Knowing When to Run
As the old Kenny Rogers lyric said so well, "You've got to know when to hold 'em, know when to fold 'em, know when to walk away and know when to run." The song was referring to playing hands in poker, but the advice is also relevant to investigating a franchise opportunity.
There are many positive attributes you want to see in any franchise business you're considering buying, but there are also a number of red flags that should send you the signal that it's time to walk or even run to a different opportunity. The top 5 red flags are:
1. Litigation History. One of the things a franchise company is required to disclose to any prospective franchisee in Item 3 of the UFOC document is the history of litigation they've had with franchisees (learn more about franchise lawsuits here ). Obviously, you're going to want to examine both the quantity and quality of any such disclosures. As a general rule, if there's a lot of litigation, it's a red flag. Certainly any number greater than about one or two cases per 100 existing franchisees is considered a lot. You should also look at the issues being contested, because there's a big potential difference between an action instigated by the franchisor against someone who refuses to pay their bills versus an action instigated by a franchisee alleging fraud by the franchisor. You should also evaluate how current the litigation history is and the outcome of the cases that have been resolved in forming an opinion. If, after doing this analysis, you're not completely comfortable in relation to this issue ... run.
2. Unit Failures. Another thing a franchise company is required to disclose to any prospective franchisee in Item 20 of the UFOC document is the history of franchisees who left the system and the reason they left. (For more information on Item 20, read " Make Sense of the UFOC .") As a general rule, high turnover of franchisees is a red flag warning to you to dig further, because it could be an indicator that the business isn't consistently successful at the unit level. In a younger franchise system that has only been active for five to 10 years, you need to carefully investigate any significant turnover of franchisees. In a more mature system, you're definitely going to see more turnover and, assuming the turnover is from the resale of successful units to new franchisees, this is, in fact, a potentially positive indicator. In any system, a high turnover rate from termination of franchises is a big red flag. If you see this as an ongoing pattern in the franchise ... run.
3. Inability to Determine the Numbers. One of the most important questions you'll have to answer in your investigation of a franchise opportunity is how the economics of the business work at the unit level and how much money you can make in this business. Some franchises publish an earnings claim in Item 19 of their UFOC to give you a head start in this research. In all cases, you'll want to have a number of conversations with existing franchisees to broaden your knowledge and confirm whatever you've learned from other sources. Sometimes--and here's the red flag--it just seems impossible to get a clear and confident feeling for what the numbers are. Perhaps there's no earnings claim in the UFOC and you can't seem to find anyone, including the existing franchisees, willing to discuss this topic with enough credibility or specificity to satisfy your need to know. Regardless of the reasons, if you can't seem to get the information you need to determine the numbers at any franchise opportunity after digging and trying hard, this is definitely a red flag ... walk away.
4. Unhappy Franchisees. Perhaps the most telling indicator for any franchise system you're researching is simply the question: "Are the existing franchisees happy?" A plain fact of franchising is that if you find a preponderance of common opinion in the existing franchisees in any system, you can safely assume you'll probably end up feeling the same way if you become a franchisee in that system. This truth cuts both ways. If you're calling existing franchisees and they're all pretty happy with their business operation, with the financial returns and with the value they're receiving from the franchise company, you probably would be, too. If, on the other hand, you find that quite a few of them are unhappy--for whatever reason--then this is a real red flag, and the safest move for you (unless you covet unhappiness in your life) is obvious ... walk away. For a list of areas to investigate, read " Interviewing Existing Franchisees ."
5. Culture and Values Fit. It almost sounds trite, but it's vitally important that you meet and interact with the personnel at the franchise company so you can form a solid opinion as to whether, for lack of a better term, they are "your kind of people." This means you've determined that what's important to them is the same thing that's important to you. You believe that they're honorable, honest and committed to assisting you in becoming successful in your business, and that you feel comfortable with them and confident that you can work closely with them in the future without conflict. Not everyone or every culture is the same, and you need to make sure there's a good match for you in this area. If there isn't ... walk away.
As you're investigating different franchise opportunities, keep this list in mind. Following this advice will potentially save you from making a big mistake. When you find a franchise opportunity that doesn't have these red flags, you can proceed knowing you have a much greater likelihood of success.
Jeff Elgin is the "Buying a Franchise" coach at Entrepreneur.com and has 25 years of experience in franchising, both as a franchisee and a senior franchise company executive. He's currently the CEO of FranChoice Inc., a company that provides free consulting to consumers looking for a franchise that best matches their needs.