Your status as either a potential purchaser or merely a curious member of the public partially determines the amount and quality of information you'll be able to discover about the financial performance of a specific franchise. Potential purchasers are able to find out about a franchise's financial performance via the Federal Trade Commission's (FTC) Franchise and Business Opportunity Rule. Under the Franchise and Business Opportunity Rule, franchisors are required to make a series of detailed disclosures to potential purchasers, either in the Uniform Franchise Offering Circular (UFOC) form or in the form provided by the rule.
There are three basic parts in a UFOC:
1) 23 sections that describe the aspects of the franchise program.
2) A set of the franchisor's audited financial statements.
3) A copy of every form or contract you will sign if you decide to purchase the contract.
The rule requires companies to include a list of the names, addresses, and telephone numbers of at least 10 recent purchasers geographically closest to a potential franchisee in their disclosures - this way, the franchisee can obtain legitimate references. Once you have this information, you will be able to contact recent purchasers and ask them questions regarding the financial performance of the franchise you are looking into.
Be aware that the FTC does not require that disclosure statements be filed. While franchisors do provide information to potential purchasers, they are not required to file that information with the FTC. It is possible, then, that only a potential purchaser would be able to obtain detailed information about a particular franchise. However, even if you are unable to glean information from the FTC because you are not a potential purchaser of a franchise, it may still be possible to find the information you're seeking if that franchisor has filed a UFOC. Fifteen states require franchisors to provide presale disclosures, and most of these states do not provide copies of these disclosures but permit review of the documents in person by appointment.
These states are:
California (filing required)
Hawaii (filing required)
Illinois (filing required)
Indiana (filing required)
Maryland (filing required)
Michigan (only notice required)
Minnesota (filing required)
New York (filing required)
North Dakota (filing required)
Oregon (UFOC filing not required)
Rhode Island (filing required)
South Dakota (filing required)
Virginia (filing required)
Washington (filing required)
Wisconsin (filing required)
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In the United States, all franchisors must abide by the Federal Trade Commission's (FTC) Franchise Rule, which requires franchisors to prepare a disclosure document called the Uniform Franchise Offering Circular (UFOC ) / Franchise Disclosure Document (FDD) and give a copy of that document to prospective franchisees prior to their purchase of a franchise.
The UFOC / FDD document consists of 23 different categories, which contain information such as basic investment, franchise fees, a financial statement of the franchisor and earnings claims (if the company discloses that information), how long the franchise will be in effect, bankruptcy and litigation history (including civil judgments and felony convictions) and information about the franchisor's executives (such as past experience).
There are fourteen "Registration States" that require franchise companies to file or register their franchise offerings with a state agency. These states are: California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin. These states (and Oregon) additionally have disclosure regulations similar to FTC regulations.
Several other states regulate the offering and sale of "business opportunities" via state business opportunity laws. Arkansas, California, Illinois, Iowa, Minnesota and a few other states regulate the termination of non-renewals of agreements. In California, Illinois, Indiana and Maryland, proposed ads must be pre-approved prior to publication.
As you may very well be aware, the government regulates all businesses, not just franchises. Regardless of what business you're going into, you'll have to find out what licenses and/or permits are required before you open that business. Such licenses/permits include a business license from your city's business license department; a fire department license (if your business uses flammable materials); air and water pollution control permits if you burn any materials, expel anything into sewers or waterways, or use products that emit gas; state licenses for certain occupations like auto mechanics, realtors, barbers and cosmetologists and educations ; a sign permit from your city or county; sales tax licenses from your state department and health department permits.
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It takes immense discipline and fortitude to survive a franchisor's bankruptcy. It's a good idea to have a plan to minimize any potential losses in revenue and reputation, just in case such an unfortunate circumstance arises. When armed with a plan, you're more likely to avoid disaster and consequently keep your business afloat.
The following are tips designed to help you get through franchisor bankruptcy:
- Heed warning signs: Hear a rumor? Investigate it. You do not want to find out the hard way - i.e., through a third party like a customer or the paper - that the franchisor is bankrupt, since doing so can compromise your rights and interests. If someone murmurs "bankruptcy," be on the alert. The worst case scenario is that you determine that the rumor is no more than a rumor, and business resumes as usual. Some signs are very subtle, so pay attention. For example, if your franchisor is collecting advertising money from you but you don't see any advertising happening, be on guard.
- Have a crisis communication plan: Make sure you have a public relations campaign that includes a crisis communication strategy - preferably, a strategy that includes several contingencies. For instance, if your franchisor goes bankrupt, the media and customers will be wondering if the business is in jeopardy. You want to be able to craft a quick response.
