Are you considering buying a franchise but uncertain about what to look for?
A comprehensive franchise due diligence checklist can help you avoid costly mistakes and ensure your investment is well-founded.
From analyzing the Franchise Disclosure Document (FDD) to assessing the franchisor’s financial performance and legal standing, each step in the checklist reveals potential red flags and critical insights.
By mastering this checklist, you’re not just protecting your investment—you’re gaining confidence in your future as a franchise owner.
Below, we take a deep dive into everything you need to know before purchasing a franchise to help you make a smart, informed decision.
Franchise Due Diligence Checklist:
When considering buying a franchise, conducting due diligence is essential to protect your investment and ensure you're making a well-informed decision.
A comprehensive due diligence process can help you:
Uncover risks
Assess profitability, and
Understand the operational framework of the franchise
Here's a complete checklist of the key areas you MUST cover during your due diligence:
1. Disclosure Document Due Diligence
The Franchise Disclosure Document (FDD) is one of the most important documents in the franchise due diligence process.
It contains essential information about the franchise’s legal, operational, and financial aspects.
The most important sections to review in FDD include:
Franchise fees and royalties: Understand the initial franchise fee and any ongoing royalties that you must pay.
Franchisee obligations: This will give you an idea of your roles and responsibilities as a franchisee.
Franchisor’s financial health: Analyze the franchisor’s audited financial statements.
Litigation history: Check if the franchisor has been involved in any lawsuits.
Franchisee turnover: Look at the number of franchises that have closed or been sold in recent years. High turnover usually points to a red flag about the franchise!
IMPORTANT: Note that the FTC Franchise Rule on FDD requires the franchisor to provide you (the franchisee) with an FDD at least 14 days before (you) sign any contract or pay any money. (Source).
2. Financial Performance
You’ll also need to analyze the franchisor’s financial health to ensure they can support the growth of your franchise.
Look for audited financial statements, typically found in Item 21 of the FDD, and examine the company’s cash flow, profit margins, and debt levels.
The key financial metrics to consider include:
Revenue trends over the past few years.
Profitability margins.
Franchisor’s debt-to-equity ratio.
Operating expenses and budget allocations for franchise support.
Strong financials usually indicate that the franchisor can continue to provide support and resources.
3. Fees and Ongoing Costs
Understanding the initial and ongoing costs involved in running the franchise is crucial.
This simply includes the upfront franchise fee, ongoing royalty fees, marketing fees, and other operational costs.
Common costs to consider include:
Initial franchise fee
Royalty fees (usually a percentage of sales)
Marketing fees (often a flat fee or percentage)
Equipment, inventory, and real estate costs
Ensure you can cover both the upfront investment and ongoing operational costs, and that these fees align with your business plan.
4. Support and Training
An essential aspect of buying into a franchise is the level of support and training offered by the franchisor.
Investigate the training programs, operational support, and ongoing assistance provided.
Be sure to ask them the following questions:
What initial training is offered?
Is ongoing training and support available?
How does the franchisor help with marketing, supply chain management, and customer acquisition?
Franchise systems that offer robust support increase your chances of success as a franchisee.
5. Territory and Market Research
Ensure you understand the territory rights and market potential for your franchise.
The franchisor typically grants exclusive territory to avoid direct competition among franchisees.
To help you easily navigate this part, here are the key points you should investigate:
Does the franchisor offer exclusive territorial rights?
What market research has the franchisor conducted for your location?
What is the competition level in the territory?
How many existing franchises are operating in the same area?
6. Conduct Franchisee Interviews
Speaking with current and former franchisees can help you gain insights into their experience with the franchisor.
So, how exactly do you do this?
It’s simple.
You just need to ask them the right questions. Some of the crucial questions to ask the franchisees include:
How satisfied are you with the level of support from the franchisor?
Are you meeting your financial goals?
What challenges have you faced?
Would you recommend the franchise?
As you can easily tell from the above questions, interviewing a franchisee will offer you real-world perspectives on what it’s like to operate the franchise.
7. Legal and Regulatory Compliance
It’s also important that you understand the legal and regulatory requirements for running the franchise.
