4 Signs a Franchisor May Not Be Around for the Long Haul

A critical part of the due diligence process for prospective franchisees is trying to discern (to the extent reasonably possible) whether the franchisor will be around for the long haul. After all, much of what you pay for in a franchise opportunity is the right to be associated with the franchisor’s brand and system, the right to use the franchisor’s proprietary materials, and in some cases, the right to an exclusive territory. If the franchisor goes out of business, all of these rights go up in the air (if not out the window), and you may well be left in a worse position than if you had just gone into business on your own in the first place.

So, what are some signs that a franchisor might not be around for the long haul?

Solvency

Solvency is one important factor, although insolvent franchisors can be (and are) successful, and even solvent franchisors may not be sufficiently “successful” in the minds of the owners to sustain maintenance of the franchise system. If the franchisor is undergoing frequent financial restructuring, or if it doesn’t appear to be doing anything to improve its financial condition, this may be a sign of trouble on the horizon.

The franchisor’s recent financial statements should be included in Item 21 of the Franchise Disclosure Document, and these should be the starting point for evaluating its financial condition.

Sustainability

Is the franchised concept a recent fad? Is the franchised concept behind the times? In either case, it is worth asking whether the business model is likely to be around for the long haul. People love frozen yogurt now (or at least they did a year or two ago), but was that the case five years ago? Will it be the case five years from now?

On the other side, if the franchisor is not making efforts to keep the concept relevant, or if its model simply becomes outdated, these may also be signs of trouble to come.

Other Interests

If the franchisor’s owners have other business interests, this too can be a potential warning sign—though certainly not always so. Now here I am not talking about the major conglomerates, but serial developers who build a franchise system to make some money, but soon will be ready to move on to the next big thing. Whether they get bored and just try to fade into the shadows to let the system “run itself,” or whether they sell the system to new owners unfamiliar with the concept, in either case this can lead to troubled times for the system’s franchisees.

Disappearing Franchisees

Finally, even if everything else appears in order but the number of franchisees is shrinking rather than growing, this too can be a sign of systemic concerns. If franchisees are exiting the system at a clip, prospective franchisees need to find out why this is the case. This may be a symptom of one of the factors noted above, or it may be a sign of other problems in the franchise system. Either way, this can cause significant harm to the system as a whole, the reputation of the brand, and potentially the resale value of your franchised outlet.

Prospective franchisees need to critically evaluate these and other risks in proposed franchise opportunities, and make sure that they make an informed decision before moving forward with a franchise purchase.

Importantly, no one factor will be determinative across the board, and a franchisor who exhibits some or all of these signs won’t necessarily be unsustainable. Like the rest of the franchise due diligence process, analyzing these signs should be part of a broader qualitative and quantitative review of the franchise opportunity.

This article is provided for informational purposes only, and does not constitute legal advice.

Jeff Fabian is a lawyer who represents prospective franchisees in evaluating and negotiating new franchise opportunities. Jeff also represents franchisors in franchise compliance and trademark matters. Visit www.fabianlegal.com for more information, and follow Jeff on Twitter @jsfabian.