical suggestions to help potential buyers approach the process thoughtfully and confidently.

​​

    1. Strongly Consider Working with a Franchise Consultant

     There are approximately 3,000 franchise system in the United States, and it is daunting to try to shift through so many possibilities and evaluate which ones best fit one’s needs.  A franchise consultant can do this heavy lifting for potential franchisees and help them narrow down options so they can find an opportunity that is synergetic with your goals, budget, and experience.  A good franchise consultant can bring invaluable insight, insider knowledge, and industry expertise to best help potential franchisees with their franchising journey.

​​

    2. Request the Franchise Disclosure Document (FDD)

     Once the list of prospective franchises has been narrowed, potential buyers should request the Franchise Disclosure Document (FDD) from each franchisor under consideration.  The FDD is a comprehensive, legally required disclosure that forms the foundation of the franchise relationship for years to come.  Buyers should ensure they have adequate time to review the FDD before signing any agreement, particularly since franchisors are required to update it at least annually.  Rushed decisions - especially those tied to territory availability or pending FDD updates - can lead to costly oversights.

​​

    3. Read and Understand the FDD

     The FDD consists of 23 distinct Items, each addressing specific aspects of the franchise system.  Reviewing the entire document is essential to understanding what is typical, negotiable, and potentially problematic.  Below are several key Items to pay close attention to (this list is not exhaustive, and consultation with an experienced franchise attorney is strongly recommended):

-  Items 3 & 4 - Litigation and Bankruptcy:
These sections disclose prior or pending litigation and any bankruptcies involving the franchisor or its affiliates.  Patterns of legal disputes or recent bankruptcies may indicate operational or financial instability.

-  Items 5 & 6 - Fees and Ongoing Costs:
These items outline the initial franchise fee and all recurring financial obligations, such as royalties, advertising contributions, and technology fees.  Buyers should have a franchise attorney cross-reference these sections with the Franchise Agreement, since some fees may appear elsewhere or under different terms.

-  Item 7 - Estimated Initial Investment:
This Item provides a range of estimated startup costs, but these figures are not audited or guaranteed so the actual investment cost may exceed these numbers (sometimes drastically so).  Actual costs often exceed projections, particularly regarding leasehold improvements and buildouts.  Prospective franchisees should speak with existing owners in comparable markets to understand real-world startup and break-even timelines, and also consult a financial advisor before committing.

-  Item 8 - Restrictions on Suppliers:
Franchisors often require franchisees to purchase certain products or services from designated suppliers.  While this ensures consistency, potential buyers should review whether the franchisor or its affiliates act as exclusive suppliers and whether they earn substantial profits from these required purchases.  Excessive markups may be a red flag suggesting the franchisor is deriving profit from supply chains rather than franchise growth.

-  Item 11 - Franchisor’s Assistance, Training, and Advertising:
This section describes the operational support franchisees receive, including initial training, ongoing assistance, and marketing programs.  Prospective buyers should assess whether the promised level of support is adequate for their experience level and business plan.  There may also be additional costs detailed in this item that are not detailed in FDD Item 6.

-  Item 12 - Territory:
Territorial rights and restrictions determine where a franchisee may operate and whether other franchisees (or the franchisor itself) may open competing locations nearby.  Territorial protection - or the lack thereof - can have a direct impact on profitability and long-term value.

-  Item 13 - Trademarks:
Since brand recognition is one of the primary advantages of franchising, it is crucial to confirm that the franchisor owns valid, federally registered trademarks.  Unregistered or contested marks can expose franchisees to unnecessary legal risks.

-  Item 20 - Franchise System Growth and Turnover:
This section provides data on the number of franchise outlets opened, closed, not renewed, or terminated over the last three years.  A stable system typically shows steady growth and reasonable turnover, whereas high closure or transfer rates may signal financial or operational problems within the network.

-  Term and Renewal:
Buyers should carefully review the term of the franchise agreement and the conditions for renewal.  Potential franchisees should also evaluate whether the term aligns with their long-term business goals and the term of a standard commercial lease (if the franchisee is considering a brick-and-mortar model).

​

    4.  Go to Discovery Day

     Potential franchisees should go to franchisor’s “discovery day” to better understand the system and get a feel for how the system works in practice.  However, note that these meetings are sales-orientated, and may not be the best way to learn “the good, the bad, and the ugly” about a system.

​

    5. Speak with Existing Franchisees

     Conversations with current franchise owners often provide the most candid insight into a system’s strengths and weaknesses.  Potential franchisees should ask about the franchisor’s support, profitability, marketing effectiveness, and real-world challenges.  These discussions can reveal how the system operates beyond the four corners of the FDD.  Click here to see a list of potential questions to ask existing franchisees.

​

    6. Consult a Franchise Attorney

     The FDD Items listed above are by no means exhaustive and there are many more obligations contained in the franchise agreement.  Consulting an experienced franchise attorney ensures that potential franchisees understand their rights, obligations, and potential risks, beyond the general business terms highlighted above.  Some examples include restrictive covenants, damages that a franchisor may be entitled to in the event of a breach, personal guarantees, what constitutes a default under the franchise agreement, to name just a few issues.  If you are serious about pursuing a system, a lawyer who focuses exclusively on franchise law can identify terms that are unusual, overly restrictive, or inconsistent with standard industry practices.

​

    7. Speak with a Financial Advisor

     Finally, I always recommend that my clients speak with a CPA or financial advisor regarding the financial information contained in the FDD so they can budget accordingly, although it is important to note that FDD Items 7 and 19 are not audited. 

 

Final Thoughts

     Franchising can be an excellent path to business ownership - but it requires thorough due diligence.  Taking the time to work with experienced professionals, analyze the FDD, and speak with current franchisees can help potential buyers make confident, informed decisions before committing to a long-term franchise relationship.