Red Flags to Watch Out for in a Franchise Opportunity

Your Guide to Franchise Ownership

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8 Warning Signs that a Franchise is Less than Ideal

As with any business venture, franchise opportunities come with certain risks. Prospective candidates should be aware of red flags that can indicate a bad investment. You can find important information in the Franchise Disclosure Document (FDD) that will help determine if a franchise opportunity is all it appears to be on the surface.

Here are some red flags to be aware of before buying a franchise.

Red Flag No. 1: Fees

If the franchise fees are higher than the competition, find out why. Another red flag is when a franchise gets most of its revenue from the initial fee. This is especially true for franchises that are not in growth mode and have many operating locations over a long period. 

Red Flag No. 2: Experience

The experience of a franchisor is a benefit of buying a franchise. If you notice a franchisor doesn’t have a lot of business experience, you may want to work with a more established brand. 

Red Flag No. 3: Litigation

Litigation is also important to consider. It is a red flag when the franchisor is constantly in legal disputes with franchisees. While there are legitimate reasons for a franchisee to be terminated, there are legal avenues to take if the franchisor did it unjustly. 

Red Flag No. 4: Turnover

If there’s high franchisee turnover, more closed locations than opened ones, and a high number of sold but not opened franchises, this could be a red flag. 

Red Flag No. 5: Bankruptcy 

An obvious red flag is if many franchisees in a system have filed for bankruptcy. Find out why it happened and if there were steps made to avoid it in the future. 

Red Flag No. 6: Territory

An unprotected territory is a red flag. While an exclusive territory ensures that your market won’t be encroached upon, you may want to reconsider buying a franchise if you have an undefined or unprotected territory.

Red Flag No. 7: Item 19

An important part of the FDD is item 19, which details a franchise’s financial performance. It may or may not be a red flag to exclude this item. While many established franchises disclose an item 19, others may not want to if they are just starting out or aren't doing braggable sales numbers. If the item 19 is not provided, additional research about the franchise’s economic performance should be done. 

Red Flag No. 8: Non-Compete Period

A lengthy non-compete could impact your decision to buy a franchise. Depending on the state where you’re doing business, local laws can limit the non-compete period to a few years. But some franchisors can have a non-compete that lasts for a decade.

How Franchise Consultants can Help

To identify red flags in a franchise purchase, speak with a franchise consultant. This professional connects prospective franchisees with franchisors and offers free business advice. The consultant along with a franchise attorney can walk you through the FDD with you and help you determine if there are any red flags. 

Red Flags to Watch Out for in a Franchise Opportunity

Before leaping into franchise ownership, there are red flags to watch out for. Beware of franchisors that charge high fees, don't have much experience, are tied up in a lot of litigation, and have a high franchisee turnover rate. To better identify these red flags, consider speaking with a franchise consultant. Since about 20% of businesses fail in the first year, speaking with a professional will likely decrease your likelihood of making a bad decision. 

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