Franchises are growing in popularity. Many large names are aggressively advertising in the Phoenix Metropolitan market, brands such as Smoothie King©, FirstLight™ Healthcare, and Anytime Fitness™ to name a few. All seem to advertise great same store sales growth, tout their “global brand power,” and promote their superior product or franchise business model. Some advertise heavily to those wanting to “diversify their portfolio,” those interested in a “low cost, high performance” business model, or folks interested in “controlling their own destiny” or “becoming their own boss.”
Here are three sobering statistics. First, franchises fail at about the same rate as independent businesses (Forbes May 27, 2014, 13 Mistakes New Franchisees Make – And How to Avoid Them). Second, 20 years from their start, less than 20 percent of the franchisors will still be around (Wall Street Journal April 30, 2007, Why Franchisees Fail). Third, of the more than 200 new franchise systems established in the United State each year, 25 percent will not make it to their first anniversary (Entrepreneur April 11, 2016, Is Franchising a Fit for You?).
Many franchise concepts are fantastic fits for an entrepreneur; undoubtedly there is money to be made as a franchisee. However, many individuals unknowingly rush into a complex business deal with personal guarantees and long term consequences without ever understanding or appreciating the provisions that bind them. Many prospective franchisees fail to perform the necessary due diligence on the franchisor before entering into a binding contract. Legally, the franchisor is required to provide a Franchise Disclosure Document, commonly referred to as the “FDD.” While the FDD contains very important information that every franchisee should understand, here are three additional questions a prospective franchisee should always ask the franchisor when considering investing in a franchise.
- What is the current status of the franchisor’s first 10 franchise locations?
- What is the average franchisee first year capital contribution per franchise location?
- What are the liquidity and capital resources currently available to the franchisor?
Before entering any agreement, carefully review with a franchise lawyer both the franchisor’s FDD and their responses to the above three questions. Competent legal advice will help you avoid becoming a sobering statistic, and better assist your money making efforts as a franchisee.
About the Author: J. Alan Soelberg is an attorney practicing franchise and business law at Davis Miles McGuire Gardner. Mr. Soelberg has a unique perspective that comes from hands on, private sector employer experience. Prior to joining the law firm of Davis Miles McGuire Gardner, Mr. Soelberg worked in house for one of the largest single member QSR smoothie franchisees. There he gained invaluable practical legal and business experience, executing asset purchase agreements and franchise documents, supervising human resource administration, and overseeing all real estate and lease agreements. He saw firsthand how a thoughtful blend of both legal and business procedures reduced risk and complied with regulations, while maximizing business productivity.