An important part of deciding whether or not a franchise is right for you is investigating the Uniform Franchise Offering Circular (UFOC). Required by the Federal Trade Commission, this document discloses extensive information about the franchise, covering 23 subjects.
The UFOC should be reviewed carefully, because it provides information on some important points, such as your anticipated earnings. Franchisors aren't allowed to make earnings claims, so you must scrutinize the UFOC to get a good understanding of what kind of earnings you can expect.
Also look at the company's audited financial statements, because they can give you a big clue as to the average revenue of a unit.
"If a franchisor reports $1 million in annual royalty revenues and they charge a 10 percent royalty, then the total network volume is going to be $1 million divided by 10 percent, or $10 million," Siebert explains. "Divide that by the number of franchises in the system and that will give you the average reported revenue per franchisee."
Siebert cautions that the above formula is less reliable when the business is a new, fast-growing franchise, but it can give you a point of reference to consider.
Another thing to look for in the UFOC is current or past litigation against the franchisor. What is the nature of the litigation? Although allegations don't necessarily mean the lawsuit is founded, litigation is a red flag. Also make sure the franchisor hasn't been involved in a bankruptcy.
You can also find in the UFOC an indication of the financial strength of the franchisor to withstand a downturn in the market, as well as the franchisor's profitability and significant net worth.
The UFOC includes a list of all the franchisees currently in the system. Experts suggest contacting as many franchisees as you possibly can and asking them about their earnings and profitability.
Another critical item to examine is the franchisee-turnover rate. The UFOC lists how many franchisees have left the system in the last three years. If only one percent or two percent have bowed out, the franchise is probably a low-risk venture.
"If the amount of franchisees who have left is significantly higher," says Siebert, "then you need to start looking at the business from the standpoint of how much risk you are really taking on."
Finally, before signing, have a lawyer experienced in franchise law review the UFOC and related contracts to make sure you are getting a fair deal.