How to spot a dud franchise

By Sarah Stowe | 19 Dec 2016 View comments

Here are some suggestions on what franchise buyers should look out for. 

Dud franchise systems are not necessarily easy to spot.

In the quest for growth, the granting of franchises is a very high priority and with that can come a well-oiled sales machine heavily focussed on the “opportunity” and the subsequent conversion of prospective franchisee leads.

However, opportunity doesn’t always equal a good outcome and like any small business effective due diligence, preferably under the supervision of a professional advisor, is required.

When looking at franchise opportunities, astute professional advisors are likely to beware of franchise systems that:

Do not provide sufficient information

With new franchisees risking their capital and often using their family home for security, an extensive due diligence and feasibility is required to justify the investment. Franchise systems that cannot or will not provide sufficient information to allow the purchaser or their professional advisor to get comfortable with the risk are, and should be, avoided.

Cannot demonstrate sufficient concept validation

The validation of a franchise concept has many components. The ability to effectively systemise and propagate the system can generally be only claimed after accumulating sufficient data over a reasonable period of time.

Are experiencing or risking,  “unchecked” growth

Fast growing franchises with insufficient capital, compromised recruitment or weak site selection disciplines can be setting themselves up for major problems in the short to medium term.

A full investigation of this can be difficult requiring a review of detailed and sensitive detailed financial information which franchisors are understandably reluctant to provide. However, with the stakes so high, it is a reasonable request that the franchisor provide sufficient comfort that they are growing in a reasonable and sustainable manner.

Cannot demonstrate a commitment to being a good franchise citizen

The whole franchise sector suffers when the actions of a system or their individual franchisees create reputational damage.  These actions can be the subject of adverse and sustained media coverage with information and opinion easily obtained through everyday search capabilities.

Quality brands desire to be identified as a genuine and transparent brand. Franchise Council of Australia membership and registration with the Australian Franchise Registry are two excellent indicators that brands are serious about their reputation and that of the franchise sector; recognising the importance of a unified, representative voice and the role improved information plays in supporting that representation.  

Under invest in lending relationships

With access to finance a recurring theme and the historical “bank accreditation” processes under constant review, the onus has fallen on franchise brands to ensure they have positioned themselves as a “lender friendly” brand.  Lender friendly brands provide better information in a timely and transparent manner to help lenders better understand them. Through a lender’s eyes less information simply means more risk. Brands that do not provide meaningful information to lenders restrict the ability of their franchisees to access finance. Similarly, brands that do not effectively support underperforming franchisees are also unattractive to lenders.

Have poor training and weak support programs

Effective initial training programs position new franchisees for early success and strong ongoing support programs help maximise their performance. Weak, unstructured training and support programs, low field support ratios and an inability to name key early warning signs of underperformance are all red flags. The most effective test for this and so many other aspects of the franchisor relationship can be discussions with several existing franchisees around their own experiences.

Like all business transactions, effective due diligence and strong professional advice are the foundations of avoiding or at least identifying risk. Franchising is no different.