Red Flags to Watch Out for When Buying a Franchise

Joel Libava
Tue, 10 May 2011 00:00:00 +0000

Thousands of people buy franchises every year. Some of them do a fine job and end up choosing great opportunities based on some very thorough factchecking. Others succumb to what I call “the bright lights.” They’re attracted to “turnkey” opportunities, which shouldn’t be confused with those amazing “ground floor opportunities” that are advertised online and offline. These are the people who skip right past the “really hard work and long hours” part of franchise ownership, and immediately go to the “now we can afford to stay in The Chairman Suite at The Bellagio, because we own 25 franchises” part.

Not only do some franchise buyers make really bonehead decisions based on what they think their life is going to look like a scant two years after they buy their first franchise, but (and you may find this hard to believe), there are actually people in the franchise industry who don’t care if the people who buy their franchises are being a little unrealistic, as long as they can get them to write a $30,000 check for the franchise fee.

Now, don’t get me wrong—I love the franchise industry. I love the fact that franchising has enabled lots of people to create wealth. It makes me happy when a downsized corporate worker makes the decision not to work for anyone else except himself or herself ever again.

I just want you to know that franchising, like any other industry, has its share of less than honorable people. This article is going to help you separate the good from the bad. But it’s up to you to get the facts before you invest in a franchise business. These five red flags will help.

Red flags to be aware of when buying a franchise

Red flag #1: The need for speed

Once you feel you’ve selected a franchise that makes sense for you, your due diligence should take anywhere from four to eight weeks. That’s from the time you have your first conversation with the franchise development representative to the time you sign the franchise contract and pay your upfront franchise fee.

If your franchise sales rep feels the need to push you into making a decision faster than you’re comfortable with, that’s a red flag. Tell him or her that you need to move slowly through this process, and that you don’t want to feel pushed. If your rep doesn’t switch to decaf after that, find another franchise.

Red flag #2: Sale prices

I’ve never been very comfortable with franchisors that discount their franchise fees. Whenever I see a franchise company advertising discounts on their upfront fees, I cringe; it reeks of desperation.

Now, I understand that everybody likes getting “a deal,” but I see it as a red flag and you should too. Buying a franchise can’t be about getting $5,000 off; it has to be about the fit. Can you see yourself being a successful franchisee of the concept that’s on sale? If so, consider buying it. If not, don’t. (Now, if a franchisor decides to discount the franchise fee for noble reasons, like to military veterans, I’m good with that.)

Red flag #3: The stall

I’ve seen cases in which the franchise rep avoided sending out the Franchise Disclosure Document (FDD) until the absolute last minute. Looking over the FDD is a critical part of franchise research. This 200-page document features important facts and figures about the franchisor, including background information on the executive team, contact information for current and former franchisees, company financial information, and more. The “more” happens to include litigation.

A common reason for holding back the FDD is a large number of lawsuits, usually of the franchisee-suing-the-franchisor variety. If a franchisor doesn’t want you to get your hands on the FDD until you meet them face to face, walk. There’s probably something that they want to explain to you (that is, “spin”) face to face.

More articles from AllBusiness.com:

5 Red Flags Every Investor Must Avoid

Keeping Customers Happy Without Giving Away the Farm

3 Biggest Challenges Every Franchisee Faces—And How to Overcome Them

How Long Does It Really Take to Open a Franchise?

10 Signs of a Great Franchise Opportunity

Red flag #4: Special franchisee lists

Some franchisors instruct their sales reps to hand out a list of specific franchisees that prospective franchise owners should call as part of their due diligence. I actually like this way of doing things; really good reps will make up a customized list of franchisees who have similar backgrounds and traits to the franchise prospect (that is, you.)

However, those franchisees should not be the only ones you call, or even meet in person. Get the FDD, and call lots of others, randomly. That’s how to get the facts. If a franchise rep discourages you from calling franchisees of your own choosing, it’s a major red flag. Is the rep fearful that you’ll hear something negative?

Red flag #5: Reps who downplay attorneys

Before you sign a franchise contract, which can lock you in for 10 years or more, find a competent franchise attorney. A good franchise attorney can help you decipher the FDD and the franchise contract. That’s because they are used to reading them, and they’ve even written a few themselves. Don’t use a general business attorney who’s “somewhat familiar” with franchise contracts.

If your franchise rep tells you that “you’re wasting your money, because nothing in the franchise agreement is negotiable” after you mention that you’re taking the FDD and/or contract to your own attorney before you sign it, ignore the rep. The contract may or may not be negotiable, but that’s not the point. The point here is for you to protect yourself. The rep’s not going to.

Do your due diligence

In general, you’ll find that our industry has some really good, really professional people in it. But this isn’t about them; it’s about you. Commit to getting the facts and tread carefully.

RELATED: Buying a Franchise vs. an Independent Business: What Are the Pros and Cons?