It is a minefield when it comes to investing in a franchise unit. Good information is very hard to find. And there's a lot of salespersons who want your money. You've read the literature. Buyer be careful. Industry wisdom says to ask franchisees about the system. But here are some easily-obtained metrics of an investment-worthy franchise and red flags for a bad one that I've learned from some of the best.

If I were to be interviewed about how to find a good franchise, this would be my list. It is a bit of a contrarian view in that a number of these points cannot be found in the prevailing literature.

Franchise metrics

1. What are the earnings? I prefer the bottom line to calculate a Return on Investment when buying a new store. But if I have to, I'll settle for the top line of a franchise system compared to its closest competitors. Sales per store are the easiest to obtain. e.g. What is an average KFC's sales per store compared to a Zaxby's? No earnings? No sale.

2. Franchise returns. What is the failure rate for paying SBA-backed loans compared to other companies that are in the same sector?

3. How many sold but not open stores are there? In Quiznos' case there were 3,200 stores that were sold but not opened. In Cuppy's Coffee, there were two hundred stores not opened compared to less than a hundred that were opened. Too many and its a big bright red danger sign

4. How does the franchise churning look? The franchise disclosure document provides three years of franchise turnover information.

5. Franchisee satisfaction. The more franchisees that are happy, the better chances that the franchise water is very nice. But how does a franchise investor know the mood system-wide? There are surveys of franchisees that can actually put a number on satisfaction, e.g. 94% of franchisees rated their franchisor outstanding in support. Buyers can find real information on a franchise by participating in franchisee associations, where franchisees are more freely able to speak. There is even information to be gleaned from crowd sourcing on the Internet.

Checks and balances / Entrepreneur development

1. Is there an independent franchisee association with elected offices that franchisees participate in? There are hundreds of franchise systems that have independent associations. If the system does not have an independent association for franchisees, then I'd move on. Inside information is too difficult to get without this. Independent associations develop better executives of both franchisor and franchisee. For franchisees in particular, participation and networking among peers within such an association is healthy for personal entrepreneurial development. And, an association provides checks and balances to a franchisor and the franchise system.

2. Is there a franchisee cooperative where elected franchisee representatives are responsible for system-wide functions such as advertising, purchasing, IT, or the supply-chain? This taps into the drive, operational know-how and entrepreneurial energy of what differentiates a franchise chain from corporate chains -- an army of entrepreneurs. It also provides checks and balances to the franchisor.

3. Is there a franchisee-to-apprentice mentoring system, and a franchisee-to-franchisee mentoring system?

Red flags  (Things that alert me to franchisor problems)

1. There aren't company-owned stores (one showcase store doesn't count). Life is too short to franchise with someone who doesn't operate and know the business. Without a sizeable amount of company stores, the franchisor is focused on franchising — the business of selling franchise licenses. These types of franchisors say they do not want company-owned stores because they do not want to compete with their franchisees. Baloney! Rather than understanding my business, they would only be able to pass on second-hand information from one franchisee to another. According to the U.S. Census Bureau, the average U.S. franchisor has 23% of its chain that is franchisor-owned. That's healthy. Franchisor CEOs with lots of company-owned stores sound different. For example, in a pizza chain, they would be wonks who know and love chatting about the factors affecting the price of cheese and how that has affected sales, or in a tax preparation chain, the implications of a new IRS rule for electronic tax filings. So if there are only two company-owned stores in a system larger than ten, I would walk away. I would go down to as few as a baker's dozen, but no less. (BTW, I didn't just pull that number out of my hat. More on this later.)

2. Young and growing super quickly. Look, growth is good. But when there is hyper-growth it can be one heck of a problem because the structure can quickly outgrow the franchisor's ability to support it. And the youngest systems are the ones that are highest risk to go bankrupt quickly and easily. Large and long-lived franchise systems are safer investments. 

3. Crowd sourcing from the Internet clearly identifies where this franchise system has major problems. There are negative blog posts that contain specific and verifiable information. Mud slinging doesn't count. I would be poking around, asking questions on interactive sites like Blue MauMau's forums, to get information from industry experts, franchisees and former franchisees.

4. The franchisor doesn't do business in registration states

5. There's a lack of business and franchise experience with the franchisor's officers

6. Does anyone have access to a Lexus-Nexus or WestLaw legal database? How many lawsuits are there? Compare that information to what they state in their franchise disclosure document. In other words, were you able to catch them in a fib?

If you have considerations that you feel need to be added to this list, let's hear them.

Related Reading:

Hedging your bets in buying a franchise, 10 points of probability in selecting a franchise by Prof. Scott Shane