Buying a Franchise – The Importance of Due Diligence

What is Due Diligence?
A legal term that has taken on extra-legal meaning over the last seventy years or so, due diligence was originally coined in reference to the U.S. Securities Act of 1933.  Following the stock market crash in 1929, brokers were given some very specific steps to follow before being allowed to sell securities (stocks and bonds) to investors.  One of the causes of the Great Depression was the lack of adequate controls on Wall Street.  My, how things have changed!  Today, the broad concept of due diligence can be summed up by a more pedestrian phrase: “Do your homework.”

Due Diligence in a Franchise Setting
For anyone considering the purchase of a franchise, the due diligence portion of the decision-making process is probably the most important.  There are certain documents that a franchisor is required to provide, whether under federal or state statute, but that is not the only evidence worth examining.  Beyond what the parent company must provide, there are a number of other elements that demand careful analysis.  The steps outlined below are hardly all encompassing but nonetheless a great place to start.

Due Diligence Process – Due Diligence Checklist

  • Analyze your expenses – Compare what a franchise will cost against what you can afford to pay.  If you will you need additional funds, know ahead of time where they will come from and what your cost to acquire them will be.
  • Analyze the market – Examine closely the particular business you plan to operate and how well others in that field are doing; look not only at franchisees of the same company, but among the competition as well.  If you see stagnant or declining demand across the entire sector, this could be a serious red flag.
  • Shop around for an opportunity – Tie your skills and interests to the type of franchise that offers the best match.  Start by finding an industry in which you would be comfortable, narrow that down to an operational method you would enjoy (retail, wholesale, mobile, or work-from-home), and then compare brands within those parameters.
  • Investigate training and corporate support – Every franchisor owes its franchisees a certain amount of upfront and ongoing training, as well as field support.  Some take these steps more seriously than others.  For a simple business, a week’s training may be more than enough to teach you everything you need to know while, for a more complex model, a week at the home office will barely scratch the surface.
  • Visit other franchisees – Everyone who bought a franchise from XYZ Corp was once in your exact position, on the outside looking in.  Now that you are contemplating a similar purchase, you have the perfect source for insider information.  Many existing franchisees will tell you things the home office either doesn’t know about its operation or chooses to gloss over.  Hearing their personal stories can be the best go or no-go signal you will experience throughout the entire due diligence process.
  • Understand the paperwork – A franchisor is required to provide significant written material to a prospective franchise buyer, which should be closely examined prior to signatures being applied to documents and money changing hands.  Something called a UFOC (Uniform Franchise Offering Circular) describes in detail the franchise system on offer, how many other franchise locations are open for business, and profit-and-loss statements that illustrate the overall financial health of the parent corporation.  A separate franchise agreement will contain the rights and rules given to and enforced upon all franchisees within the system.  If you don’t understand what you’re reading, hire an attorney who can explain it to you in words of one syllable.

Once again – do your homework!

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