When you invest in a franchise, it’s important to keep in mind that you’re investing more than just money – you’re also investing your time, passion, and hard work. With the resources required to start and maintain your franchise venture, you’ll want to have a complete picture of the franchise opportunity before you sign on the dotted line of the franchise agreement. That’s where due diligence comes in.
“Proper due diligence occurs when a prospective franchisee investigates and evaluates a franchise opportunity, looking at everything from the total cost to the training programs offered to how well he or she fits with the corporate culture of the company,” says Lorraine McLachlan, President and CEO of the Canadian Franchise Association (CFA). “It’s essential that prospective franchisees ensure that the franchise is a good fit for them before making a commitment. A comprehensive investigation and evaluation is an important first step towards franchise success and fulfilment.”
Lyn Little, Senior Manager, Assurance and Accounting with BDO, says the due diligence process also allows prospective franchisees to determine whether they will be investing in a bona fide franchise opportunity, with all legal and financial requirements in order.
“It is important for a prospective franchisee to conduct proper due diligence, as this may allow the franchisee to identify potential red flags of the business, or indicators which may suggest that the franchisee should look at an alternate franchise system, or request reductions in the franchise fees, royalties, or other fees to the franchisor,” says Little.
When you’ve checked off every item on the following list, you should be ready to make an informed decision and be prepared to invest in the perfect franchise opportunity for you. Don’t forget to ask lots of questions, so everything is as clear as possible at every step of the investment process. For questions to ask the different people you’ll meet along the way, consult the Checklist for Franchisees.
1. Research the franchise system.
As outlined in the “How to Find the Right Franchise Fit” article, you should undergo a self-assessment, outlining your skills, assets, and abilities, before looking into specific franchise opportunities. Once you have a good idea of what you can contribute to your franchise business, you can create a short list of franchise systems that you want to research further. These systems should take the aforementioned strengths and abilities into consideration, along with your interests and passions.
You can start by heading online to review the system’s franchise website and any other information about the system available online. You can also conduct this research in-person by attending a franchise-specific tradeshow, where you can meet and speak with representatives of the franchise system, and/or by visiting one of the brand’s established franchise locations so you can see firsthand how the franchise operates in its market.
Some key factors to look for when researching franchise systems include franchisee selection, training, communications, marketing, problem-solving, rewards, and corporate culture. You’ll also want to evaluate the market, taking consumer demand, location, resale value, whether it’s an established or new and emerging system (and the pros and cons of each), and whether it’s a resale location into consideration.
2. Submit a completed franchisee application form to the franchise system.
Once you’ve started researching specific franchise systems, you can fill out and submit a franchise application form, which will provide the franchisor with important details about your background and experience, your financial information, and the skills you have to offer.
Keep in mind that as you’re conducting your due diligence, the franchise system will also be carrying out their own research to determine whether, based on their experience, you will be a good fit as a franchisee of their system.
3. Meet with current franchisees of the franchise system.
“You will want to talk to eight to 10 existing franchisees of the franchise concept that you’re most interested in. You will want to learn, from their perspective, what is required to drive success. You will also want to know a lot about their relationship with their franchisor,” advises Gary Prenevost, President of FranNet, Southern Ontario.
These franchisees should have different levels of experience, and should be chosen from franchise locations at different performance levels.
4. Meet with franchise system representatives (attend a Discovery Day).
You’ll get to this stage if you’re almost ready to make a purchase. You should be prepared to fly to the franchisor’s head office for a Discovery Day, where you will meet with their leadership team and get a final sense of whether the culture will be a good fit.
“Essentially, you are going there to look for reasons to say ‘no’ and hope that you don’t find any. You will not make a purchase decision while you are there, but usually within one to three weeks after you return, you should be ready to sign a franchise contract and pay the initial franchise fee,” explains Prenevost.
Most established franchisors have a franchise review process in place that clearly defines their practices and procedures to help prospective franchisees make informed decisions, so you can follow this process, asking any questions that come up along the way.
5. Build a comprehensive business plan.
A business plan lays out the goals of your franchise business, providing banks, investors, and lenders with an idea of the scope and specifications of the project in which you’re investing. This plan should include cash flow projections for the first three to five years your franchise will be in business, outlining the earning potential of your location and the strategy for achieving these goals.
Your business plan should start with a summary of the franchise you intend to purchase, including essential background information about the franchisor and their track record.
The financial section of the business plan should include your personal financial information, along with financial projections for your franchise. A realistic budget should also be provided, with details about the cash flow projections and profit and loss forecasts. The business plan should also analyze the marketplace, and should contain information about the products and services you will be providing, consumer demand, and the customers who will be looking for these products and/or services.
6. Consult with franchise professionals.
As you contemplate your franchise investment decision, you’ll want to enlist the help of franchise professionals, who can provide you with the guidance you need to make the right decision.
- A franchise consultant can help you identify your objectives as you carry out a self-assessment, help you understand the franchisee/franchisor relationship, introduce franchise opportunities that you may not have considered, assist in evaluating and analyzing opportunities, and introduce you to other franchise experts.
- A franchise accountant can help you pinpoint the profitability of the venture, and can also help you calculate the start-up cost, assist you in reviewing documents from the franchisor, advise you on the advantages and disadvantages of a franchise investment opportunity, and help you put together your business plan.
“In preparing to purchase a franchise, the prospective franchisee should look at fixed and variable costs to determine the break-even sales figure required to turn a profit. Understanding this figure, and the prospective market the franchisee will operate in, will allow the franchisee to determine whether the franchise location has the potential to generate sufficient revenues to cover costs,” notes Little of BDO.
- A representative from the franchising division of a bank can help you determine the financing plan that works best for you and your business, providing financial solutions that are tailored specifically to your franchising situation. A franchise banker can also be an asset when it comes to figuring out your financing requirements so you will be able to sustain your business in the long term.
- It’s also critical for prospective franchisees to enlist the services of a franchise lawyer, who can explain and elaborate on the details of the franchise agreement, and review and explain the disclosure document, specifically outlining what each party is expected to provide. A franchise lawyer can also help in negotiating any terms or conditions of the franchise agreement as required.
7. Review the franchise disclosure document.
In addition to speaking with the franchisor, existing franchisees, and franchise professionals, prospective franchisees should receive a franchise disclosure document once they reach a certain point in their investigation. An important part of a proper due diligence process, disclosure documents contain a summary of information on the franchisor, its executive team, and its franchise agreements.
In Canada, franchise systems are required by law to provide a disclosure document to prospective franchisees in provinces where franchise legislation is in place (currently British Columbia, Alberta, Manitoba, Ontario, New Brunswick, and Prince Edward Island). It’s important to fully review the disclosure document with your franchise lawyer and financial advisors to ensure that you understand the information it contains, including your obligations as a franchisee. Turn to the “Navigating Franchise Disclosure” article, which provides more in-depth details about the disclosure process.
8. Trust your own judgment.
Ultimately, you will be the owner-operator of your franchise system, so it’s essential that you be the one to make the final decision before signing the franchise agreement.
“Do not allow yourself to be sold or unsold by anyone else. Rely solely on your own research and make a decision to proceed only when you can justify how and why this business meets your criteria, and why you know you will be successful at running it (or to eliminate the opportunity when you can logically identify why it’s not right for you),” cautions Prenevost.