How to Evaluate and Select a Franchise

Once an entrepreneur has carefully weighed the pros and cons of franchising and has concluded that he or she wants to operate that type of business, the real work begins. A prospective franchisee must conduct thorough due diligence and consider many factors when evaluating franchise opportunities.

A franchise is an individually owned business operated as part of a large parent company. There are hundreds of thousands of franchise operations from which to choose. Even though most franchise systems have proven business models, success for every franchise operator is not guaranteed. It's up to the entrepreneur to judge which opportunities bode well and which do not.

Franchise expositions
One of the first steps in exploring franchise opportunities might be attending a franchise exposition. These shows provide the chance to discover and compare many different franchise systems at one time.

Before attending, however, it's a good idea to decide which types of franchises interest you. The event will be more productive if you have an idea of which franchises might suit your professional experience and future goals.

Visit the various booths, take notes, gather promotional literature, and ask plenty of questions, but avoid high-pressure sales pitches. Remember that the objective of the exhibitors is to sell franchises at the event. But don't feel pressured to make a commitment on the spot. It's important to investigate a franchiser before signing any contract or making a down payment.

Large versus small franchise systems
Opening a franchise with a big-name franchise system may offer a higher chance of financial success than a smaller, less well-known company, but the larger the system, more than likely the higher the initial investment will be. However, larger franchise companies usually do not have booths at these shows, unless it is one of the main features of the exposition.

Keep in mind that while smaller franchises may require smaller investments, they may also be more risky and their business models less proven. They require even more thorough investigation than a large franchise system.

Questions to ask
Once you've found a few franchise opportunities that interest you, there are many key questions to ask the franchiser either at the exposition or in follow-up discussions:

Financial strength - How well are the individual franchises doing? The financial strength of a franchise system's units is a good indication of how your franchise would do.
Upfront costs - How much is the total initial investment? Find out if you are required to lease property or equipment from the franchiser to get the business started.
Ongoing costs - What are the monthly expenses owed to the franchiser associated with operating the franchise? Are there ongoing costs based upon a percentage of revenues or other benchmark?
Suppliers - Are the franchises required to buy goods and services from certain vendors or the franchiser itself? Will they cost more than they would if you bought them elsewhere?
Regional protection - Will the franchiser guarantee not to sell other franchises in your area? Will you have the opportunity to open more franchises in your area?
Contingency - Are you allowed to sell your franchise if it doesn't work out? Will you be restricted from pulling out in any way? Are you permitted to pass the franchise to an heir?

Disclosure document
Before investing in a franchise opportunity, request a copy of the franchiser's disclosure document - sometimes called a franchise offering circular - and review it carefully. Under the Federal Trade Commission's franchise rules, a prospective franchisee must receive this document at least 10 days before signing any contracts and making any payments to the franchiser.

This document will provide the following details about the company:

background and management team;
litigation history;
financial history including all audited financial statements;
all costs involved in opening and operating a franchise;
restrictions on how a franchise may be run;
type of training provided to operate a franchise; and
conditions under which an agreement can be terminated.

The disclosure document also provides information about current and former franchisees, including contact information. Call or visit them and ask questions about the company.

Finally, before making a decision to invest, hire a lawyer and an accountant to review the disclosure document, franchise contract, and financial disclosures. They, and other financial professionals, can help you assess whether the investment makes sense for you, in light of your investment resources and goals. They can help you understand your obligations to the company and what reasonable expectations you should have of your new business.

Updated: January 1, 2013

This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.

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