Investigating a franchise business: What does due diligence mean?

Embarking on a franchise ownership journey can be both exhilarating and daunting. You are looking at a business to see if it meets the things you want in a business. (We say this in general terms as there are a wide range of ‘things’ people want.)

Speaking of daunting, far too many aspiring franchise owners can get tangled up when it comes to dealing with the complexities of the Franchise Disclosure Document (FDD).?

This federally mandated document, presented to franchisee candidates during the due diligence process, is a treasure trove of information, revealing much about the franchise opportunity at hand. Yet, it demands a discerning eye to differentiate between genuine red flags and misleading alarms.

In this article, we’ll take a closer look at the FDD along with some potential situations that can be viewed as either an obstacle or an opportunity, depending on the circumstances.

Deciphering the FDD: A Closer Look at Red Flags

The FDD is the key document for franchise evaluation, but it requires a nuanced understanding. Some potential red flags, upon closer inspection, may not be as alarming as they initially appear.?

In fact, they might even signal hidden opportunities.?

That revelation begs the question: how do you differentiate between genuine concerns and misinterpreted signals?

The New Franchise Paradox

Contrary to popular belief, a new franchise brand is not an automatic red flag. Newer franchises can offer unique opportunities, such as lower franchise fees and prime territory choices. They often embody innovation and present a chance to shape the business direction.?

However, this comes with heightened risks, and demands a thorough review of the franchise model and leadership team. The people running it, and their experience, will make all of the difference. In fact, in every FDD is a history of the company and the people running it. Be sure to read this often skipped part of the FDD.?

Age is Just a Number: Young Leadership Teams

A young leadership team does not inherently signal trouble. Today's younger executives bring fresh perspectives and agility, often proving adept at navigating challenges.?

The key is to assess their track record and the diversity of the leadership team. Different experiences and backgrounds can bolster the strength of the leadership in fostering business success. Their business history is included in the FDD and you can always ask them about their history.

Lawsuits: A Common Franchise Reality

The presence of lawsuits in the FDD shouldn't be an immediate deterrent. Most established franchises have faced legal challenges at some point.?

The real concern lies in the frequency and nature of these lawsuits.?

Worth noting: You’ll want to be wary of franchisors frequently embroiled in legal disputes or those with government (or state) sanctions, as these can be indicative of deeper issues.

The Slow Growth Misconception

Slow growth in a franchise isn't necessarily a negative. For new business owners, a steady growth pace can be more manageable and less risky.?

Yet, it's crucial to analyze the growth pattern.?

A sudden halt or downturn in growth can be a warning sign of potential management issues or market misalignment.

Blank Items in the FDD: Not Always a Red Flag

The FDD contains optional items that might be left blank, such as financing options, celebrity endorsements, and financial performance representations.?

A blank space in these sections should not necessarily be alarming. In fact, it's often standard practice.?

For instance, many franchisors opt out of offering financing to avoid additional risks and complexities.

What to Watch for in Financing and Financial Representations

If a franchisor provides financing options, scrutinize the terms closely. Alternatives like Small Business Association (SBA)? loans might offer more favorable conditions.?

Similarly, if financial performance data is disclosed, approach it with a critical eye. This information, while valuable, may be selective and should be understood in its proper context. You can always ask more questions of the franchisor so that the data is clear to you.?

A Balanced Approach to Franchise Evaluation

Navigating the intricacies of the FDD and identifying true red flags requires a balanced, informed approach.?

Aspiring franchisees must learn to see beyond initial impressions and understand the nuances of each potential red flag.?

The journey to franchise success is paved with careful analysis, discernment, and a willingness to look deeper.

Ready To Explore Franchising? Let’s Talk!

Mack and Sharon Strange are on a mission as Franchise Consultants to help others go from “Start” to “Success” when it comes to franchise ownership.

If you’re curious about exploring franchising as a career pivot, investment vehicle or lucrative side hustle, let’s talk!

You can book a free, no obligation call with Mack here and/or a free call with Sharon here.

As Franchise Consultants, there’s no fee for our services.

Rather, our role is to serve as a trusted guide and educational resource, and we’re compensated by franchisors only if and when you decide to move forward with (and are approved for) franchise ownership.

Lastly, you can learn more about our story and how YOU can follow in our footsteps via the Franchise Together Podcast.

We look forward to connecting with you soon!