From the January 2010 issue of Entrepreneur

New franchisors are a high-risk proposition. They may become the next Baskin-Robbins or McDonald's, or they may go belly up before the ink is dry, leaving franchisees without a strong brand name or the economies of scale that come from being part of a big chain--not to mention their hard-earned investment.

Assessing the risk with a new franchise is harder, too: Much of the information about a franchise usually comes from existing franchisees, and with a new one, of course, that's hard to come by. On top of that, there are more new franchisors out there than ever before. In recent years, the number boomed, partly because of the growth of franchisor-packaging firms that help companies become franchise operations. In 2007, the trend's peak year so far, the International Franchise Association added 106 new franchisors.

It's too early to tell how those newbies will fare, but if you look back a decade, 25 new franchises were introduced in 1998, including major chains like HoneyBaked Ham and 1-800-Got Junk. On the other hand, according to the IFA, five franchisors from the Class of '98 still have fewer than 30 units. The IFA doesn't track franchisors that have gone out of business.

"A lot of the new ones never should have become franchisors in the first place," says franchise consultant Joel Libava of Franchise Selection Specialists Inc. in Cleveland. "They weren't ready. People should know that some franchise development companies will take any company on, and some of those franchisors never end up selling a franchise."

How can you tell if you're looking at a great ground-floor opportunity or a shaky foundation? By doing much more research than you'd ever do on an established franchise. Here is what Libava and Gordon Dupries, a San Francisco franchise consultant with FranNet, would examine closely:

  1. Check the track record. Start by asking how long the company has been in the business they are now franchising, Dupries says. Of the new franchises introduced in 2008, for instance, more than a dozen started their business that same year. That means the franchisor doesn't have a lot of expertise with the concept that it can share with franchisees, and that often leads to problems as it tries to support franchisees.
  2. Vet the management. Especially if the original concept is new, you'll want to know how much experience the management team has in the business sector it is franchising, Libava says. If the founders of a new retail franchise have never operated a retail business, they don't have a lot of expertise they can share about how to do it.
  3. Check the paperwork. Some new franchisors jump the gun and start selling franchises before they are legally registered to do so, Dupries warns. Or they may be registered in some states, but not in yours. Be sure the offer is valid where you want to open a unit.
  4. Read the financials. In Item 21 of the Franchise Disclosure Document (FDD), which all franchisors must file with the Federal Trade Commission, franchisors provide an audited financial statement that reveals their own operating costs and profits.

    "If I'm looking at a startup franchisor," Dupries says, "I want to make sure they have the working capital that's required to support their growth."
  5. Ask about the growth plan. Before you open a franchise in a young chain, Dupries notes, make sure your region is a priority for the franchisor. You may love the concept, but if you're in Arizona and the five-year plan calls for colonizing the Eastern seaboard, you're going to find yourself alone in your territory. You won't gain brand strength from having other franchisees nearby, and you won't be able to leverage advertising deals by pooling funds with those franchises.
  6. Inquire about training. One common problem with new franchisors is that training may be rudimentary--perhaps a day spent observing at the company store. But new franchisors should be hiring experienced franchise managers who can present a full training program. "I want to see a formal training program at the company headquarters," Libava says. "That's a big part of what you're paying the fee for."
  7. Talk to franchisees, if there are any. Your pool of possible sources will be small, but you still may be able to get critical information about the day-to-day realities. "Understand that if there are no franchisees, you're not getting the benefit of what franchising should offer--the ability to verify what you've been told by the franchisor," Dupries says. "If the franchisor says you'll need $10,000 in working capital, well, a franchisee might say, 'I actually needed $40,000.' And you'll never know."

    Libava suggests trying to form close relationships with the franchisees. If possible, meet them in person. "Realize they're crazy busy and don't have time to spend an hour with you on the phone," he says. "Ask if you can spend the day at their store, and tell them you'll pitch in."

    While you're there, ask about their experience with the franchisor. Find out what made them decide to purchase the franchise and whether they'd do it again, knowing what they know now. Find out if the franchisor is helpful and accessible when there are problems. "Make sure the first few franchisees are successful," Libava says. "If the franchisor isn't supporting these first ones, that's trouble."
  8. Take your time. The newer a franchise system is, the slower you should go in your research. Be wary of any efforts by the franchisor to rush you into signing on to open a franchise.
  9. Consider your background. Early franchisees of a new chain are often experienced entrepreneurs who don't need as much support as a first-timer would. That was the situation for HomeGamers franchisee Chris Guldi, who opened the company's first franchise in Waldorf Town Center in Waldorf, Md.

    Guldi, 36, had five years' experience owning a Keller Williams Realty franchise when he found HomeGamers while browsing franchise ads online. Last October, he opened his 6,000-square-foot HomeGamers store, which offers a mix of sports-team goods for tailgaters and playroom equipment such as pool tables. His store is near the original company store in Westminster, Md., so Guldi benefits from built-in customer awareness.

    Because he hadn't worked in retail, Guldi hired an experienced retail manager to run the store. He says he had a strong opening weekend, with six former Washington Redskins players on hand to sign autographs.

    Though HomeGamers has been in business only two years, Guldi was impressed that one of the co-founders had spent his entire career in retail management. Guldi was offered a weeklong training course to bring him up to speed. And, he says, his research showed a void in the market for a one-stop sports-nut/man-cave emporium.

    "This concept really appealed to me," Guldi says. "There wasn't one place where you could get all this stuff--team gear, pool tables, foosball tables, all of it."