Playing It Right

Read the Cards

Once you close in on a serious prospect, talk to an accountant or other financial advisor who has experience representing small businesses. Go over the franchisor's financials together (Item 21), so you know whether the company is on firm or shaky financial footing. An attorney experienced in small-business law can advise you on the terms of the franchise agreement, making sure you understand the legal relationship, the restrictions imposed by the contract and whether you should insist on any changes before signing the agreement. Resist the natural inclination to save a few bucks by not hiring these rather expensive specialists. Consider their services cost-effective insurance.

When all the pieces fall into place, it will feel just right. The trick is working hard and researching an opportunity to pull those pieces together.

Red flags
Five warning signs that a franchise has problems:

  1. Weak financial statements: There's nothing wrong with a modest net worth in a franchisor, but it should tell you to look for some other track record indicating the company will be in business for the duration of your franchise relationship. Weak financial statements increase your investment risks.
  2. High franchisee turnover: If many owners have left the system in the past year, find out why. The UFOC guidelines require the franchisor to include a list of the names, addresses and phone numbers of everyone who left the system in the preceding fiscal year. Call a few, and ask why they left.
  3. No UFOC: What do you mean, "no UFOC"? The law requires it, no exceptions. Don't believe it if the company rep says "We don't have to give you a disclosure, because we are a private company," or "You won't receive a UFOC because you qualify as a 'sophisticated investor.'" Balderdash.
  4. Many lawsuits: No one knows how many is too many. Too many lawsuits in a system with a few thousand franchisees will be greater than in a system with only a dozen. Discuss the litigation listed in Item 3 with your attorney and the company.
  5. No franchisee recommendations: If the current franchisees do nothing but complain to you about the franchisor and the business they bought, re-evaluate.
It's Official
Fourteen states require franchisors to register before offering franchises, including:
StateAgencyTelephone Number
CaliforniaDepartment of Corporations(866) 275-2677
HawaiiDepartment of Commerce(808) 586-2744
IllinoisAttorney General(217) 782-2538
IndianaSecurities Division(317) 232-6681
MarylandAttorney General, Securities(410) 576-6360
MichiganAttorney General(517) 373-7117
MinnesotaDepartment of Commerce(651) 296-4026
New YorkDepartment of Law(212) 416-8211
North DakotaSecurities Commissioner(701) 328-2910
Rhode IslandDepartment of Business Regulation(401) 222-2246
South DakotaDivision of Securities(605) 773-4823
VirginiaState Corporation Commission(804) 371-9051
WashingtonDepartment of Financial Institutions(360) 902-8700
WisconsinCommissioner of Securities(608) 266-1064

Andrew A. Caffey is a franchise attorney in the Washington, DC, area; former general counsel of the International Franchise Association; and the author of Franchise & Business Opportunities.

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This article was originally published in the October 2003 print edition of Entrepreneur's StartUps with the headline: Playing It Right.

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