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Franchise Business Review Checklist
Written by: Patrick Findaro
I wanna go through an essential checklist you need, so today, I wanna share with you our franchise business review checklist. This checklist is really important for anyone that’s considering buying a franchise here in the United States. As you might know, the Federal Trade Commission regulates franchises in the U.S. And every franchise, before they’re sold to the public, needs to disclose a franchise disclosure document, also called the FDD.
How to review an FDD
Vital Review Checklist
☑ FDD Received
Number one on the checklist, you need to receive the FDD of the franchise that you’re investigating.
☑ Review of Item 3 (Litigation)
Now that you have the FDD, let’s start by first reviewing item three, which goes through prior litigation, current litigation against the franchise war, and any of the executives.
Before you enter into potential marriage with a business partner, which that’s what a franchise agreement is, is generally for 10 years, you better know if they have any skeletons that are somewhat exposed in their closet in the form of ongoing litigation or prior litigation. And that will be disclosed, again, in item three of the franchise disclosure document.
☑ Review of Item 4 (Bankruptcy)
Item four is gonna go over any prior bankruptcies that the executives, owners, the franchisor themselves have had.
☑ Item 6 Review (Other Fees)
Then going on to item six is gonna go through the fees that you’re responsible for paying to the franchisor to basically use their system, the branding throughout the term of the contract.
☑ Review of Item 7 (Initial InvestmentThe amount of funds necessary to begin operations of a business or franchise including the first three months of operation. Cost)
Item seven goes to the initial investment cost to open up that franchise. And it generally includes three months of working capital. Really important to understand what’s included in those initial costs.
☑ Review of Item 19 (Financial Performance Representations)
Then item 19, roughly 60% of franchisors in item 19 will disclose financial performance.
The fine print
Now, they might show just average salesThe total amount in dollars made in the business before expenses are deducted. See also Gross Revenue., median sales. They might even show the net income, the profit of the business. This will be in item 19. And it’s really important you read the fine print and understand that if they’re disclosing all franchises that have been operating over a year, or if they’re disclosing all their franchises or just a handful of corporate locations.
☑ Review of Item 20 (Total unit count, openings, closures, and transfers)
Item 20, I love diving into this section and seeing how many franchises have open, close, transfer rates, which can show churn in the system, the franchisor that recently acquired franchises. And you can also see this on a state-by-state basis. Again, that’s item 20, you’ve gotta check that.
☑ “Google Review of Principals / CEO / Leadership members until 3rd Google page – In the search please check “”lawsuit””, “”litigation””, and “”dispute”” along with the relevant name(s) of the executive(s)”
And then go on some easy third-party searches. You’ll be surprised what you see on Google searches. Check out 10, 20 of the locations, see what customers are reviewing, see what the average star rating is.
Google the whole leadership team, first and last name. Go at least five, six pages into Google to see their prior background and what things you might find in the public domain about the owners, executive team, and that exact franchise.
Google search
When you’re doing your Google search and review, you might wanna add in a litigation dispute. Again, you’re trying to uncover some red flags here while you might not wanna continue evaluating that franchise.
☑ “Google review of franchise name in the news. Litigation, issues, Yelp reviews (average rating, types of reviews) – In the search please check “”lawsuit””, “”litigation””, and “”dispute”” along with the relevant name of the franchise”
As, again, part of the franchise business review is reviewing the news released on that franchise. And you can do that through the Google News feature. Just search the name of the business franchise, and you should be able to get some news over the last few years from that franchise brand.
☑ Item 21 (Audited Financials)
And then item 21 in the franchise disclosure document goes through the audited financials. This is really important to understand the income statementOne of the major financial statements focused on a business’s revenues and expenses in a particular period. It is also known as the profit and loss statement. The income statement includes the gross profit, earnings before tax, and net profit.Tax Returns: The forms a business…, the balance sheetOne of the major financial statements for a business that reports a company’s assets, liabilities, and stockholders’ equity typically in that order. Assets and liabilities are also listed from most to least liquid., what’s the financial stability of the business, and what their projections might indicate for the coming years based on the historic.
You’re gonna wanna look through these financials, or at least have your advisor, your accountant, your corporate attorney review the long-term debt on the franchisor, how their net income or net loss looks for the prior three years, statement of cash flowThe net profit before taxes plus payments to the owner(s), interest, and depreciation of assets. is very important, also ownership breakdown of the franchisor, and see if they have related entities. Sometimes franchisors like to be clever and receive kickbacks or related entities, and this all should be legally disclosed in the franchise disclosure document.
Enhanced Review Checklist
☑ Latest current year and full prior year Income Statement (up to 3 years if possible)
☑ FY balance sheet of parent company for prior year (up to 3 years if possible)
☑ Long-term debt for the parent company – any debt besides credit cards?
☑ Statement of Cash Flows (only obtain if franchise)
☑ “Ownership % breakdown of parent company. Ask – do you expect any changes to this within the next 1-2 years?”
☑ Individual unit income statements & balance statements
☑ Tax return for prior year
☑ “Google Review of Principals / CEO / Leadership members until 3rd Google page – In the search please check “”lawsuit””, “”litigation””, and “”dispute”” along with the relevant name(s) of the executive(s)”
☑ “Google review of brand name in the news. Litigation, issues, Yelp reviews (average rating, types of reviews) – In the search please check “”lawsuit””, “”litigation””, and “”dispute”” along with the relevant name of the business”
☑ 5-year Pro-forma P&L for the proposed unit model
☑ Proposed employee organization chart for an individual unit
☑ Ask – do any of the executives or business has any settled, upcoming, or pending litigation we should be made aware of?
Conclusion
As part of this franchise business review, it’s really to see if there are red flags or yellow flags. So you should ask further questions, put it on hold, get your attorney, get your accountant more involved.
And if they pass through this checklist with flying colors, you still have some other things to consider
Part of that is asking questions… And part of the things that you should consider next is to get to book those conversations with actual franchisees.
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