Specifically, you need to ensure the franchise complies with federal, state, and local regulations.
To ensure 100% compliance, be sure to review the following areas:
Franchise registration laws (which vary by state).
Employment laws, tax requirements, and zoning regulations.
Intellectual property protections for trademarks and patents.
8. Franchise Agreement
The Franchise Agreement is a legally binding contract that outlines the terms and conditions of your franchise ownership.
It’s critical to review this document carefully, preferably with the help of a franchise attorney.
Ideally, a Franchise Agreement should include these key sections:
Terms of renewal or termination.
Franchisee obligations and restrictions.
Territorial rights and expansion opportunities.
Intellectual property usage rights.
Non-compete clauses.
Check out this real-life example of a franchise agreement to get an idea of what it should look like.
9. Have An Exit Strategy
Yes! Keeping in mind that you may need to sell the franchise in the future, you’d also want to evaluate your exit strategy.
That said, understanding the franchisor’s resale policies and restrictions here is essential.
This is what you should consider for your exit strategy:
What are the terms for reselling the franchise?
Are there any transfer fees or approval requirements from the franchisor?
How easily can the franchise be sold to a new owner?
10. Franchise Trends and Industry Analysis
Don’t forget to research the broader industry trends and the franchise’s competitive position within its market.
Ideally, you want to understand how the industry is evolving. This will give you insights into the long-term potential of the franchise.
Here are the key trends to research:
Are there any emerging trends or disruptions in the industry?
What is the market growth forecast for the franchise sector?
Who are the franchise’s main competitors?
Due Diligence for Franchise Cost
Given the daunting process involved in conducting due diligence for a franchise, you may consider hiring an expert to do it for you.
So, how much should you expect to pay them?
The prices can vary significantly based on several factors. These include:
Complexity of the franchise
The type of professional you choose, and
the thoroughness of the due diligence process itself.
For instance, franchise consultants and attorneys typically charge between $1,500 and $5,000. For larger and more intricate franchises, these fees can increase.
These professionals play a crucial role in reviewing key documents such as the Franchise Disclosure Document (FDD), financial statements, and contracts.
If you opt to hire a franchise accountant to assess the financial health of the business, you can expect to pay anywhere from $500 to $2,500, depending on the level of detail required for the analysis.
NOTE: Some firms provide combined services that encompass legal, financial, and operational due diligence.
These comprehensive packages can range from $2,500 to $10,000, again influenced by the size and complexity of the franchise in question.
Franchise Due Diligence Checklist Template
Here’s a template (of key areas to examine) to help you quickly get started in conducting due diligence for a franchise:
1. Franchise Disclosure Document (FDD)
Review all 23 sections of the FDD
Pay special attention to litigation history, franchisee performance, and fees
2. Franchisor’s Financials
Review audited financial statements
Assess the company’s growth trends and profitability
3. Territorial Rights:
Investigate territorial restrictions and exclusivity clauses
4. Training and Support:
Evaluate the franchisor’s training programs and ongoing support
5. Current Franchisee Insights:
Contact current and past franchisees to gain firsthand knowledge about the franchisor
6. Franchise Agreement:
Review the franchise agreement with a legal expert to understand your obligations
By following this template, you can ensure a thorough investigation into all aspects of the franchise opportunity.
Frequently Asked Questions:
What is due diligence in a franchise?
Due diligence in a franchise involves thoroughly evaluating a franchisor's business model, financial health, legal history, and operational support to ensure you're making an informed decision.
How do I make a due diligence checklist?
To make a due diligence checklist, include key areas like financial statements, franchise agreements, training programs, franchisor support, and insights from existing franchisees. This ensures a comprehensive evaluation.
Conclusion
Thorough due diligence is key to ensuring the long-term success of your franchise investment. Remember to review the FDD, analyze financials, speak with franchisees, and evaluate market trends. And you can minimize risks and make informed decisions. Don’t rush—understand the risks and rewards before investing. If you're unsure about the process, we’re here to guide you every step of the way. From due diligence to negotiations, we manage the entire acquisition process with precision. Afterward, we help scale the business for maximum profits, preparing for a 3-10x exit. Book a call here to get started!
