When starting a franchise business, it’s important to carefully evaluate the franchisor before making a selection. A new franchisee’s ability to succeed relies heavily upon the quality of the franchisor’s business model and process, but also upon the franchisor’s expected longevity. An unstable franchisor can wreak havoc on new business owners, making a careful study of a potential franchisor critical to a new business’s long-term prospects.
One tool that can help franchisees evaluate a franchisor’s stability is the Franchise Disclosure Document (FDD). This substantial document offers franchisees detailed information about the franchisor’s organization, business model, and much more. To assess stability, the first four items on the FDD can provide important information about a franchisor’s background, litigation history, and financial history. Because past history is often the best indicator of future performance, all of these items are critical information when determining a franchisor’s stability.
Item 1 on the FDD focuses on the franchisor’s background. In this section, franchisees will find information about how long the franchisor has been in business. Operations that are relatively new tend to carry higher risk since their ability to sustain a profitable business over the long term is unproven. FDD Item 1 also typically contains information about a franchisor’s likely competition, providing insight into how much effort it will take to attract customers. An additional piece of information often found in Item 1 is whether there are any legal requirements unique to the franchised business. This information is valuable because it clarifies any costs or risks involved in purchasing a particular franchise.
Where Item 1 focuses on the history of the franchisor, Item 2 looks in detail at the executives of the franchise and offers information about their professional experience. Understanding the business backgrounds of a franchise’s executives is an important part of evaluating a franchisor’s stability because the more experienced the franchise leadership is in managing a franchise system, the more stable that franchise is likely to be. Item 2 will also explain how long each executive has been with the current franchisor, providing insight into how well the franchise attracts and retains quality people.
FDD Item 3 offers a detailed history of the franchisor’s litigation activity. This will include information about the criminal histories of company executives, particularly when it comes to felony fraud, violations of franchise laws, or deceptive practices. Of particular interest to a franchisee is information about any litigation related to the franchise relationship itself, and whether there have been claims made by franchisees against the franchisor. If there have not been many claims, that is a sign that the franchisor is honoring their franchise agreements. A low number of claims also speaks to a high level of franchisee satisfaction, another important sign of a franchisor’s stability.
To obtain the financial history of a franchisor, FDD Item 4 is one of the best resources available. Item 4 offers detailed information about recent bankruptcy. In particular, Item 4 explains whether or not the franchisor, its predecessor, affiliates, or any of its executives have been involved in a recent bankruptcy. The absence of any recent bankruptcy activity is a critical indicator of stability, and points to a franchisor’s ability to deliver the promised support services. Other indicators of good financial stability are the franchisor’s financial statements, which should be examined carefully.
The information provided in a franchisor’s FDD offers key information about the franchisor’s history, financial track record, and overall stability. A careful study of each section of the FDD is necessary to determine whether the franchise is a business venture worth taking. While there are no guarantees, a careful evaluation of a franchisor’s stability can significantly increase a franchisee’s chances for long-term success.