11.29.2010

Tips for Investing in a Franchise

This is intended to be a general guide for anyone looking to buy a franchise. I will be providing steps you should take prior to signing your name to a franchise agreement. I will also explain the key points to review in a Franchise Disclosure Document (FDD).

1. Learn What You Can From Other Franchisees

Speak to as many franchisees in the franchise system as you can, asking them what they liked and disliked about the support and training they received. You should also speak to prior franchisees – people who have left the franchise system and ask them what they liked and disliked about the support and training they received from the franchisor. Both existing and former franchisees are listed as exhibits to Item 20 of the FDD.

2. Evaluate The Franchisor’s Financials

It is important to evaluate the franchisor’s audited financial statements which are contained in the FDD. The evaluation should consider whether the franchisor is strong enough financially to support both the system that is currently in place and the growth that the franchisor expects, based on the Item 20 charts. This is important, because if the franchisor is financially weak, it may declare bankruptcy and franchisees may still have to pay royalties, advertising fees and other on-going fees, but to a guardian, trustee or receiver in bankruptcy, and receive no product or support in return.

3. Read The FDD

You should read Items 1-22 of the FDD. It describes vital information about the investment you will be making such as the initial investment you will be making (Item 5), the on-going fees (Item 6), the likely costs you will incur to open up the business (stated in terms of a range in a chart in Item 7 of the FDD), the legal obligations that you will have to follow and other important information that the franchisor is required to disclose to you. The FDD is required to be written in “plain English” and not “legalese” for that purpose.

4. Retain An Experienced Franchise Attorney

Many people make the mistake of assuming that the documents cannot be negotiated, so they do not need an attorney. Or they assume that their local attorney or relative can represent them in reviewing and negotiating the franchise agreement. Both of these assumptions are incorrect. An experienced franchise attorney should do the following: 1) check that the trademark is federally registered (this is the cornerstone of your investment); 2) review the bankruptcy and litigation disclosures in the FDD (Items 3 & 4) for any red flags; 3) explain your obligations to the franchisor and the franchisor’s obligations to you; 4) review the franchise agreement to determine if there are concerns, red flags, or issues that need to be addressed; etc. An attorney who does not practice in this area routinely will not know what to look for in the franchise documents.

Posted In: Franchising
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