5 Franchise Red Flags That Actually Aren’t

If you’ve been following this blog or just researching franchises on your own, you probably know about the Franchise Disclosure Document (FDD). This is a federally required document that franchisors must give franchisee candidates during due diligence . You should always read it carefully for any franchise red flags : signs that the opportunity you’re considering is not a smart investment.

Keep in mind, however, that some “red flags” actually aren’t. These are issues that might seem like strikes against a franchise, but in reality, they’re neutral – sometimes fine, sometimes not, depending on context. Some may even be signs of a hidden gem, so don’t let them distract you from a solid choice.

New Franchise Brand

Just because a franchise brand is new doesn’t mean it’s a bad choice. In fact, a new franchise brand can be an excellent opportunity to get in on the ground floor of something big. Newer franchise brands often offer special incentives for early adopters, such as lower franchise fees or first pass on new territories. You may also get more opportunity to influence the direction of the business.

What to watch for: Risk is higher with a new brand. They also might not offer the support structures of an established brand (though the support they offer is likely to be more personal). For those reasons, new brands are a safer bet for people with significant business experience . If you’re considering investing in a new franchise brand, take some key steps to help reduce your risk. Review the franchise model very carefully, take advantage of any opportunity to interview existing franchisees, and make sure the company has a solid leadership team.

Young Leadership Team

Like a younger brand, a younger leadership team isn’t necessarily a franchise red flag. Executives in their 40s or even 30s can still be extremely capable, especially if they already have considerable leadership or key qualities that make for business and leadership success. I’d rather collaborate with a 40-year-old who listens to their team, is smart about balancing operational needs with innovation, and has a clear vision for a company than a 55-year-old who thinks they’re the only smart person in the room, is constantly chasing the “next big thing,” and isn’t disciplined about executing toward goals.

What to watch for: Younger leaders should still have a consistent pattern of success, preferably in businesses or industries similar to the one they’re in now. Interview them thoroughly and pay special attention to how they talk about failure or challenges: have they learned from them, or do they try to pretend they don’t happen? Also look for balance and diversity in the leadership team. Numerous studies (such as this one from McKinsey) show that diverse leadership teams, even less-experienced ones, tend to make smarter decisions that increase the odds of business success.

Lawsuits

Items 3 and 4 in the FDD list any lawsuits brought by or filed against the franchisor. If this part of the document is empty, that’s a great sign. Most franchisors, however, have faced at least one lawsuit, especially if they’re large and well-established. It’s just the law of averages. So don’t run the other way simply because you see one or two items listed in this area.

What to watch for: Do avoid franchisors who have a history of frequent litigation, regardless of the reason or outcome. It can be a sign of unscrupulous business practices, consistently poor relationships with franchisees or vendors, or shaky finances. Be especially wary of franchisors who’ve been sued or sanctioned by government agencies such as the EEOC or FTC, since these entities usually only get involved in the worst cases.

Slow Growth

Your personal financial horizon may require you to find a franchisor that offers rapid growth. If your horizon is flexible, however, note that slower growth is not an inherent reason to walk away from a franchisor. In fact, slow, steady growth can be easier for inexperienced business owners to handle. It’s also lower-risk, which is ideal for owners who want a safer investment .

What to watch for: Along with the rate of growth, pay close attention to the pattern of growth. It’s normal for a franchisor to experience rapid growth in the early years, followed by a gradual change to a slow, steady growth rate as the company becomes well-established. But if a franchisor has been growing rapidly, then suddenly screeches to a halt or goes into a downturn, that’s a franchise red flag. It can signal poor management, overly ambitious expansion, or poor product-market fit, among other problems.

Blank Items

Franchising is an incredibly diverse industry, so not all items in the FDD apply to every franchisor. Items 10, 18, and 19 are considered optional and are often left blank. Let’s look at these one-by-one.

Item 10: Financing

If a franchisor offers financing options to help a franchisee fund their business , the franchisor must list those options and their terms here. However, it’s completely normal for franchisors not to offer financing, since it creates extra risk for them and complicates their financial situation.

Item 18: Public Figures

This item contains disclosures about any “public figures,” such as celebrity endorsers, who are involved with the franchisor. Celebrity buy-in has nothing to do with a company’s credibility or the quality of their business model, so a blank Item 18 is not a true franchise red flag.

Item 19: Financial Performance Representations

If a franchisor chooses, they can disclose information about franchise financial performance in this item. For instance, they might list the average profit of top performers or share profit-and-loss numbers from a selection of franchise locations. To avoid liability and protect proprietary information, however, more than half of franchisors leave this item blank.

What to Watch for

If a franchisor does provide information in any of these sections, read it carefully. And for Item 10, be aware that franchisor financing doesn’t necessarily offer the best terms. You’re often better served exploring alternatives such as Small Business Association loans.

If your franchisor completes Item 19, that’s a major mark in their favor. But remember that the information may be selective. Franchisors are at liberty to disclose any numbers they like, as long as the numbers are factual and they explain the source. Review the information carefully to make sure you understand the context, such as whether the numbers are averages or only from a specific subset of locations or owners.

No matter what, any information the franchisor does provide should be truthful. If you find evidence that a franchisor is misrepresenting the state of their business, or if they are not willing to answer good-faith questions about anything in their FDD, that is a true franchise red flag and a sign that it’s time to look elsewhere.

Trying to make a safe franchise investment? My co-consultant Lauri and I can help. We stay with you every step of the franchise process, so you can feel confident about your franchise choice. And our services are completely free! Book a 20-minute call with one of us to find out how we can help maximize your time and accelerate your journey to personal and financial freedom.

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This content originally appeared on https://empoweredfranchisee.com/ .