Sellers Share How to Research a Franchise Purchase

Those who want to sell you a business offer a well trodden path of advice on how to research a franchise. The path of advice gives a sense of confidence through procedure and check-off lists while very possibly digging a six foot deep hole for the buyer to be used long after the sale is made.

After you select a chain that strikes your fancy, the first step is to read its franchise disclosure document from cover to cover. Get help if you don't understand the content.

Now the potential franchise owner is ready to ask franchisors the hard questions to spot winners from losers. For corporate types, you'll recognize the questions below for buying a business as eerily similar to questions used when applying for a job. Entrepreneur.com reports:

If he could only ask a franchisor three questions, Jeff Elgin, CEO of franchise consulting firm FranChoice, says they would be:

What's your number-one focus? "The answer you want is ‘the success of our franchisees,'" says Elgin. "But I've gotten: ‘Our number-one focus is our own bottom line.' That would concern me."

Why do franchisees get in trouble? Try to identify exactly what's going wrong for troubled franchisees, Elgin says. If the franchisor says, "They didn't follow the system," press on by asking in what way. "You want to learn where the pressure point is," Elgin says. "What is the difficult thing to do successfully in this system?"

How are conflicts resolved? Ask franchisors for details of a recent franchisee conflict and how it was resolved. You'll learn a lot about the franchisor's respect for franchisees and its commitment to making them successful, Elgin says. If the franchisor says there's never been a conflict, be skeptical. "If it has more than three franchisees, it has had a conflict," Elgin says.

If it were me and my money, I would have an overriding questions. The first question I would ask is — How much profit does an average store make?

I would want a breakdown by store size and geography. Any good business investor will naturally want to know what kind of return on investment to expect. The vast majority of franchisors won't give you that information. Nonetheless, it's a good question to ask because even if they don't want to tell you, it is a helpful benchmark to hear what b.s. they utter in not providing those figures.

That brings me to the next metric - the b.s. barometer. Use the franchisor's answers on store profits as a gauge of whether you are on a green grassy meadow of complete honesty or on top of 10,000 leagues of pucky. Of course, it is easy to spot the red flags if scammers are crude enough to whisper such numbers in your ear - wink, wink - or scribble them on a napkin to be later denied in a court of law. Some actually do. Don't expect that. Most scammers have learned that to be successful they need to be as smooth as a baby's bottom. They usually know better than to say to a prospective franchise owner that their main focus is on their own bottom-line.

If they are throwing some bull around, you have to determine why they are doing it. Are they engaging in sales hyperbole to persuade you on a fairly costly investment? How far are they willing to stretch the truth? If they are lieing to you, the good news is that at least they know reality. They are somewhat predictable because they choose to spread falsehoods for their own selfish ends. The leader that sends shivers down my spine is the kind that convinces themselves of their own b.s.. That person cannot tell reality from myth. Such leaders navigate their boats with false maps, oblivious to the waterfall in front of them until it is too late.

You need to determine how clear management's understanding is. If the prospective buyer doesn't know the industry well, they are disadvantaged. They are a prime target to be easily snowed. Look for robust tools that the franchisor uses in order to pop bubbles - to check false perceptions that can easily develop within the management team. Franchisor's easily believe that their franchise owners view them highly. Franchisors can build structures that simply confirm what top management wants to hear about the marketplace.

Although it isn't in his questions above, FranChoice's Elgin understands the need to know what the return on investment is. Elgin suggests the best of a bad situation, asking a few stores in hope that they are representative. "You may have to ask several different franchisees to get all your questions answered," Elgin says. "How much does it really cost to open a unit? How soon can you start making money? How much can you expect? Only franchisees can give you the real story."

They may know the inside story, but will franchisees give you the real story? That isn't discussed in the article.

A good test of whether you are getting pure bull or not with franchisees is to go back and look at the franchise agreement in the disclosure document to see if there is a disparagement clause. That's where companies terminate franchise owners for saying bad things about the brand. Also, when you interview a franchise owner, think of how they could possibly gain with their franchisor by deemphasizing the bad and highlighting the good.

The next question not mentioned anywhere in the article is to discuss in detail store closures over the past few years, using the franchise disclosure document as a guide. That gives a sense of the business risk. Franchisee failure is different than store failure rates. A given store location can continue to exist even though a string of five sequential owners in five years have gone bankrupt. Fortunately, franchise terminations is something that franchisors keep records of.

You'll want to validate whether the information in the disclosure document is accurate. Construct a timeline of how many franchisees have stopped operating and compare them to industry statistics. Elgin's suggested questions can help gain some insights as you discuss those closure rates. You'll naturally want to ask why did these franchises get in trouble? (Go beyond the answer that they didn't follow franchise standards.)

It's your money and it is the franchisor that wants your money. Make them work for it. You should hear directly from the franchisor themselves, not just from a surrogate franchise owner, on how much you can reasonably expect to make. You will need to know their franchise owner failure rates in a five to ten year time frame to assess business risk. And finally, you will need to assess how much b.s. is being thrown about. Asking a franchisor about earnings can help you determine that. That's a good launching point in your first meeting with the franchisor.