- Be sure to stay in touch with the local media: True, newspapers and media generally go straight to corporate headquarters for information - but don't let that deter you from establishing your own relationships with writers, reporters, producers, and news directors. This way, you'll be in a better position to field inquiries should disaster strike.
- Keep a list of alternative suppliers: Occasionally the initial problems occur with suppliers who may be nervous about getting paid. Moreover, if the franchisor can't provide supplies, a franchise must look elsewhere. Develop a list of viable and trustworthy suppliers to prepare for a possible distributer catastrophe situation.
- Maintain a stash of supplies: Your franchisor declaring bankruptcy could very well leave you with an inadequate amount of supplies. By keeping a surplus of items you may need, you can avoid this scenario.
- Ensure that the community is aware that you're independently owned: While you don't necessarily need to regularly remind your customers that you're independently owned, you do need to establish your business as a separate entity from all the other franchises. This can be accomplished by either letting fellow business owners know or becoming involved in the community. You want your business to feel as "local" as possible, because customers tend to favor locally owned businesses over nationally owned ones.
- Get the support of fellow franchisees: Moral support from your colleagues - even if they're also your competitors - never hurts. In fact, helping out your fellow franchisees in times of need could ultimately mean the difference between success and failure. If the distance between you and other franchisees isn't too great, you may be able to share supplies, which would help everyone.
- Consult a lawyer specializing in franchising: Consulting an attorney who has expertise in franchising could end up being invaluable in the case that your franchisor goes bankrupt. The time and money you put into hiring an expert is, simply stated, an investment in your future. A lawyer can educate you about your rights and help you concoct the right business plan for your business. You owe yourself this and more as a business owner.
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Because investing in a franchise is a life-changing event, every prospective franchisee should thoroughly investigate a franchise opportunity before signing any sort of franchise agreement.
While there are multiple websites and books floating around that outline the steps that ought to be taken in the interests of due diligence, you should take a minute to review the "red flags" we've outlined below:
1) Is the franchise salesperson putting on the pressure? One of the traits of a good franchisor is that it wants to make sure there is a mutually good fit before "closing the sale." Should you find yourself being pressured into making a decision but feel like you haven't been given adequate time to think everything through, don't sign an agreement. Frankly, the franchisor wouldn't be hounding you like that if the franchise opportunity were, in fact, spectacular or if there were, in fact, a long line of potential franchisees. What's more likely in a pressure situation is that the franchise opportunity is not that spectacular, their line is not that long, and, conversely, they need your money in order to make their payroll.
2) Do the salesperson's explanations not match up with what's in the UFOC? Is the salesperson making promises and/or commitments above and beyond what's written in the Uniform Franchise Offering Circular (UFOC)? If so, you should have the contract amended to include those promises. Remember: always get it in writing.
3) Has the franchise salesperson not followed through? Sometimes franchisors lead prospective franchisees through a bunch of hoops so they can better predict how the prospective will respond as franchisees. Just make sure that the franchisor keeps his word during this "courtship" period - if he doesn't, you'd be wise to not jump into marriage!
4) What do existing and former franchisees have to say? There's no better way to find out whether a franchisor has lived up to its promises and provided leadership to its franchise network than by conversing with current and former franchisees. Keep in mind that, while there are always those disgruntled franchisees that had unrealistic expectations to begin with, a large number of complaints among a set of franchisees signals a definite red flag.
5) Is there a history of litigation? Litigation is not, by definition, a bad thing - for instance, a good franchisor is willing to litigate in order to protect the brand in question. And there will always be a contingent of disgruntled franchisees that will blame the franchisor for their own shortcomings. However, excessive litigation is certainly a sign of trouble; if this is the case, dig deeper.
6) Are you uncomfortable with the level of training and support provided by the franchisor? Consider the length and composition of the program (all lecture or some hands-on experience?), the subjects to be covered, and the qualifications of the training instructors. If you're not sure whether or not you'll learn what you need to know to operate the business, look into the issue. Current franchisees are a good source of information: Did they learn enough via training to operate effectively? Did they get needed help on an on-going basis from a qualified support staff? Are you confident that the support outlined in the agreement can effectively assist you in managing your business?
7) Is the franchisor's financial stability questionable? You should have a franchisor's UFOC reviewed by a professional. While most franchisors have the best of intentions when they promise support, what matters is that they are able to ultimately provide the support you need.
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