Red Flags & Warning Signs
The points detailed below reflect common franchise problems, franchisor red flags and warning signs that have arisen with respect to franchise sales that, in many instances, have proven to be troublesome for franchisees. If you find one or more of the following franchise red flags — proceed with caution.
The following does not constitute legal advice, which you can only get from a competent franchise lawyer, and is meant solely to provide helpful indicators of common franchise problems.
Franchise Red Flags and Warning Signs
Does the franchisor or its representatives or brokers talk about how much money you can make, or show you illustrations of how much money you can make? Those illustrations and statements, by law, should be only in the franchise disclosure document (FDD). There are strict regulations on what a franchisor can say, so finding that information outside the FDD is a franchise red flag.
Another franchise red flag is if the franchisor suggests or points to particular franchisees that you should speak to in order to get an idea of how the franchisees are doing. Sometimes franchisors “cherry pick” franchisees who will only say good things. You should be wary if the franchisor has “cherry picked” the franchisees for you to talk to. The FDD should have a complete list of existing and former franchisees. You should be free to talk to any franchisee, and you should try to reach out to some not recommended by the franchisor, to see if they have different perspectives.
Other Common Franchise Problems
- If the franchisor has not operated at least one company-owned store for at least three years, you should be cautious. It often takes that long to work out kinks in the system.
- Are you required to obtain products from only one source? This is a common franchise problem and red flag. Requirements that you purchase from a single source can drive prices up and quality down.
- Does the franchisor have any history of bankruptcy or a recent and serious history of claims of fraud? You can find this information in the FDD. If so, you should investigate further.
- Has the franchisor had experience in your particular geographic area or is it on the other side of the country? Franchisors with experience in only one area may not function well in another part of the country.
- Has the franchisor had experience with franchisees or company-owned stores in the type of demographic that you are located in? If you are in a densely populated urban area and the franchisor’s experience is in suburban locations, the franchisor may not have the experience you need.
How Can You Tell if a Franchise Is Bad?
In addition to the points detailed above, ways to determine whether a franchise may not be good for you to get involved with from an investment perspective may include:
- If you are planning to use retirement money — 401(k) or IRA money — to purchase and finance the franchise, you should probably stop and re-evaluate. Even if the risk of failure is very small, the consequence of failure — losing your retirement — is disastrous. Don’t do it unless you are extremely confident that it will work out.
- New business, absentee owner. If you are planning to buy a franchise as an investment and to have it run by third-party managers, you should proceed with extreme caution. The model of an absentee owner who “supervises” the business is one that may work when the owner has come up through the ranks and actually done hands-on management in the business for a number of years. Especially if the franchise is new, or the franchisee is going to be the owner’s first business venture, absentee ownership can be a recipe for disaster and is a big franchise red flag.
Noticing Franchise Red Flags and Need Assistance?
If you’re looking into buying a franchise, or are already in the process of buying one, but are concerned about common franchise problems and red flags, the attorneys at Garner, Ginsburg & Johnsen P.A. have years of experience and the expertise to help guide you on a path to success. Contact us today for assistance with your specific issue!